The Securities and Exchange Commission's ("SEC") Division of Examinations (the "Division") issued a Risk Alert on February 26, 2021, to identify recurring issues that Division staff have observed during past examinations of market participants in the digital asset industry. The Alert also provides guidance about what the Division will focus on for future examinations relating to digital assets. Because such Risk Alerts often presage enforcement actions, broker-dealers, investment advisers, and others engaging in digital asset securities transactions should review the Alert and, if needed, amend their supervisory and compliance systems to take the Division's guidance into account.
The Division highlighted six areas of primary risk for investment advisers, derived from examinations of investment advisers managing digital asset securities for clients both directly and through pooled vehicles:
- Portfolio management (including whether digital assets are securities, and whether the adviser is fulfilling its related duties to clients);
- Books and records;
- Custody issues (including safekeeping and unauthorized transactions);
- Disclosures regarding the unique nature of risks associated with digital assets;
- Pricing client portfolios, including volatile digital assets; and
- Registration issues (especially calculating regulatory assets under management).
For broker-dealers, the Division pointed to six rather different areas of regulatory and compliance risk to consider:
- Safekeeping funds and operations (including custody);
- Registration requirements (e.g., for affiliates effecting transactions in digital asset securities);
- Anti-money laundering (especially tied to "pseudonymous aspects of distributed ledger technology");
- Offerings disclosure and diligence;
- Disclosing conflicts (e.g., a broker-dealer operates in multiple capacities); and
- Outside business activities of registered representatives that potentially should be overseen by the broker-dealer employer.
Additionally, the Division reinforced that operators of trading platforms should determine whether registration as a national securities exchange or alternative trading system ("ATS") is required. If they are an ATS, the Division will examine compliance with Regulation ATS. Further, transfer agents servicing digital asset securities are reminded of the need to comply with applicable transfer agent rules in the digital securities environment.
Acknowledging the rapid pace of financial innovation, the Division encourages market participants to speak with the agency's Strategic Hub for Innovation Technology about applicable regulations. The Division also encourages market participants to review their policies and procedures related to digital asset securities and to consider any necessary improvements to their supervisory and compliance programs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
