Advisors who are employees of a financial institution or independent contractors with a broker/dealer must stay on top of firms’ policies and procedures when considering recommending Bitcoin and other digital assets to clients, according to Max Schatzow, an attorney with Stark & Stark, during a presentation at CoinDesk’s second-annual Bitcoin for Advisors event.
Schatzow, who is also the author of the investment advisor blog AdviserCounsel, said he approached questions of how Bitcoin relates to compliance concerns as a “digital asset realist” (though he recognized some might consider him a skeptic). During his presentation, Schatzow said that there was little stopping owners and operators of independent RIAs from recommending digital assets to clients.
But failing to follow their firm’s policies was the “lowest hanging fruit” for Securities and Exchange Commission examiners looking into employees and independent contractors for other firms, including when investigating digital asset recommendations.
“The staff comes in, they open up your compliance manual, they go through it, they quiz you on it, they find you’re not following things, and they’ll write you up for a deficiency,” he said. “If those deficiencies are bad enough, if they cause client harm, or investment losses or misplaced assets, you can almost guarantee you’re getting referred to enforcement. This isn’t a small matter.”
Schatzow cautioned advisors to check whether firm policies allow employees to recommend held away assets and, if so, whether it must be done for a fee, which could affect whether (and how) an advisor recommends a digital asset. A firm might only allow employees to recommend certain, on-platform assets, which could limit an advisor’s flexibility, and most firms also have personal trading requirements, meaning an advisor would need to report their own holdings in digital assets.
Schatzow recommended advisors read the SEC’s February risk alert on digital assets, calling it a “holy grail” for advisors navigating the relationship between digital asset management and compliance. Schatzow said the risk alert focused on several issues, including portfolio management; in short, he said, to fulfill their fiduciary duty advisors must understand an asset when recommending it to clients. Advisors also had to understand their complexity, stressing that digital assets were much different from equity securities or ETFs, and advisors could not open clients to undue risk out of ignorance.
But advisors also needed to be willing to confront clients on unsuitable ideas, with Schatzow "hypothetisizing" a client request for 100% allocation to Bitcoin. Schatzow said he did not consider this a "defensible" situation, and suggested advisors have a detailed note-taking system or a waiver in place for a client to sign in such instances.
“Because, at the end of the day, God forbid, if Bitcoin falls 50% and that client now can’t make his mortgage payment or something along those lines, you’ve got to make sure you’re in a situation where you can defend yourself from that customer’s complaint,” he said.
Additionally, Schatzow said there was still ambiguity in understanding how digital assets are (and should be, from a compliance standpoint) custodied, and said he was also seeing issues with disclosures to clients, in which advisors had unclear disclosure materials while already working with digital assets. Finally, Schatzow said advisors had to be cognizant that even if they have errors and omission insurance policies through the firm, most policies do not cover digital assets.
“If you receive a client complaint, if there's fraud, if client assets go missing, you might not have coverage unless your errors and omission insurance covers that asset class,” he said. “So you have to make sure, ‘Do we have the coverage you need?’"