The Securities and Exchange Commission’s Office of Investor Education and Advocacy is urging caution to investors considering investing in crypto asset securities.
The SEC’s warning highlights the volatility and speculative nature of crypto asset securities and the lack of investor protection on the platforms where investors buy, sell, borrow, or lend these securities. The SEC warns that investors risk significant losses if they participate in transactions involving crypto assets.
The SEC also cautions that those offering crypto asset investments or services may not be complying with applicable law, including federal securities laws. Under the federal securities laws, a company may not offer or sell securities unless the offering is registered with the SEC or an exemption to registration is available.
Similarly, the law requires parties such as securities broker-dealers, investment advisers, alternative trading systems (ATS), and exchanges to register with the SEC, a state regulator, and/or a self-regulatory organization (SRO), such as FINRA.
Registration of a securities offering requires the issuer to disclose important information about the company, the offering, and the securities offered to the public. Unregistered offerings in crypto asset securities may not provide key information that investors need to make informed decisions.
For example, registration typically requires an issuer to include financial statements audited by an independent public accounting firm registered with the Public Company Accounting Oversight Board (PCAOB). Audited financial statements play an important role in making sure investors are provided the information they need to understand the securities in which they want to invest. Issuers of unregistered crypto asset securities offerings might not provide audited financial statements, depriving investors of this key information.
Moreover, the SEC cautions that proof of reserves, a method used by crypto asset entities to offer evidence that they have sufficient reserve assets to cover what is held for customers, may not provide meaningful assurance that these entities hold adequate assets to back their customers’ balances.
Crypto asset entities might use proof of reserves instead of audited financial statements to obscure and confuse customers about the safety of their assets. A proof of reserves is not as rigorous or comprehensive as a financial statement audit and may not provide any level of assurance.
Finally, the SEC warns that registration with the SEC by an entity as a “broker-dealer” and/or “investment adviser” provides important protections for investors. These benefits include rules around custody of assets, fees, conflicts of interest, standards of conduct, and minimal capital requirements for broker-dealers.
A broker-dealer making recommendations of securities or investment strategies involving securities (including crypto asset securities) to retail customers is subject to Regulation Best Interest, which requires broker-dealers to make recommendations in the retail customers’ best interest and requires compliance with specific disclosure, care, conflict of interest, and compliance obligations.
The SEC’s warning comes at a time when cryptocurrencies and other digital assets have become increasingly popular among retail investors. Investors should be aware of the risks associated with investing in crypto asset securities and exercise caution when relying on proof of reserves to conclude that a crypto asset entity has sufficient reserve assets to meet customer liabilities. Investors are advised to only put money at risk with any speculative investment that they can afford to lose entirely.
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