In the midst of a cryptocurrency frenzy -- which in the last 12 months saw bitcoin soar from $2,659.63 on June 12, 2017 to an all-time high of $19,497.40 on December 16 and close yesterday at $6,615 -- financial advisors are split on the subject of letting their clients invest in the medium. In the broker-dealer space, both Merrill Lynch and Morgan Stanley are known to have banned their brokers from recommending bitcoin and refuse to trade the instrument. In February the brokerages' parent company, Bank of America, began declining credit card transactions with known cryptocurrency exchanges.
But in the RIA space the lines are less clear. Most RIAs won’t let their clients anywhere near cryptocurrencies. And there’s a crucial legal reason why RIAs would be hard-pressed to let their clients invest in bitcoin: It might not be fiduciarily responsible.
Under their fiduciary duty, putting their client’s best interests first, many RIAs think cryptocurrencies are far too risky for most retail investors.
Enforcing the idea that cryptocurrencies are risky business, last month SEC Chairman Jay Clayton told CNBC the U.S. regulator would not be defining cryptocurrencies as securities anytime soon – a move which would allow RIAs to actively trade the instruments.
“We are not going to do any violence to the traditional definition of security that has worked for a long time," Clayton told the television news network.
Jesse Clinton, an advisor in the New York office of Snowden Lane Partners, says he would personally do everything he can to talk clients out of investing in cryptocurrencies. His firm does not hold or trade the assets.
Clinton says if a client had a good case for “being involved in bitcoin,” Snowden Partners would allow him, as a fiduciary, to monitor the client’s investment as part of the client’s overall asset allocation – and even point the client towards public exchanges where the coins are traded. But for compliance reasons owing to their fiduciary duty, neither the firm nor the advisor could be involved in the transaction itself.
Yet it would be wrong to cast Clinton as a cryptocurrency naysayer. Clinton personally holds bitcoin in his own investment portfolio and actively mines the instrument from a server he has set up in his house. In fact, some might call him a cryptocurrency evangelist, albeit one fully aware of his responsibilities to his clients.
“I set up a bitcoin server so I could educate myself on cryptocurrencies and be the guinea pig, so my clients don’t have to be,” says Clinton. “It is our job to understand these instruments and advise our clients on their suitability, regardless of whether we execute the transaction or not.”
Those RIAs who simply avoid cryptocurrencies by hiding behind their fiduciary responsibility are taking the easy way out, Clinton says, rather than truly fulfilling their fiduciary duty to their clients and taking the steps to understand bitcoin.
Timothy Spangler, a partner in the Silicon Valley office of law firm Dechert, has also seen a reticence among RIAs to deal with cryptocurrencies but agrees RIAs owe their clients a duty to become familiar with the instruments.
“There are a lot of hurdles RIAs need to overcome to put bitcoin in a client’s portfolio,” says Spangler. “Chief among them is the perceived volatility and risky nature of the instruments, and the apparent possibility of fraud.”
But while most RIAs are convinced they cannot recommend or trade bitcoin for their clients, Spangler says these hurdles are not necessarily regulatory in nature, but rather come from a lack of understanding of the market. From a fiduciary perspective many other instruments – such as volatility indices and certain futures contracts – look just as hard to argue in terms of placement in a client portfolio.
“Like any risky asset, RIAs shouldn’t put client money into investments they don’t understand,” says Spangler. “We wouldn’t have had the Madoff scandal if people invested in instruments on which they’d done adequate due diligence,” he adds, alluding to the largest Ponzi scheme in history, perpetrated by Bernie Madoff, who convinced his clients to invest in an opaque – and ultimately fraudulent – investment fund.
One key regulatory consideration for advisors operating under a fiduciary duty is their responsibility to clearly identify custody of the assets, says Spangler, explaining that until recently there were not a lot of options for institutional money looking for bitcoin custodians.
“RIAs that do their due diligence will find custodians which comply with the SEC’s custody rules,” says Spangler.
Movements in the area of custody services include a January announcement from crypto-security firm BitGo Inc., which revealed plans to buy regulated bitcoin custodian Kingdom Trust, with the intent to attract as much as $20 billion in digital currencies from institutional investors.
Clinton sees a time in the not-so-distant future – “maybe even in the next 12 to 18 months” – when RIAs will be forced to understand cryptocurrencies and ultimately trade them, as the instruments move further into the mainstream.
Yet with the majority of RIAs still hesitant to put bitcoin in client portfolios – arguably hampered by a regulatory landscape which may still seem to them opaque – ultimately Spangler cites a consumer protection argument for more participation. “There’s a huge amount of ma-and-pa money already invested in the space without the help of financial advisors. Surely it makes sense to give these retail investors the benefit of good asset allocation advice and greater regulatory protection.”