On February 26, 2021, the SEC's Division of Examinations released a long-awaited risk alert outlining observations made during examinations of investment advisory firms who utilize digital assets in client portfolios. The alert applies to firms who utilize these assets either directly (cryptocurrency) or indirectly (through private funds, publicly traded funds etc.).
Main areas identified by OCIE include:
Portfolio Management - Specifically due diligence and evaluation of the various risks inherent in digital assets as well as the fulfillment of fiduciary duty.
Books and Records - Digital asset trading platforms vary in reliability and consistency with regard to order execution, settlement methods, and post-trade recordation and notification, which an adviser should consider when designing its recordkeeping practices.
Custody - Specifically for firms that have custody due to access to digital wallets for their clients with an emphasis on the safeguarding of private keys needed to access digital asset holdings.
Disclosures - Examinations will look for adequate disclosures regarding the unique risks associated with digital assets, including any risks that are heightened as a result of the digital nature of such assets.
Pricing Client Portfolios - It was noted that advisors may face valuation challenges for digital assets due to market fragmentation, illiquidity, volatility, and the potential for manipulation.
Registration issues - Classification of digital assets in AUM and whether the assets meet the definition of a "Security".
Click here to read the full alert.
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