- The U.S. Securities and Exchange Commission (SEC) has approved the first spot Bitcoin ETFs, also known as an exchange-traded product (ETP).
- With the SEC now permitting spot Bitcoin ETFs, brokers must become deeply familiar with the various cryptocurrencies to minimize the risks.
- Clients will rely upon brokers to guide them through these uncharted waters, and being prepared is key.
The theory of an Exchange-Traded Fund (ETF) is not novel. An ETF is a bundle of securities you sell or buy through a brokerage firm on a stock exchange. Bitcoin ETFs are funds that track the value of Bitcoin and trade on traditional financial exchanges rather than decentralized cryptocurrency exchanges. They permit clients to invest in, and gain exposure to, Bitcoin without having to go through the risks and hassle of using a cryptocurrency exchange.
On January 10, the United States Securities and Exchange Commission (SEC) approved the first spot Bitcoin ETFs, also known as an exchange-traded product (ETP).
While the futures market settles the delivery of its underlying assets and futures contracts on a predetermined future date, a spot market is where commodities, stocks, currencies, and bonds are traded with immediate delivery.
ETFs are issued by investment companies regulated by the SEC. The shares issued by the ETF are securities that must be registered with the SEC. Like mutual funds, ETFs have stated investment objectives and use professional money managers to meet those objectives.
With the SEC now permitting spot Bitcoin ETFs, brokers must become deeply familiar with the various cryptocurrencies dominating the space in order to minimize the risks. Unlike in the past, brokers working in traditional finance must become educated on Bitcoin (and Bitcoin ETFs), in order to provide clients with competent investment advice. Clients will rely upon brokers to guide them through these uncharted waters, and being prepared is key. Further, the permissible crypto ETFs will not likely be limited to Bitcoin based ETFs, as there are also pending applications for Ethereum (Eth) ETFs.
Eth is the native token of the Ethereum blockchain. Brokers will need to know the differences between the different crypto based ETFs. With this in mind, a brief summary of the regulation best interest and the suitability rules is warranted to detail the broker’s standard of care.
According to the suitability rule, a broker is mandated to learn about both the securities it recommends, as well as its customers’ financial circumstances and investment objectives. A broker must disclose the known facts and those which are reasonably ascertainable and cannot recommend a security unless there is a reasonable basis for such a recommendation. Generally, a suitability claim stems from a broker-made recommendation to a customer to make an investment that was inappropriate regarding the customer’s financial investment objectives. The standard is detailed in FINRA Rule 2111.
Regulation Best Interest
The Regulation Best Interest rule, also known as SEC Rule 15l-1, requires SEC registered brokers and their associated persons to act in the “best interest” of retail customers when making a recommendation of any securities transaction or investment strategy involving securities. Rule 15l-1(a)(1) necessitates that recommendations must be made without placing the financial or other interest of the broker or associated person ahead of the interest of the retail customer. While the Regulation Best Interest rule does not define best interest, it does provide some safe-harbor provisions. The best interest duty placed upon the broker can be satisfied if the broker complies with four responsibilities addressing disclosure, care, conflicts of interest, and compliance policies and procedures, See Rule 15l-1(2)(i)–(iv), 17 C.F.R. § 240.15l-1(2)(i)–(iv).
Of course, with these new opportunities will come a large demand and risk. Risk to the investors, as well as risk for the brokers that do not become fully informed about these new crypto ETFs. Customers are likely to be very intrigued with the newly approved Bitcoin ETFs and brokers need to be fully informed in order to satisfy their standard of care.
Matthew H. Feinberg counsels and defends corporate officers, attorneys, stockbrokers, and other industry professionals in a range of professional liability matters for Goldberg Segalla’s Management and Professional Liability, Commercial Litigation and Arbitration, and White-Collar Defense and Government Investigations practice groups. He is Co-Chair of the New York State Bar Association’s Task Force on Emerging Digital Finance and Currency, where he studies and evaluates the legal issues and questions surrounding the expansion and regulation of the digital finance and digital currency industries.