On Nov. 2, 2022, a cryptocurrency exchange collapsed as hackers stole more than $400 million in digital currency. The collapse marked a devastating loss for investors and severely shook their trust in cryptocurrency and investment advisers.
For many regulators, the collapse served to highlight the tremendous need for regulations in the cryptocurrency space, which has been a topic of contention for some time now. Cryptocurrencies are predominately unregulated, but regulators, like the Securities and Exchange Commission (SEC), have shared plans of implementing regulations in 2023.
With such disruption and potential regulatory activity, cryptocurrency is now one of the top concerns for compliance teams. Investment firms will have to determine how to navigate clients’ enthusiasm about cryptocurrencies, while performing their due diligence in looking out for their best interest.
Investment advisers’ and clients’ opinions about cryptocurrencies
Investment advisers tend to approach cryptocurrencies with skepticism, because they’re relatively new, not heavily regulated and don’t have the stability of more tenured approaches to investment, an especially troubling challenge especially in light of the recent cryptocurrency collapse. In contrast, however, many clients remain enthusiastic about investing in cryptocurrency, looking at it as the new frontier of investment opportunity.
According to a Wealth Solutions Report survey that was conducted at the end of 2022:
- 92 percent of respondents “strongly agreed” cryptocurrencies are “unlikely to become a credible investment asset for the foreseeable future.”
- Within this group of respondents, 64 percent “strongly agreed” they received the most pressure about engaging with cryptocurrencies from younger members of their clients’ families, as well as third-party vendors which “did not have a strong background in product diligence or asset management.”
It’s worth noting that while investment advisers are generally hesitant to implement cryptocurrencies into their financial planning, their clients often tend to be eager to do so. Regulators have made it clear investment advisers are the experts and they must do their due diligence and look out for the best interests of their clients.
After the cryptocurrency collapse, 78 percent of respondents “strongly agreed” that compliance supervision restrictions prevented them from engaging with cryptocurrencies when the asset was booming. This might have helped them avoid the devastation of the cryptocurrency collapse.
John Gebauer, COMPLY chief regulatory officer, said that although some clients might be upset about investment advisers’ apprehension or challenges to investing in cryptocurrencies, “part of the core mandate of any firm’s compliance functions is to avoid unsuitable products that are overly-risky, over-hyped and under-regulated as part of their fiduciary duty as responsible advisers, and these are terms that most certainly apply to the recent crypto mania.”
How can investment firms adjust their compliance programs to navigate the uncertain world of cryptocurrencies?
It’s clear that given their popularity, cryptocurrencies aren’t going anywhere and regulators are prepared to adjust to this change. Regulators like the SEC have stepped up their probes of how investment firms and investment advisers manage digital assets like cryptocurrencies. In fact, the SEC has nearly doubled the size of its digital assets and cyber enforcement team.
Firms operating in the crypto space face significant financial and reputational risk if they fail to keep pace as compliance demands emerge. In order to meet existing and upcoming regulatory requirements, firms should ensure that their compliance program:
- Establishes consistent and repeatable employee compliance processes which ensure control and stand up to regulatory scrutiny.
- Ensure policies and procedures address due diligence and regulatory best interest regulations.
- Provide investment advisers with up to date training on the services your firm provides and offer guidance for when they should implement them in financial planning.
- Ensure there are internal controls to monitor and archive employee communications.
While cryptocurrency may be the new hot item on the market, its standing as an effective investment strategy remains in question. As firms continue to navigate this digital maze, compliance must remain a top priority, weighing risk and reward to ensure client’s best interest is always protected. At NRS, our compliance consultants help firms stay ahead of ever-changing regulations, promptly spotting and addressing gaps in their compliance programs.
We can help you meet regulatory requirements and remain in compliance while minimizing burdens on business processes. Let’s talk about how we can improve your firm’s compliance program!