Full and Fair Disclosure: Regulatory Disclosure Guidance Relating to Digital Asset Activities

Financial professionals are required to provide full disclosure of all material facts when dealing with customers, including the disclosure of any conflicts of interest and the relevant suitability risks associated with investment recommendations. See, e.g., S.E.C. v. Capital Gains Research Bureau, 375 U.S. 180 (1963). The U.S. Securities & Exchange Commission (the “SEC”) and the National Futures Association (the “NFA”) often bring enforcement actions against advisers and brokers for providing inadequate disclosures to customers. This Alert discusses some recent disclosure guidance from the NFA which highlights the importance of providing full disclosure to customers trading digital assets, including tokens and virtual currencies.

On July 20, 2018, the NFA released a proposed interpretive notice regarding disclosure requirements for NFA members engaging in virtual currency activities. See, the link below for details. The NFA’s notice was intended to educate and warn customers of the unique risks when engaging in activities related to digital assets, including the risks associated with price volatility; valuation; liquidity; cybersecurity; custodians and the use of private keys; transaction fees; and the lack of regulation over certain virtual currency Exchanges.

When drafting disclosures for digital asset activities, firms should consider the following: 1. the potential for hard and soft forks in open-source applications that could split away market participants, increase the number of digital coins, or make coins obsolete; 2. mining or validation costs; 3. the facts relating to the value of a digital coin or token and the offered product or service; 4. the adoption of the digital coin or token as a broad medium of exchange or store of value; 5. the future competitors or technological changes that could disrupt the underlying business; 6. the future demand or uses for an application, network, product or services; 7. the liquidity in the market for a specific digital coin or token; 8. the changes to the underlying technology that could devalue digital coins or tokens; 9. risk of theft from hacking; and 10. the risk of nascent technology.

The Commodities Futures and Trading Commission (“CFTC”), which supervises the NFA, also issued its fourth advisory notice with respect to virtual currencies on July 16, 2018. See, Customer Advisory 7756-18, which warned customers to exercise caution and do extensive research before purchasing virtual coins or tokens.

The SEC, CFTC and the NFA will continue to examine financial professionals and sanction those that provide inadequate disclosure. Firms must conduct periodic in-depth reviews of all their written materials provided to customers and to the public and carefully compare these disclosures against their actual business operations. This review must also be conducted by a group of knowledgeable employees of the firm that represent all aspects of the firm, including compliance personnel, portfolio managers and members of a trading desk.

For more information on these notices, please contact Dan Viola at dviola@sglawyers.com or 212.573.8038.

NFA Proposed Interpretive Notice, July 20, 2018