The starts and stops of digital asset regulation have started to congeal around an emerging scheme of regulation. The Biden Administration’s Executive Order on Ensuring Responsible Development of Digital Assets underscores this important development. The order calls for a broad review of digital assets and set several objectives including consumer and investor protection, financial stability, mitigation of illicit finance and national security risks.[1]
SEC and FINRA Approach
When someone is contemplating an Initial Coin Offering (ICO) or otherwise is engaging in the offer, sale, or distribution of a digital asset, that person needs to consider whether the federal securities laws apply. A threshold issue is whether the digital asset is a “security” under those laws. A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of “security.” The SEC and the courts use the “investment contract” analysis to determine whether unique or novel instruments or arrangements, such as digital assets, are securities subject to federal securities laws.[2]
The focus of the Howey analysis is on the form and terms of the instrument itself (e.g., a digital asset) and circumstances surrounding the digital asset and the manner in which it is offered, sold or resold. Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply, including registration of the security[3] and the triggering of broker-dealer registration requirements under SEC and FINRA rules where securities-based compensation is received for such sales.
Many other FINRA rules are potentially implicated by various DLT applications, such as financial condition, verification of assets, anti-money laundering, know-your-customer, supervision and surveillance, and payment to unregistered persons. Materiality impact on business operations may be impacted depending on the nature of the DLT application.[4]
Department of Labor
The DOL has cautioned plan fiduciaries to exercise extreme care before they consider adding a crypto option to a 401(k) plan's investment menu for plan participants. It noted its serious concerns about investments in crypto or other products whose value is tied to crypto. These investments present significant risks and challenges to participants' retirement accounts, including significant risks of fraud, theft and loss, due to the speculative and volatile nature of the assets. The DOL also noted custodial and recordkeeping concerns, as crypto are not held like traditional plan assets in trust or custodial accounts, readily valued, and available to pay benefits and plan expenses.[5]
FinCen and OFAC
FinCEN expressed concern about the use of crypto in connection with illicit activity and noted that the majority of ransomware-related payments were made in Bitcoin.[6] In addition, the Treasury’s Office of Foreign Assets Control also noted that OFAC sanctions have increasingly targeted individuals and entities using virtual currency in connection with malign activity.[7]
There is much for compliance to do!
Upcoming Webinar
Join the SS&C Learning Institute July 13, 2022 for our next webinar on Special Purpose Acquisition Companies (SPACs). The last year has been a wild ride for SPACs. Explore the mechanics and evolution of SPACs, why firms choose to do SPACs and the risks associated with them in our upcoming webinar. Register and view the webinar agenda today.
The SS&C Learning Institute is a division of SS&C dedicated to providing continuing education for today’s professionals. Our webinar offerings are delivered by industry-leading subject matter experts and cover a wide variety of topics, from key regulatory updates and new investment vehicles to trending topics such as ESG investing and digital assets. Learn more about the SS&C Learning Institute.
