The Securities and Exchange Commission’s Division of Investment Management issued a letter to two industry organizations stating its belief that, as of now, it was not appropriate for investment fund sponsors to seek registration of SEC-regulated funds—such as mutual funds or exchange traded funds—to “invest substantially in cryptocurrency and related products.” This is because “there are a number of significant protection issues that need to be examined before sponsors begin offering these funds to retail investors,” said the SEC.
Moreover, the Division said that if an existing fund able to use a post-effective amendment to substantially invest in cryptocurrencies did so, it would view such act “unfavorably” and might recommend a stop order to the Commission.
The two industry organizations receiving the Division’s letter are the Investment Company Institute and the Securities Industry and Financial Markets Association’s Asset Management Group.
Although the Division noted that “[f]lexibility to innovate” is an important feature of the law governing investment funds and that advocates of cryptocurrencies have suggested numerous potential benefits associated with the product, critics “have raised various concerns regarding transparency of information, trading, valuation and other matters…”
As a result, the Division sought input regarding a number of relevant matters. These include how funds would value cryptocurrencies; choose newly created cryptocurrencies to invest and deal with forks of existing digital products; take steps to assure that they had adequate liquidity to meet redemptions; and comply with custody requirements. The Division also inquired how concerns expressed by some, including SEC Chairman Jay Clayton, regarding the potential for manipulation and other risks associated with cryptocurrencies impacted fund sponsors’ views regarding valuation and liquidity.
The Division implied that, until its questions were answered “satisfactorily,” it was not likely to consider for approval any registered fund to invest in cryptocurrencies. The Division provided no deadline for the two industry groups or others to respond to its questions.
Separately, in unrelated developments regarding cryptocurrencies:
- ICE Backs Cryptocurrency Data Fee: The Intercontinental Exchange, Inc. and Blockstream announced the launch last week of the Cryptocurrency Data Feed. The companies said this feed will include real-time cryptocurrency data from more than 15 global cryptocurrency exchanges (click here for the relevant press release).
- IOSCO Provides ICO Guidance: The International Organization of Securities Commissions issued an advisory regarding its concerns about initial coin offerings of digital tokens. In many cases, said the IOSCO, there have been instances of fraud in connection with such offerings, and some offerings have been accomplished in violation of law. As part of its advisory, IOSCO affixed an appendix containing hotlinks to commentary by different worldwide regulators regarding ICOs and related matters (click here to access the IOSCO advisory and appendix).
- Quebec AMF Reiterates Prior ICO Guidance: Quebec separately issued an advisory regarding ICOs that included prior advice describing when digital tokens issued as part of ICOs might be securities (click here to access Quebec’s advisory).
- Massachusetts Sues ICO Promoters: The Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Caviar— a Cayman Islands exempted company— and Kirill Bensonoff, the majority owner of the firm, for engaging in an ICO from Massachusetts in violation of applicable securities laws requirements. Among other things, the defendants were charged with acting as a broker‑dealer without being registered, and offering and selling a security that was not registered or subject to a valid exemption from registration (click here to access the relevant complaint).
My View: Although the process by which the SEC is seeking industry comment on an important topic appears a bit unusual, and at least some fund sponsors are likely very disappointed by staff’s delay in approving and even threatening to disapprove registered funds to trade cryptocurrencies until further notice, it is at least a positive development that staff has articulated its specific concerns and is soliciting dialogue.
Previously, in its denial of a proposed BZX rule change to accommodate trading of shares in the Winklevoss Bitcoin Trust, the SEC indicated that its principal concern was the lack of a federally regulated market that traded Bitcoin or Bitcoin futures (click here to access the relevant SEC Order). Since that time, trading in cash-settled Bitcoin futures overseen by the Commodity Futures Trading Commission has commenced on the Chicago Mercantile Exchange and the CBOE Futures Exchange, and trading in swap contracts potentially settling in Bitcoin was approved by the CFTC for LedgerX and has been underway for a few months. Clearly, based on the plain language of the prior SEC Order, this should have been enough to give comfort to the SEC to approve investment funds to trade derivatives on CFTC-overseen cryptocurrency markets.
But apparently, this has not been the case as other concerns remain.
Hopefully, responses received by the Division to its solicitation for comment will empower the SEC to promptly authorize investment funds to trade at least some types of cryptocurrencies subject to disclosures and other reasonable and appropriate conditions it may determine, even if the Commission generally remains uncomfortable with the asset class. As CFTC Chairman J. Christopher Giancarlo said last week before lawyers at the ABA Derivatives and Futures Section conference, “I am disinclined to set regulatory policy from personal value judgments as to the social utility of a lawful, emerging technology, however considerable the inherent risks.” (Click here to access Mr. Giancarlo’s full comments regarding the federal oversight of cryptocurrencies.)