SEC’s Division of Examinations’ Continued Focus on Digital Asset Securities

Through its recent audits, the SEC’s Division of Examinations (the “Division”) has observed a number of activities related to the offer, sale, and trading of digital assets that are securities. A “digital asset” as used by the SEC is an asset that is issued and/or transferred using distributed ledger or blockchain technology (“distributed ledger technology” or “DLT”), including, but not limited to, so-called “virtual currencies,” “coins,” and “tokens.” This Risk Alert includes observations made by its staff during examinations of investment advisers, broker-dealers, and transfer agents regarding digital asset securities that may assist firms in developing and enhancing their compliance practices. In addition, as more securities industry participants seek to engage in digital asset-related activities, this Risk Alert provides transparency about areas of focus for the Division’s future examinations.

Focusing on risks identified through regulatory coordination and through observations from recent examinations of broker-dealers, future examinations of broker-dealers will focus on regulatory compliance associated with, among other things:

• Safekeeping of funds and operations. The SEC”s staff will examine broker-dealers to understand operational activities, including operations that are unique to the safety and custody of Digital Asset Securities. To this end, the SEC has previously issued a July 2020 and December 2020 statements as well as a September 2020 no-action letter.

• Registration requirements. Examinations will include broker-dealers’ and any affiliated entities’ compliance with registration requirements. For example, if an affiliate of a registered broker-dealer engages in the business of effecting transactions in Digital Asset Securities for the accounts of others, that affiliate may be required to register as a broker-dealer.

• Anti-Money Laundering (AML). Broker-dealer AML programs that have not consistently addressed or implemented routine searches or, to the extent they implemented routine searches, have not updated those searches to check against the Specially Designated Nationals list maintained by the Office of Foreign Assets Control (“OFAC”) at the U.S. Department of the Treasury. The staff also has observed inadequate AML procedures, controls, and documentation regarding Digital Asset Securities.

• Offerings. Broker-dealers may be involved in underwriting and private placement activity with respect to Digital Asset Securities, which can raise unique disclosure and due diligence obligations. Examinations will include a review of the due diligence performed by broker-dealers, and the disclosures made by broker-dealers to customers related to the offering of Digital Asset Securities.

• Disclosure of conflicts of interest. Broker-dealers may operate in multiple capacities, including as trading platforms or proprietary traders of Digital Asset Securities on their own and other platforms. Examinations will include a review of the existence and disclosures of conflicts of interest and the compliance policies and procedures to address them.

• Outside Business Activities. Broker-dealers have offered services related to digital assets apart from their employer. FINRA-member broker-dealers must evaluate the activities of their registered persons to determine whether such activity constitutes outside business activities or an outside securities activity and therefore should be subjected to the approval, supervision, and recordation of the broker-dealer.

The full Risk Alert document can be viewed here.