Future Crypto Regulations Take Center Stage in Wealth Management

RegTech Firm Smarsh Emphasizes Urgency for Getting Ahead of New Burdens


Crypto is on a roll across the wealth management space, as Wall Street financial institutions, independent broker-dealers and RIA firms increasingly explore how to offer crypto-based financial products and strategies.

Jeff Nash, CEO of BridgeMark Strategies, a national consultancy focused on the wealth management space, said even firms and financial advisors who are not necessarily sold on crypto are increasingly under pressure from clients who are asking for more crypto investment opportunities.

“More than ever, cryptocurrencies are top of mind for wealth management firms when it comes to product-driven growth strategies. But for every firm or advisor who is excited about this, there are also firms and advisors that are approaching crypto with skepticism.”

One of the biggest drivers of this skepticism?  According to Nash, it comes down to potential future regulatory complexities and greater compliance burdens relative to the comparative “wild west” of what has been a lightly-regulated crypto environment…until now.

“Any new asset class or investment product is going to attract the attention of regulators, which naturally raises roadblocks to successful execution.  This is especially the case with something like crypto, which is attracting so many prominent names, big dollar amounts and breathless headlines.”

The stakes could be especially high for wealth management firms across the country, already operating under a constellation of regulatory and legislative complexity, including from both FINRA and the SEC at the federal level.

Crypto Regulatory Landscape

In a report published recently by Cornerstone Research, an economic and financial consultancy, 52% of SEC enforcement actions to date involve allegations of fraud. The report highlights that many of these cases of fraud involve the delivery of false, misleading, or inaccurate reporting of crypto-related transactions.

Sander Ressler, Managing Partner of Essential Edge, an outsourced compliance supervision firm for the wealth management space, is unsparing in his views on crypto and the potential regulatory risks involved for firms and advisors.

“With crypto, there’s no product, no service, no underlying value, and to me that’s a profile of something that has the potential to fall apart. If you can put a regulatory framework around it — if the world can figure out a way to have consistency around custody, transfer, liquidity and arbitrage value — then perhaps it’s here to stay.”

“But if any of those things fail because regulators can’t put a framework around it, crypto could well go the way of tulips, penny stocks and many other formerly hot assets that fizzled out.”

Leaders at Smarsh, the global regtech firm for financial institutions and wealth managers, agree that crypto presents real regulatory and compliance risks that need to be addressed urgently but also believe more helpful clarity from regulators is on its way in the not-too-distance future.

Indeed, multiple regulatory affairs experts say that the groundwork is rapidly developing to create greater regulatory certainties in the future, with a growing recognition across the US regulatory community on the need for a broader regulatory mechanism for crypto across the board. 

Such an approach could encompass each regulatory body with a stake in the system to coordinate on a centralized basis and define market participants, while establishing universal and consistent registration requirements.

According to Robert Cruz, Smarsh’s Vice President of Information Governance, “Once those regulatory foundational components are in place, I’d expect that both FINRA and SEC will provide more explicit guidance on how market participants will be required to monitor and report on risks that are unique to crypto should follow.”

“Ultimately, I’d expect the landscape to treat cryptocurrency as another asset class, subject to the same financial market basic regulatory obligations, with incremental requirements due to unique risk and volatile nature of digital currencies.”

Ressler added that wealth management firms entering the crypto products space must assume future compliance burdens will carry little forgiveness from regulators for any supervision failures.

“I don’t think adding cryptocurrencies to the product shelf is like adding a new preferred stock or a new type of muni bond. The underlying premise of due diligence is to understand what it is that you’re selling. To do that firms have to invest in the education of their internal personnel so they can supervise it properly.  And another one of the most important things firms will need is the technology to properly monitor crypto transactions.”

RegTech to the Rescue?

On Ressler’s lattermost point is where Smarsh believes regtech will play a pivotal role in the future of crypto as a financial product for wealth managers and banks.

The company believes the best path forward is for firms and their client-facing professionals to have in place the right digital communications compliance architecture – Especially when it comes to record-keeping and compliance supervisory functions.

Robert Cruz notes that the very nature of crypto virtually guarantees a heavier usage of digital communications tools in how it is marketed as a financial product. 

“It’s fair to presume that a sizable chunk of the market for digital currencies will be communicated through digital communications platforms. Forcing the younger investor demographic that is likely driving a bulk of activity in this market to engage through email is only slightly different than asking them to communicate via pay phones, fax machines, and dial-up modems.”

“While traditional financial institutions offering cryptocurrency products will continue to rely on the preferred, familiar platforms of established and institutional investors, the pressure upon all firms to support the latest communications platforms will only intensify.”

Where to Begin

Cruz said that a good place for wealth management firms and financial institutions to start is by testing the resilience of existing record keeping and supervisory procedures and the technologies they leverage to support such procedures.

“It’s important for wealth managers and financial institutions to gauge their readiness for the volume and volatility that offering crypto products will introduce.”

According to Cruz, FINRA’s recent guidance includes direction that compliance supervisory policies should include processes and protocols designed to spot crypto red flags, including Outside Business Activities, to ensure registered reps “are not engaging in an area outside of their day job if crypto products are not yet offered by their firm.”

“From a communications perspective, the lesson is to know where the action is happening and have a plan and process in place to evaluate which communications platforms preferred by participants in the cryptocurrency market can be captured and controlled – or if alternatives need to be identified.”

Adding that technology innovation is frequently ahead of automated controls, and firms need to have the due diligence, policies, and training to fill the gap, Cruz emphasizes that Smarsh is actively developing new offerings to better prepare its customers involved with crypto.

“A primary value we offer with our technology is to provide the flexibility that allows firms to respond to new financial product opportunities, and to help construct policies that help focus on the risks that are highlighted by regulatory notices.”

Nobody Has a Crypto Ball

So where does the wealth management industry go from here? 

Reflecting the views of many of his peers in the compliance supervision profession, Ressler emphasizes that one of the first steps regulators will take once there is greater consensus on establishing universally accepted standards and definitions will be to adopt tighter regulations on the trading of crypto.

“Cryptos are going to have to meet a standard of viability in order to be traded, including a set of standards that will allow for the custody and ease of transfer of the most viable cryptos.”

“When there’s a frenzy around something where people are only buying and selling based on the volatility and not getting an understanding of the underlying fundamentals, the question becomes whether investors are making informed decisions. That’s when regulators will step in.”

According to Cruz, a big opportunity and challenge for wealth management firms and financial institutions is to stay aggressively engaged with the regulators and the regulatory process. 

Towards this end, Smarsh continues to host regularly scheduled events for its financial services customers to share emerging best practices on crypto compliance, while also encouraging regulators to share feedback and guidance to the industry at every opportunity.

For Cruz, it’s the downside risk mitigation involved with being prepared for the new normal for crypto regulations that should be a key driver for most broker-dealers, RIAs and banks entering the crypto space.

“Obviously, no firm wants to see their name in the SEC or FINRA regulatory enforcement action summaries. However, given the volatility and current valuations associated with this market, the frequency and dollars associated with individual cases is likely to increase, as will negative repercussions of even greater magnitude.”

Ressler agrees that wealth management businesses that have decided to offer crypto products to financial advisors and their clients must get prepared sooner rather than later in developing the expertise, education, technology and other resources that will likely be crucial for crypto compliance. 

“You’re either in or you’re out. You can’t dip your toes in the water and not get wet. Less than full commitment won’t work, if only because of the big investments that firms will have to make to participate, including in regtech.”