SEC Regulators Are Targeting Cryptocurrency Broker-Dealers

 As cryptocurrency and blockchainbecome more prominent in today’s financial markets, regulators around the worldare coping with how to maintain transparency and legitimacy in the market. Recently, the Securities and Exchange Commission (SEC) and its new cyber unit began requesting specific information about cryptocurrency brokerage and Initial Coin Offerings(ICO’s) for enforcement purposes. (Josephine Wolff, Slate; Benjamin Bain, Bloomberg). The results of the requests remain unclear, but the probe for information sheds light on the SEC’s suspicion of misconduct.  

Following requests for information from hedge funds about their digital assessment pricing, the SEC put the Office of Compliance and Examinations (OCIE) in charge of current review of smaller brokerage firms dealing virtual tokens. (Benjamin Bain, Bloomberg). OCIE conducts examinations aimed to protect investors and ensure market integrity. If OCIE’s examinations show signs of misconduct, it refers the findings to SEC’s enforcement division for further formal investigations. (Benjamin Bain, Bloomberg). Industry self-regulators, such as Financial Industry Regulatory Authority (FIRA) and the National Futures Associations (NFA), also are questioning companies about their cryptocurrency dealings. As governmental and non-governmental (self-regulating) regulatory authorities attempt to understand the entire cryptocurrency ecosystem to ensure an efficient marketplace, this line of questioning will likely continue. 

Regulatory agencies heightened scrutiny of cryptocurrency comes directly from the top—as SEC Chairman Jay Clayton believes the ICO market is “rife with fraud.” (Benjamin Bain, Bloomberg). Protecting retail investors from cryptocurrency risk is a primary focus of OCIE’s investigations. Retail investors are individual investors that buy and sell securities for their own personal investment. ( Specifically, the OCIE wants financial professionals to maintain safeguards and controls to protect retail investors’ assets against fraud and misappropriation. (Benjamin Bain, Bloomberg). For guidance in complying with the law, some brokers and money managers have openly reported their cryptocurrency involvement to regulators, while others are less willing to volunteer information. This kind of self-reporting is difficult because there is a debate in the regulatory landscape about what crypto assets should be considered securities and thus under the SEC’s jurisdiction. 

The NFA notified the Commodity Futures Trading Commission that in the future they plan to require firms dealing in cryptocurrency derivatives and cash markets to make additional disclosures. (Benjamin Bain, Bloomberg). Whether or not regulators will request additional information or turn over findings to enforcement divisions remains uncertain. An important question the SEC must answer is if cryptocurrency, like bitcoin, will be considered a security for regulatory purposes. Chairman Clayton previously stated bitcoin-type cryptocurrency will be considered a commodity like other sovereign currency, but tokens or coins sold in ICO’s do classify as securities. (Nick Marinoff, Bitcoin Magazine; Josephine Wolff, Slate).

Regardless of the decision, the more guidance regulators provide for cryptocurrency, the more informed investors and institutions can be in their dealings with cryptocurrency. The push for information in this area reminds us that the cryptocurrency world is still relatively unknown, and regulators cannot fully act without a sufficient understanding of the market.  JJ Kinahan, chief market strategist for TD Ameritrade, summed up the uncertainty in the landscape by stating, “[n]o one is quite sure what the rules are.” (Bob Pisani,CNBC). As information from recent inquiries come in, regulators may be able to contribute more guidance to investors regarding their conduct with cryptocurrency.