IA Settles SEC Charges for Crypto Asset Custody Violations
Commentary by Steven Lofchie and Rachael Hashmall
An investment adviser settled SEC charges for misleading statements regarding its redemption practices and for failing to maintain crypto asset securities with a qualified custodian.
In the Order, the SEC found that the adviser misled investors about the redemption practices of its fund. The SEC said that the adviser communicated a redemption policy requiring at least five business days' notice, while permitting certain investors, including its affiliates, to redeem with less notice.
Additionally, the SEC determined that the adviser violated the "Custody Rule" by failing to ensure that crypto asset securities held by its fund were maintained with a qualified custodian. The SEC found that the fund's assets were kept in online trading accounts on crypto platforms such as FTX, which did not qualify under SEC rules to custody securities.
The SEC concluded that the adviser violated Advisers Act Section 206(4) ("Prohibited transactions by investment advisers") and Rules 206(4)-2 ("Custody of Funds or Securities of Clients by Investment Advisers"), 206(4)-7 ("Compliance procedures and practices") and 206(4)-8 ("Pooled investment vehicles").
To settle the charges, the adviser agreed to (i) cease and desist from further violations of the Investment Advisers Act, (ii) a censure and (iii) pay a civil monetary penalty of $225,000.
Commentary
There is no little irony in the SEC bringing an enforcement action against an adviser that failed to custody crypto-assets with a qualified custodian, such as a bank, when the SEC has effectively acted to discourage banks from providing custodial services as to crypto-assets. Wouldn't investors have been much better off if the SEC had facilitated the provision of custodial services for crypto-assets by banks, rather than effectively pushing investors into obtaining custody from unregulated entities such as FTX? Perhaps the SEC should now reconsider its policies as to banks providing custodial services in respect of crypto-assets.
Commentary
The SEC's decision to charge the adviser, despite the firm having shut down operations over a year ago, raises questions about the timing and effectiveness of such enforcement actions. Critics argue this does little to protect current investors and, instead, highlights a reactive rather than proactive approach to regulation. Nonetheless, it serves as a stark reminder for investment advisers to ensure compliance with the Custody Rule and that crypto assets are not exempt from these regulations.