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Compliance Software Crypto Employee Conflicts of Interest Regulations

All Securities Are Equal – But Some Are More Equal Than Others

As mainstream adoption of digital assets increases globally, regulatory scrutiny is on the rise. As with any asset, conflicts of interest may arise when employees trade crypto assets, putting both the firm and individual employees at risk. With Rule 204A-1 of the Investment Advisers Act of 1940 mandating that registered investment advisers adopt policies and procedures requiring their employees to report personal transactions and holdings in reportable securities, there is growing concern among firms that they may be held liable for the crypto trading activity of their employees.  

There has been widespread debate and confusion over which digital assets constitute securities, and whether or not trading of these assets is covered by legislation for traditional securities.  

Securities and Exchange Commission (SEC) Chair, Gary Gensler, has repeatedly emphasized that some crypto assets “don’t just resemble securities, they are securities”. Back in December, when explaining the SEC’s decision to deny a rulemaking petition filed on behalf of Coinbase, he stated that “the existing securities regime appropriately governs crypto asset securities.” Following the Supreme Court’s verdict in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), securities laws apply to all ‘investment contracts’, not only to stocks and bonds. But Gensler also acknowledged that “not every crypto asset is necessarily offered and sold as a security.” 

So, does this mean the question has been resolved once and for all? And what does this mean for firms whose employees are trading digital assets? 

Some Securities Are More Equal Than Others

In November 2023, the SEC issued a complaint against Kraken, a US-based cryptocurrency exchange, that has potential implications for firms’ compliance programs. It claimed that, since at least since September 2018, Kraken had made hundreds of millions of dollars unlawfully facilitating the buying and selling of crypto asset securities. In a similar vein to previous complaints against Bittrex, Binance and Coinbase, the SEC alleged that Kraken was operating as an unregistered exchange, broker, dealer, and clearing agency.  

However, this complaint follows a decision last July by Judge Analisa Torres in SEC v. Ripple Labs,  holding that Ripple’s sales of XRP through secondary trading platforms did not constitute securities transactions, while its direct sales to institutional investors did.  

This was widely anticipated to challenge the SEC’s view that most digital assets are securities. Yet once again the Commission reiterated that these are in fact securities, implying an expectation that either the Ripple case will be overturned on appeal or that other cases will result in different verdicts.  

In the complaint against Kraken, the SEC pointed to its previous exchange charges, noting 16 digital assets that have previously been positioned as securities, and which were available on Kraken. It then focused on 11 others that Kraken had made ‘security-esque’ statements about.  

This raises exchange-specific questions regarding whether employees’ trading of an asset on one exchange is particularly high risk, given what the exchange itself has said about that asset. 

To avoid the risk of non-compliance and potential regulatory penalties, digital assets need to be treated in the same way as any other tradeable asset class. Firms should be seeking as much information as possible about digital assets and the applicable regulations to ensure they fully understand the associated risks. 

What Action Do Firms Needs to Take?

In our 2023 Crypto & Compliance Market Survey, 43% of firms surveyed said they now have an employee crypto trading policy in place, up 6% from 2022. These policies center around the need for employees to pre-clear crypto trades as they would with any securities; prohibition on crypto mining and participation in initial coin offerings (ICOs); and disclosure of crypto trading accounts and holdings for future regulations.  

This substantial increase highlights growing recognition of the importance of having a crypto trading policy in place, as regulations continue to develop. 

Some of those who did not have a crypto trading policy in place cited that crypto assets are already captured in the same trading policies as securities and grant exemptions. Alternatively, they were already established in their current conflicts of interest policies that refer to trading in shares and crypto, and therefore a separate policy was not required. 

However, those who have only just started their compliance protocols for this relatively new asset class have some catching up to do, so it is imperative that they take urgent action to develop and implement employee crypto trading policies and procedures. 

How Star and Aer Compliance Can Help

In April 2023, Star launched its Crypto Asset Pre-Clearance software solution, which enables greater transparency and visibility into employee crypto-trading activities, as a first step in mitigating regulatory compliance conflicts. This complements Aer Compliance’s crypto system, as an end-to-end digital assets employee/personal account dealing solution that captures information across employee exchanges and wallets. Additionally, Aer Compliance maintains an SEC-designated securities list for heightened monitoring, which can be loaded into clients’ compliance platforms. 

This facilitates efficient and accurate pre-approvals and post-trade monitoring. It also allows firms additional visibility into their employees’ financial behaviors to surface potential issues (such as day trading and excessive leverage) before they emerge in employees’ work lives. 

By combining the expertise of both Star and Aer, the partnership provides our clients with a holistic offering that spans a wide range of future-ready compliance tools and services. These have been designed to address both traditional securities, as well as the evolving cryptocurrency markets, for monitoring employee trading activities. By gaining a holistic view of these activities, our clients gain a crucial competitive edge.