Fiduciary Duty During Uncertain Times

The market capitalization of crypto-assets has grown significantly. As of March, 2023 the global cryptocurrency market capitalization was US$1.2 trillion. Moreover, the market capitalization of all stablecoins on February 13, 2023 equaled more than $137 billion. But this growth has come amid large bouts of price volatility.

For example, prices spiked in early May 2021 only to fall by 40% in the same month. Cryptocurrency prices rose once again, peaking in November 2021, only to fall precipitously during 2022. Bitcoin, for instance, hit more than US$65,000 in November 2021 only to lose around 70% of its value by September 2022.

Current market conditions have become known as a “crypto winter”. How can financial professionals support client investment interest in this asset class through this volatility?

Noah Billick, Partner - Director of Regulatory, Funds and Compliance from Rennoco & Co. law firm, shares his perspective from working with financial firms on how advisors can meet their fiduciary duty to their clients in this changing environment.

– S.M.

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How Does the Current Crypto Regulatory Landscape Impact Fiduciary Duty?

In the course of the last five years, investing in cryptocurrencies has evolved from a fringe activity fraught with risk to a much more mainstream practice. In my legal practice I regularly work with advisors and portfolio managers, and the great majority of investment professionals I speak with have told me that their clients are increasingly asking about cryptocurrency investing.

Advisors need to have an awareness of the risks and benefits of investing in cryptocurrency, both from a business perspective and also to comply with their fiduciary duties. Simply put, advisors who cannot intelligently discuss the place of cryptocurrency in a client’s overall investment portfolio are doing their clients a disservice and are putting themselves at risk.

Advisors are professionals. Like any professional, advisors need to continually add to their professional body of knowledge in order to meet their ongoing professional obligations. While the decision to add cryptocurrency to a portfolio still depends on taking the client’s overall circumstances into account, advisors can no longer remain ignorant of this asset class.

As long ago as March of 2021 (a lifetime in the crypto industry) Morgan Stanley Wealth Management’s Global Investment Committee published a report entitled, “The Case for Cryptocurrency As an Investable Asset Class in a Diversified Portfolio.” Since then the market has matured, allowing service providers (including custodians end exchanges) to refine their offerings and, in many cases, to become regulated entities.

In March of 2022 the U.S. Department of Labor (DOL) issued Compliance Assistance Release No. 2022-01, which warned 401(k) plan fiduciaries to "exercise extreme care" when considering adding cryptocurrencies to client portfolios. The guidance identified five areas of concern, being:

1) Speculative and volatile nature of crypto investments;

2) The difficulty for plan participants to make informed decisions;

3) Custodial and recordkeeping concerns;

4) Valuation concerns; and

5) The evolving regulatory environment.

From my point of view, these considerations should be preeminent in the minds of any financial professional advising in connection with cryptocurrencies, whether considering ERISA, outside of that legislative framework in the United States, or north of the border.

The good news is that the industry is progressing on all fronts. While crypto is still speculative, better information about the qualities of different tokens is allowing advisors to gain a more nuanced understanding of the factors that make some coins more or less attractive than others. This information is also allowing individual investors to understand crypto as an asset class, rather than as a speculative lottery ticket type of investment (or, to use more modern terminology, a “YOLO”). Custody and recordkeeping have also matured, with regulated service providers emerging on both sides of the border. As markets become more liquid and transparent valuation becomes less of a concern, especially with the most highly traded tokens. Finally (and while this has been painfully slow to occur) the regulatory environment is evolving. The Canadian regulatory environment is arguably more mature than in the United States (owing, in large part, to the early, high-profile collapse of Canadian-based QuadrigaCX) but American regulators are quickly catching up.

The ultimate proof of the mainstreaming of cryptocurrency as an investable asset class is the approval of regulated products and services. The first crypto fund prospectus accepted by a North American securities regulatory authority was in 2019, when the Ontario Securities Commission approved a bitcoin ETF managed by 3iQ, a Canadian leader in cryptocurrency investment. In July of 2023, the U.S. Securities and Exchange Commission announced that it has accepted applications to create spot bitcoin exchange-traded funds from six firms, including BlackRock, Bitwise, VanEck, WisdomTree, Fidelity and Invesco. Crypto can also be purchased directly through any number of regulated trading platforms. And while inappropriate for most retail investors, crypto derivative products are available for sophisticated investors. With these significant developments there is no longer any question that advisors, in meeting their fiduciary duties, must be able to intelligently and responsibly provide advice regarding cryptocurrency investment.

Noah Billick is a partner at Renno & Co., a law firm specializing in crypto and blockchain law, where he leads the firm’s regulatory practice. This article is provided for information purposes only and is not legal advice.

- Noah Billick, Partner - Director of Regulatory, Funds and Compliance, Renno & Co

Ask an Advisor: Setting up Business to Support Crypto

Q: What is your infrastructure allowing the investment in crypto assets and benefits?

A: As a private capital management firm performing many roles, including Discretionary Portfolio Manager, we provide a structure where the client possesses the crypto asset directly, and the funds and coins do not pass through our firm. To do this, we place the capital and coins in accounts in each individual's or company's name with custodians. Our clients want to own the asset directly, which they can not do with ETFs and other funds.

As the advisor, we have the mandate to meet our client's interests in this space. The firm is responsible for the selection of crypto assets, as well as the choice of exchanges and setting up the contracts with the custodians who meet the required qualifications.

We ensure that we meet the tax and reporting requirements for this asset as we do other investments.

– Daniel Fréreault, CFA, Platinium Capital

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