United States: Private Funds and SEC Crypto Regulation
By: Rob Weiss
Fund sponsors continue to search for ways to get their investors exposure to cryptocurrencies.
For sponsors able to offer registered fund products, exchange-traded products (ETPs) are attractive: available to retail investors, highly liquid, and without a fixed term, ETPs check several boxes for sponsors and investors alike. However, while the SEC has authorized listing of ETPs that trade in bitcoin futures regulated by the CFTC, the SEC has not authorized listing of ETPs that trade directly in spot cryptocurrency. We recently wrote an article on this point, which can be accessed here.
Sponsors who want to offer investors direct exposure to cryptocurrency must look instead to private funds. But managing funds that will invest in cryptocurrencies is fraught for sponsors as well. Unsurprisingly, given how fast crypto technology changes, it’s not always clear how sponsors of private crypto funds can comply with existing regulation. The Custody Rule, for example, presents difficult technical and practical issues for sponsors required to comply. In February 2021 the SEC took its first step toward tailored rules relating to custody for digital assets by regulated parties – it may be a while until rules specifically for funds will be forthcoming.
Even existing rules that don’t relate to crypto may present challenges for sponsors launching crypto funds. Funds that invest in cryptocurrencies that are not securities (e.g. Bitcoin or Ether), although not subject to regulation under the 1940 Act, must nevertheless abide by the offering requirements under the Securities Act. Funds that invest in cryptocurrencies that are themselves securities must also qualify for an exemption from registration under the 1940 Act. As a practical matter, this means that only accredited investors may invest in private funds under existing exemptions. Sponsors of funds with both spot and future crypto exposure may be subject to regulation under CFTC rules, adding to compliance obligations and further limiting the investor pool.
As with everything else in crypto, though, stay tuned – regulatory interest in crypto remains sky-high, as the President’s executive order from March 9, 2022 suggests, and the landscape can change in a hurry.