March 02, 2021
by Macauley B. Venora

Last week, the SEC's Division of Examinations (the "Division") issued a Risk Alert (the "Alert") highlighting its "Continued Focus on Digital Asset Securities." The Alert highlights the need for SEC registrants engaging in digital asset businesses or using distributed ledger technology in their businesses to be aware of and address the unique regulatory and compliance challenges posed by these new assets and technologies. 

The Division issued this Alert to provide firms with "observations made by Division staff during examinations of investment advisers, broker-dealers, and transfer agents regarding Digital Asset Securities that may assist firms in developing and enhancing their compliance practices." The Alert also describes "areas of focus for the Division’s future examinations."

Here are the areas of focus from the Alert:

For Investment Advisers

  • Portfolio Management, including classification of digital assets, due diligence and mitigation of risks;
  • Books and Records;
  • Custody, including controls around private keys and hardware wallets, software reliability and security procedures;
  • Disclosures;
  • Pricing Client Portfolios; and
  • Registration issues.

For Broker-Dealers

  • Safekeeping of Funds and Operations;
  • Registration Requirements;
  • Anti-Money Laundering (AML) Procedures;
  • Offerings, including underwriting and private placement activity;
  • Disclosure of Conflicts of Interest, specifically when acting in multiple capacities; and
  • Outside Business Activities.

For National Securities Exchanges

  • Exchange Registration, specifically when facilitating trading in digital asset securities; and
  • Compliance with Reg ATS.

Transfer Agents

  • Compliance with Transfer Agent Rules.

Generally, the Alert reiterates that a firm's obligations under the federal securities laws apply to digital assets. However, some of the areas of focus emphasize the novel compliance challenges posed by cryptocurrencies and other digital assets. For example, the Risk Alert advises that custody, specifically control of and employee access to a client's digital private keys, could be reviewed during an investment adviser examination. For broker-dealers, the Division reminds firms of their robust anti-money laundering obligations due to "[c]ertain pseudonymous aspects of distributed ledger technology."

The Alert notably does not single out any instance of impropriety, but rather highlights compliance considerations and areas of risk for financial markets participants.


About Blockchain Law Center

Blockchain technology utilizes a distributed digital ledger to record and track information, and can be leveraged to gain transparency and certainty in transactions ranging from cryptocurrency to supply chain tracking.  This blog provides information on the legal developments surrounding implementation of blockchain technology, with an initial focus on the financial services sector.