SEC Raises Cryptocurrency Fund Questions – An Open Dialogue

On January 18, 2018, the U.S. Securities and Exchange Commission (the “SEC”) Division of Investment Management (the “Division”) sent a letter to the Investment Company Institute and the Securities Industry and Financial Markets Association addressing the Division’s significant questions concerning how proposed registered funds investing in cryptocurrencies and related products would satisfy the Investment Company Act of 1940 (the “Company Act”). The letter was signed by the Division’s Director, Dalia Blass, and warned potential fund sponsors against initiating fund registrations until these questions can be addressed. This letter was also similar to SEC Chairman Jay Clayton’s statement on December 11, 2017, which warned retail investors of the potential risks in the crypto sector and warned market professionals, including lawyers, accountants and administrators or consultants, regarding the potential risks of concluding that an initial coin offering (“ICO”) or token offering was not a security. In particular, Chairman Clayton stated, “…replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.”

The Division’s letter on January 18, 2018 raised the following specific questions for registered funds engaged in cryptocurrency-related holdings, as follows:

• how funds would value cryptocurrencies and related products given their volatility and lack of regulation;
• liquidity and whether funds could meet daily redemption requests;
• custody concerns such as how funds can validate existence, exclusive ownership, and software functionality;
• ETFs pose additional questions related to authorized participant and arbitrage processes; and
• are there particular challenges investment advisers would face in meeting their fiduciary obligations?

Similar questions are also applicable to un-registered private funds relying on established exemptions under the Company Act. The Division’s letter expressed that until these questions can be addressed satisfactorily, it does not believe that fund sponsors should initiate registration of funds that intend to invest substantially in cryptocurrency and related products. The Division has asked sponsors that have registration statements filed for such products to withdraw them. The Division also does not believe that such funds should utilize SEC Rule 485(a) under the Securities Act of 1933, which allows post-effective amendments to previously effective registration statements for registration of a new series to go effective automatically. The Division’s letter concluded that it would view that position unfavorably and would consider actions necessary or appropriate to protect retail investors, including recommending a stop order. On a positive note, the Division’s letter also emphasized that the SEC stands ready to engage in meaningful dialogue with sponsors and other market professionals regarding the potential development of these funds, which appears to indicate that the SEC will continue to foster an informed rule making process to enhance the relevant protections and controls in the cryptocurrency and ICO sectors.

If you have questions about this Alert, please contact Daniel G. Viola at 212.573.8038,

Staff Letter from Dalia Blass: Engaging on Fund Innovation and Cryptocurrency-related Holdings – January 2018

Statement from Chairman Clayton: Statement on Cryptocurrencies and Initial Coin Offerings – December 11, 2017