Brokers’ Cryptocurrency Deals Are Focus of SEC Review

August 3, 2018 Last Updated: August 3, 2018

Wall Street’s main regulator is boosting its scrutiny of brokerages that deal in cryptocurrencies, according to two people familiar with the matter, the latest sign that authorities want to know more about a burgeoning market that they fear might be full of misconduct.

Brokerages have been peppered in recent weeks with questions from Securities and Exchange Commission examiners about their business practices and how they deal with clients, according to one of the people, who requested anonymity to discuss the review. Among other things, the SEC is seeking specific information about fees generated from trading, financing and initial coin offerings. The agency is also gathering data on investment advisers’ involvement, another person said.

Cryptocurrencies have gotten increasing attention in the past year from regulators including SEC Chairman Jay Clayton, who has said he believes the ICO market is rife with fraud. The agency’s enforcement unit has sued firms that it says violated securities laws through coin offerings, and Bloomberg News has reported that Justice Department lawyers have opened a criminal probe into whether traders are manipulating the price of Bitcoin and other digital currencies.

It’s predominantly smaller brokerage firms that deal with virtual tokens. No Wall Street banks currently trade cryptocurrencies.

Self-Regulators

The SEC review, being led by the Office of Compliance Inspections and Examinations, follows requests seeking information from hedge funds about how they price digital investments. It comes as industry self-regulators like the Financial Industry Regulatory Authority and the National Futures Association question member companies about their dealings in cryptocurrencies.

“They’re trying to understand the whole ecosystem,” John L. Jacobs, executive director of Georgetown University’s Center for Financial Markets and Policy, said of regulators’ inquiries. “They’re still wrestling with how to make sure that this an organized efficient marketplace.”

Natalie Strom, a spokeswoman for Clayton, declined to comment.

OCIE’s primary function is conducting examinations with the goal of protecting investors and ensuring market integrity. When the unit’s inspectors spot signs of misconduct, they typically refer findings to the SEC’s enforcement division for further scrutiny that can lead to formal investigations, fines, and other penalties when wrongdoing is found.

‘Retail Investors’

“The cryptocurrency and ICO markets have grown rapidly and present a number of risks for retail investors,” OCIE said in a February report outlining its exam priorities for this year. “Areas of focus will include, among other things, whether financial professionals maintain adequate controls and safeguards to protect these assets from theft or misappropriation.”

To be sure, some brokerages and money managers have reported their involvement to regulators and have asked for guidance to ensure they’re complying with the law. Others have been less forthcoming, and the regulatory landscape is complicated by legal wrangling over which assets should be considered securities under the SEC’s jurisdiction.

In addition to asking brokerages about whether they’ve been involved with ICOs, the SEC has also been questioning firms over their clearing agreements, as well as personnel and other in-house matters, one of the people said. Finra, the front-line brokerage regulator overseen by the SEC, sent firms a notice last month asking them to notify the agency if they get involved with digital assets.

NFA, the industry-funded regulator for the derivatives industry, notified the Commodity Futures Trading Commission last month that it plans to require that firms dealing in the cryptocurrency derivatives and cash markets make additional disclosures.

“This seems to be transitioning from where the house is on fire to incorporating supervision of the intermediaries,” said Jeff Bandman, principal at Bandman Advisors whose clients include crypto firms.