The U.S. Securities and Exchange Commission (SEC) has advised finance professionals to apply “heightened scrutiny” when recommending complex or risky products such as crypto assets.
In a new bulletin, the SEC recommended that finance professionals thoroughly understand the risks associated with certain investment products, including cryptocurrencies, or “crypto asset securities” in the agency’s language, before offering related products and services.
The SEC noted that some products possess added complexities or risk characteristics that may make it challenging for firms and financial experts to gain a comprehensive understanding of their terms, features, and risks.
As a result, argues the agency, it may become difficult to establish a reasonable basis for believing that these products “are in the best interest of retail investors.”
“Examples of products where heightened scrutiny may be necessary include, but are not limited to, inverse or leveraged exchange-traded products, investments traded on margin, derivatives, crypto asset securities, penny stocks, private placements, asset-backed securities, volatility-linked exchange-traded products, and reverse-convertible notes,” the SEC said.
The SEC’s recommendations
What this means in practice is that, apart from having the actual understanding of the investment products they offer, the SEC wants firms and financial professionals to acquire information about the retail investor to conclude that a complex or risky product is indeed suitable for them.
Depending on the product, this information may include whether the retail investor has a specific trading objective that is consistent with the product’s description, and/or has the capacity to tolerate heightened risk of financial loss.
However, having such an objective or ability does not automatically imply that the product is in the retail investor’s best interest, added the SEC.
Per the agency, firms and their financial professionals must still have “a reasonable basis” to believe that, based on all the relevant facts and circumstances, the investment is in the best interest of the retail investor.
The publication of the staff bulletin comes shortly after the SEC filed charges against crypto exchange Bittrex, accusing the Seattle-based company of failing to comply with securities law.
According to the complaint, Bittrex failed to register as a broker-dealer, exchange, and clearing agency, taking in at least $1.3 billion in illicit revenue between 2017 and 2022.
Since Gary Gensler took on the role of the agency’s chair two years ago, the SEC has filed about 1,500 enforcement actions, which, according to Gensler, also involved actions against “rampant noncompliance in the crypto markets.”
The SEC has faced criticism from the crypto industry for its approach to digital asset regulation. Kraken CEO Jesse Powell—whose exchange was forced to wind down its staking service as part of a settlement with the regulator—stating that its so-called regulation by enforcement approach “does not help the industry or regulators.”
Coinbase chief legal officer Paul Grewal has also taken aim at the SEC, arguing that, “The public shouldn’t have to parse complaints in federal court in order to understand what a regulator expects,” during the company’s latest earnings call with shareholders. While CEO Brian Armstrong states that Coinbase’s “interests are aligned” with the SEC, the exchange has been ramping up plans to expand outside the U.S., and recently obtained a license from the Bermuda Monetary Authority.
