The SEC’s Digital Asset Questions For RIA Firms
By Lacey Shrum
Recently, we’ve seen a handful of seemingly routine SEC exam requests asking Registered Investment Advisor (RIA) firms high-level inquiries regarding digital assets. These RIAs have no exposure to digital assets or any public communication regarding the subject. Specifically, the SEC asks if the firm is providing any advisory advice regarding any digital assets or blockchain related products and whether any supervised persons manage or recommend digital assets outside of the firm.
Many RIAs today will answer simply: No and No. However, if we’ve spent any time with the SEC, we know that this casual inquiry can get dicey quickly. Simple follow up questions are: “What do you say when a client calls to ask about digital assets?” “What is your firm policy, how is it documented and communicated to the supervised persons, and how are you ensuring it is followed?” And, a long shot – “Bitcoin is an asset that has went up 27x over the last five years. As a fiduciary, did you look at this asset for your client? Why not?”
Because a digital asset introduces so many new elements to deal with, most RIAs are not equipped, nor have the resources available to handle these new assets. However, it is apparent that the SEC is starting to take a look around and see just how advisors are addressing the new elephant in the room.
In helping firms learn about this asset and develop appropriate policies and procedures, here are some best practices:
Learn the Asset
Digital assets offer a combination of characteristics that aren’t available in other assets. They are governed differently, held differently, and present far different risks than RIAs are prepared for. Best execution, custody, suitability issues are all applicable here, but must be addressed in different ways than a traditional security. Firms need to start by being open to learning about these assets. They are weird, but they are staying. If there is someone in your firm who has an interest, let them run with this in researching and keeping the firm updated. One of my favorite research platforms is Messari.io (recently raised $4M, so expecting lots of new features).
Support your “Supervised Persons”
In a time when advisors are clamoring to serve clients and offer more services, it is difficult to believe that advisors can continue to repeat to clients, “That is just something we don’t know a lot about and therefore don’t recommend.” As employers, business owners, and lawyers we know that can lead to employees giving bad advice off to the side, which creates risk. Educate advisors and employees and determine a firm approach. Continue to address that firm approach as you learn more and adjust as necessary.
Make a Policy
Very basic simple policy examples that may apply to a firm*:
- The firm does not advise on digital assets, nor make any recommendations or give advice to clients regarding any digital assets. The firm does not expect to include any future business plans for the introduction of digital assets into clients’ portfolios.
- The firm is educating advisors about digital assets to stay abreast of new and various assets in the current market. The firm does not recommend or advise on digitial assets to our clients.The firm does not expect to include any future business plans for the introduction of digital assets into clients’ portfolios.
- The firm is educating advisors about digital assets and is researching, analyzing, and discussing digital assets, on an internal basis only, including possible methods to properly advise clients while remaining cognizant of suitability, best execution, and other SEC requirements. Currently these actions are simply for research and internal education. At this time, the firm does not recommend digital assets but responds to client questions regarding digital assets. The firm has no future plans for the introduction of digital assets into clients’ portfolios.
Figure out what clients are doing
Do your clients have digital asset exposure outside of your firm? Should this exposure be included on their overall asset allocation and worth statement? If your client owns the asset, does she have a plan in place for generational transfer? Generational transfer is a tricky one, and Casa Inheritance is looking to solve it.
Address your Code of Ethics
Most tokens are securities, per the SEC. Review your disclosure requirements and determine if tokens-as-securities are included in your policies and if you should include them on your quarterly attestations. If you collect information about tokens – collect the name, location of the asset (custodian, exchange, hardware wallet), date of purchase, location of purchase, purchase price and quantity. Never collect or request private keys or seed phrases.
Digital assets are ever-evolving and will gradually become more and more prevalent in the RIA world. Keeping an open mind and eye as the market grows is essential to continuing to provide the best advice for your clients.
*Always tailor your policies to your individual firm and make sure you are doing what you say you’ll do.