By Jacquelyn Lumb
Staff from the SEC’s Division of Investment Management reviewed the past year’s developments in cryptocurrencies and blockchain at the Practising Law Institute’s SEC Speaks conference. In the past year, 12 exchange-traded funds and two mutual funds sought to add new series that invest in cryptocurrencies, according to the staff. The funds were asked to withdraw their filings because the futures on which the cryptocurrencies were based did not yet exist. All but one of the funds withdrew and the remaining fund extended the effective date while it worked to resolve the issues that arose.
Fund series investing in cryptocurrencies. After the Chicago Board Options Exchange approved bitcoin futures contracts, all of the funds again filed applications, but they were once again withdrawn after Dahlia Blass, the director of the Division, sent a letter to SIFMA and the Investment Company Institute outlining a series of questions that must be addressed before it would be appropriate for fund sponsors to initiate the registration of funds that intend to invest substantially in cryptocurrency and related products.
In addition to asking the funds to withdraw their registration statements, Blass advised that the Division does not believe it is appropriate to rely on Securities Act Rule 485(a), which allows post-effective amendments to previously effective registration statements for the registration of a new series to go effective automatically. She said that if a sponsor were to file a post-effective amendment under the rule to register a fund that invests substantially in cryptocurrency or related products, the staff would view that action unfavorably and would consider actions, which may include seeking a stop order from the Commission.
Staff guidance. The Investment Management letter raised questions about how funds would value any cryptocurrency-related products, how they would assure there was sufficient liquidity to meet redemptions daily and how they would satisfy the custody requirements; it also inquired about arbitrage for ETFs and potential risks, including manipulation, given the lack of investor protections in this sector.
The staff is under a time clock with respect to automatic post-effectiveness. Blass said that so far, the Division is waiting to see if anyone steps forward to act as a custodian and whether methodologies are put in place. She noted that SIFMA and ICI are pretty active in this space. The questions raised in IM’s letter are pretty fundamental to the Investment Company Act, she advised. These innovations may not fit squarely within the Act, she said, but there may be answers that are workable.
Former commissioner Daniel Gallagher, a commentator on the panel, said the cryptocurrency market is fraught with bad players and a lack of transparency which poses a real risk for retail investors. He said the new futures products do nothing to change the staff’s analysis and urged that it proceed very carefully.
The staff also warned against funds changing their names to incorporate blockchain references when that is not a primary business line. The name must not be misleading about the funds’ primary investment objectives.
Standard of conduct of IAs and BDs. The staff is working with the Division of Trading & Markets to develop a standard of conduct for investment advisers and broker-dealers. The Division plans to repropose ETF rules that will allow the funds to operate without seeking exemptive relief. A proposal was issued in 2008 but it was not adopted. Another pending issue is proposed Rule 30e-3, which would allow funds to post annual and semiannual reports on their websites while still allowing investors to opt for paper delivery.
Guidance regarding MiFID II. The staff also noted that time is running out on the no-action relief it provided in response the European Union’s MiFID II directive. The staff provided no-action assurances that will expire 30 months from MiFID II’s implementation date, which was in January 2018. The staff said that it would not recommend enforcement action if a broker-dealer provides research services that constitute investment advice under the Investment Advisers Act to a manager that is required to pay for the research services by using research payments.
In a separate letter, the staff said it would not recommend enforcement action against an investment adviser that aggregates orders for the sale or purchase of securities on behalf of its clients in reliance on a position taken in SMC Capital while accommodating the differing arrangements regarding the payment for research that will be required by MiFID II. The staff is actively seeking engagement in this area and asked interested parties to make their views known.