The U.S. Securities and Exchange Commission (SEC) has issued a risk alert to market participants who handle digital assets that qualify as securities. It points out that these assets present unique challenges and risks which firms must consider when designing their compliance program.
The regulator issued the risk alert through its Division of Examinations which is charged with protecting investors and ensuring market integrity. The alert is to assist broker-dealers, investment advisers and transfer agents to develop and enhance their compliance programs.
For investment advisers, the regulator advised them to focus on regulatory compliance associated with portfolio management. This will include due diligence on digital assets, evaluation and mitigation of risks related to trading venues and management of risks stemming from forks and airdrops. They must also focus on custody, including ensuring they have a business continuity plan in cases where employees have exclusive access to private keys.
The regulator acknowledged that determining the value of digital assets can be challenging. This may be due to market fragmentation, potential of price manipulation and volatility. The regulator’s examination of investment advisers will look into this, examining “the valuation methodologies utilized, including those used to determine principal markets, fair value, valuation after significant events, and recognition of forked and airdropped digital assets.”
The risk alert also laid out the key areas that broker-dealers must focus on to stay compliant when handling digital assets. They include safekeeping of funds and operations and registration requirements. Broker-dealers must also focus on anti-money laundering compliance. The SEC pledged to continue examining broker-dealer AML compliance, such as the filing of suspicious activity reports (SARS).
The regulator authorized broker dealers to engage in digital assets offerings. However, they must conduct due diligence of the companies and make necessary disclosures to their customers. In cases where there’s conflict of interest, they must disclose this to their customers.
The risk alert also addressed national security exchanges which must register or pursue an exemption. This exemption will only be on the grounds of operating as an alternative trading system.
The regulator concluded, “In addition, this Risk Alert describes factors that firms may consider to (i) assess their supervisory, compliance, and/or other risk management systems related to these risks, and (ii) make any changes, as may be appropriate, to address or strengthen such systems. These factors are not exhaustive, nor will they constitute a safe harbor.”
See also: CoinGeek Live panel, Regulation of Digital Assets & Digital Asset Businesses
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