The SEC Division of Investment Management recently published a letter to the Securities Industry and Financial Markets Association (SIFMA) addressing the interest among sponsors in offering registered funds that would hold cryptocurrencies and cryptocurrency-related products. The Division emphasized that flexibility to innovate is a key feature of the Investment Company Act of 1940 (the “1940 Act”) and reiterated that the Division seeks to “foster innovation that benefits investors and preserves the important protections that Congress established in the 1940 Act.”1 The Division noted, however, that cryptocurrencies and related products are in many ways unlike the types of investments typically held by registered funds, and, as a result, there are a number of investor protection issues that need to be addressed before sponsors begin offering investments in cryptocurrency-holding funds to retail investors.
With the intention of starting a dialogue with the industry, the Division raised questions regarding five categories: valuation, liquidity, custody, arbitrage (for ETFs), and potential manipulation and other risks, and invited interested sponsors to engage on these issues. With regard to these categories, the Division posed a number of thought-provoking questions. For example, with respect to valuation, would funds have the information necessary to adequately value cryptocurrencies or crypto-currency products?2 Similarly, how would fund policies address “forks” in the blockchain for cryptocurrencies, which could result in differing currencies or prices?
For liquidity, the Division questioned how funds would classify the liquidity of cryptocurrencies for purposes of the new fund liquidity rule.3 In terms of custody requirements, the Division asked how funds would comply when, to their knowledge, no custodian is currently providing custodial services for cryptocurrencies. In a similar vein, the Division asked how ETFs would comply with the terms of their Commission orders, given the fragmentation, volatility, and trading volume of the cryptocurrency marketplace. Finally, the Division reiterated concerns raised by Chairman Jay Clayton regarding greater opportunities for fraud and manipulation, given that the current functioning of cryptocurrency markets offers substantially fewer protections than traditional securities markets.
Perhaps most importantly, the Division specifically stated that it is inappropriate for sponsors to register funds that will substantially invest in cryptocurrencies until these questions are satisfactorily addressed and requested that sponsors that have filed registration statements for such funds withdraw them. Given the foregoing, fund sponsors should carefully evaluate the substantive issues raised by the SEC’s questions prior to or in connection with any fund registrations.
For a copy of the Staff Letter, click here.
[1] Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings, January 18, 2018.