In March of this year, the NFA issued a notice reminded futures commission merchants (“FCM”), introducing brokers (“IB”), commodity pool operators (“CPO”) and commodity trading advisors (“CTA”) that trade in, solicit or accept orders in virtual currency products (spot and derivatives) of their ongoing obligation to notify the NFA of such activities by amending the annual questionnaire (please see Reed Smith client alert here). More recently, the NFA issued an August 2018 Interpretive Notice (“Notice I-18-13”) effective on October 31, 2018, establishing the disclosure requirements for NFA Members engaging in virtual currency derivatives activity.
What does this mean for NFA Members and how does it reflect broader regulatory concern over virtual currencies and digital assets?
Disclosure Obligations of FCMs and IBs
The disclosure requirements state that FCMs and IBs must provide the NFA Investor Advisory: “Futures on Virtual Currencies Including Bitcoin” and the CFTC Customer Advisory: “Understand the Risk of Virtual Currency Trading” to customers that are engaging in virtual currency derivatives. The NFA stated it is also concerned that customers may not understand that the NFA does not regulate an FCM or IB Member’s underlying or spot virtual currency activities. Accordingly, the NFA is also requiring that FCM and IB Members provide explicit disclosure language provided within Notice I-18-13.
Disclosure Obligations of CPOs and CTAs
In addition, the NFA expressed a concern that pool participants and managed account clients may not fully understand the nature of virtual currencies and virtual currency derivatives or the risk of loss that is associated with them. CPO and CTA Members that are offering pools, exempt pools or trading programs that trade virtual currencies or virtual currency derivatives are therefore required to customize their disclosure documents, offering documents and promotional materials to account for such risk in accordance with the guidelines set forth within Notice I-18-13, including, but not limited to, transaction fees and price volatility. The NFA also requires a disclosure akin to that required of FCMs and IBs.
Regulatory Concern
Notice I-18-13 was issued just one month after FINRA issued Regulatory Notice 18-20 (“Notice 18-20”), which encouraged regulated firms to notify FINRA if they engage in activities related to digital assets like cryptocurrencies and other virtual coins or tokens. Notice 18-20 expressed a concern that growing retail investor interest in relatively nascent digital assets presents the risk of fraud and other securities law violations.
The demand for virtual currencies and other digital assets swept through the marketplace ahead of detailed regulatory oversight and rulemaking. That is now changing and the regulators quickly are catching up.