There is nothing like widely publicized market volatility to draw scrutiny from regulators. When you combine that with…
- an emerging area of financial technology, and…
- commentary from Warren Buffet describing the source of the volatility as “casino-like,” plus…
- an upcoming Saturday Night Live appearance from the self-proclaimed “DogeFather” Elon Musk that has helped drive the value of Dogecoin to over $70 billion…
…you are bound to draw the attention of regulators. Such is the case with recent news related to cryptocurrency.
In the U.S., the Federal Reserve’s head of supervision, Randal Quarles, has called on banking regulators to increase focus on cryptocurrency following announcements from Morgan Stanley and Goldman Sachs of plans to offer bitcoin funds to investors. Quarles said, “the inexorable march of technology is a huge opportunity but also a supervisory challenge for the financial system.”
In Europe, the Markets in Crypto-Assets (MiCA) proposal continues to work its way through the EU legislative process, eventually seeking to harmonize definitions and regulatory frameworks for cryptocurrency across EU nations. This effort could represent an important step forward for pan-EU banks as well as institutions in other parts of the world struggling with crypto regulation, where currently over 140 different regimes exist.
Implications for investment advisors and broker-dealers
The inevitable regulatory response is not about whether cryptocurrency is exempted or carved out from existing regulatory mandates. It’s more likely to center on establishing consistent definitions of products and market participants, common frameworks for registration and operation, and specific areas of risk unique to cryptocurrencies that firms will need to monitor. In February 2021, the SEC released a risk alert focused on digital assets, highlighting specific areas of risk for investment advisors and broker-dealer firms.
Investment advisors should pay attention to recordkeeping practices, given that “digital asset trading platforms vary in reliability and consistency with regard to order execution, settlement methods, and post-trade recordation and notification.”
Broker-dealers should put focus on supervision for outside business activities (OBA) among other areas of risk following lessons from the recent controversy with Roaring Kitty and OBA. The SEC notes, “staff has observed instances of registered representatives of broker-dealers offering services related to digital assets apart from their employer.
“FINRA-member broker-dealers must evaluate the activities of their registered persons to determine whether such activity constitutes outside business activities or an outside securities activity and therefore should be subjected to the approval, supervision, and recordation of the broker-dealer. The staff will continue to review FINRA-member broker-dealer compliance processes in connection with the evaluation, approval, and monitoring of outside business activities.”
Interpreting SEC 17a-4 for cryptocurrency
The SEC language on recordkeeping raises interesting technology questions about the applicability of the immutability requirements defined in SEC 17a-4. FINRA has previously commented on the use of distributed ledger technology in 2017, noting that broker-dealers “should carefully consider the capabilities and limitations of the DLT network before determining whether they are able to rely on the records developed within the network to fulfill their minimum recordkeeping requirements.”
How an organization leverages DLT for cryptocurrency transactions — while also meeting SEC 17a-4 “write once, run many” (WORM storage) requirements for electronic communications — is unclear. It will increase pressure on the SEC to update the 17a-4 standard to reflect today’s technology.
The future of finance is here
The impact of digital currencies and the underlying blockchain and distributed ledger technology (DLT) is a current focus for every financial services firm. This goes for both traditional and non-traditional organizations.
Traditional firms considering the addition of bitcoin or cryptocurrency investment offerings should inspect current recordkeeping, storage and supervisory procedures. They must address the incremental risk vectors raised by the SEC and FINRA notices.
For non-traditional financial firms, the speed and rapid evolution of this market may be moving faster than their investments in compliance infrastructure, procedures and technology. However, it’s evident they will not be given a pass by the regulators. Like Elon Musk on SNL, cryptocurrency has taken center stage.
Source & author: Robert Cruz. Vice President, Information Governance at Smarsh.
Robert is Vice President, Information Governance for Smarsh. He has more than 20 years of experience in providing thought leadership on emerging topics including cloud computing, information governance, and discovery cost and risk reduction.
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