Should Wall Street executives trading and processing digital securities transactions be legally required to pass licensing or mandatory in-house training programs?
The answer to the question raised in a comment letter sent to the US Securities and Exchange Commission in April concerning its December 2020 framework for the custody of digital securities appears to be a resounding no. Cryptoasset practitioners and legal experts interviewed by FinOps Report say that cryptoasset trading and post-trade processing executives will do just fine learning on the job, listening to webinars, and attending educational programs. It isn’t necessary to mandate any accreditation specific to cryptoassets simply because of the unique technology used to trade and process transactions. All investors must do is ask the right questions. “The SEC views digital securities– those using blockchain technology — the same as other securities,” Richard Levin, chair of the financial technology and regulation practice at the law firm of Nelson, Mullins, Riley & Scarborough tells FinOps Report. “However, investors should proceed with caution when investing in the asset class and should consider the trading strategy, risk controls and number of years of experience with similar asset classes.” Similar products include over-the-counter derivatives and precious metal commodities.
As part of a new alternative asset class cryptoassets, such a tokens and cryptocurrencies, initially attracted the attention of retail investors, but institutional investors are now showing an interest because of the high rate of return. The job market for cryptoexecutives is booming with employment website CryptoJobsList.com recently showing over 3,000 listings from large cryptoexchanges, banks and smaller concerns in the decentralized finance space. Boston-based asset manager Fidelity just announced it wants to fill 100 spots in its Salt Lake City, Boston, and Dublin offices with finance, compliance, operations, and technology cryptospecialists. Based on the required qualifications for candidates, prospective employers appear to be looking for comparable experience in financial services or technology, rather than cryptospecific credentials. Naturally, an understanding of the cryptomarket will likely be a competitive edge.
Nicholas Bruno and Tyler Yagman, who identified themselves as third-year law students at Hofstra University’s Maurice A. Deane School of Law in New York were among the signatories to the April comment letter and the only respondents to the SEC’s request for comment on its December 2020 announcement to advocate for mandatory training and certification exams. Their rationale: just as human mistakes due to ignorance can cause the loss or theft of a digital asset, the right knowledge can mitigate those risks. “The Co-Authors propose the SEC require broker-dealers dealing digital assets to train employees at minimum annually,” write the authors adding that the training should be on mitigation of reasonably preventable attacks stemming from human error, lack of technological accuracy, and blatant carelessness. They go on to propose the SEC create a “unique licensing examination for principals, registered representatives, as well as other relevant employees of a broker-dealer who want to engage in digital asset trading and storage,” The authors suggest that the exam include questions on the technology underpinning cryptoassets and hypothetical risk scenarios about compliance, general trading, and storage of digital assets. Because the digital asset space is quickly evolving continuing education should also be required, they say. Bruno and Yagman also co-chair the blockchain subcommittee of the New York City Bar Association’s Informational Technology and Cyber Law Committee. The other authors of the letter were Philip Dursey, David Ackerman, and Ariel Deschapell. Dursey is the founder of Keyed, a London-based cryptocurrency security consultancy while Ackerman, an attorney, is the regulatory subject content expert at NICE and NICE Actimize. Deschapell is the head of engineering at Lincoln Network. The authors declined to comment for this article.
Bowing to industry pressure for regulatory clarity, the SEC decided to allow broker-dealers to safekeep digital securities through separate special-purpose broker-dealers (SPBDs) following specific oversight rules. The SEC would work with the Financial Industry Regulatory Authority, the broker-dealer watchdog, to approve the new member applications of SPBDs, leading market players to be concerned about potential delays. The consensus of those responding to the SEC’s request for comment on its December 2020 announcement is that the regulatory agency is unfairly highlighting digital assets as riskier than other asset classes and creating SPBDs would be too expensive. That same rationale appears to be the case when it comes to requiring certification and training of crypto securities trading and operations professionals. “Larger broker-dealers and other financial institutions might be okay with certification and training requirements as they have deep pockets to meet the additional cost within their compliance infrastructure, but smaller firms might think the requirements are cost prohibitive,” Todd Kornfeld, an attorney specializing in blockchain and capital markets at Troutman Pepper in New York tells FinOps Report. “Likewise, some institutional investors might be happier with required certification or education programs, while others might not feel the need.”
The distinction between using distributed ledger technology from other technologies when executing and processing digital securities trades should not be the driving force behind mandated certification or training, say other attorneys. “Digital asset securities are a new asset class, but why require firms of having their executives pass an SEC certification exam or a cryptoasset-specific FINRA exam simply because of blockchain technology,” says Joel Telpner, of counsel at the blockchain and fintech practice of the law firm of Sullivan & Worcester in New York. “When the US migrated from certificated holdings to book-entry holdings there weren’t any additional certification requirements, so why there should not be for digital assets.” The term book-entry refers to blips on computer screens as providing evidence of securities ownership, rather than requiring physical certificates to do so.
However, Telpner believes that over time as distributed ledger technology changes how digital asset transactions are processed — as could be the case with real-time settlement or the elimination of netting– existing certification exams will need to change accordingly. Marlon Paz, head of the broker-dealer practice at the law firm of Mayer Brown, believes that the SEC could ensure investor protection by having FINRA adapt its current exams to incorporate cryptoassets. “The questions could be focused on the specific function of the broker-dealer executive,” he says. For example, the SEC could include questions regarding the suitability of crypto assets for a particular investor in its Series 7 exam which registered representatives at broker-dealers are required to pass. The SEC could also include questions about on its Series 27 exam on the valuation, possession, and control of crypto assets while the Series 99 exam could include questions about the transfer of ownership of cryptoassets, says Paz who has represented some crypto asset firms. FINRA’s Series 27 exam, otherwise known as the FinOp exam, licenses financial and operations principals while the Series 99 exam is dedicated for operations managers. In a statement to FinOps Report, a spokesman for FINRA would not specify whether FINRA is planning to add specific questions on cryptoassets or blockchain technology to its qualification exams. All he would say is the following: “The FINRA qualifications exams test, among other subject matter, a candidate’s knowledge about products that fall under the definition of a security. An individual must pass the exams prior to engaging in the securities activities in which he or she will work. In general, digital assets may or may not be considered securities. FINRA will continue to monitor the development of such assets.”
Part of the problem in deciding whether crypto asset traders or operations managers should be subject to licensing or certification specific to crypto assets is that there is no uniformity in the asset class says Levin of Nelson Mullins Riley & Scarborough in Denver. Some digital assets are securities, while others are commodities. and others are digital currencies. The SEC’s December 2020 pronouncement on digital asset custody relates to only those financial instruments which fall in the category of securities. The more popular crypto assets, such as Bitcoin and Ethereum, are not classified as securities, so the trading of those assets fall outside the SEC’s jurisdiction leaving the Commodity Futures Trading Commission or the US Treasury’s Financial Crimes Enforcement Network, and state banking regulators to decide on the proper oversight.
Currently, firms trading in cryptocurrencies or crypto securities are not registered as broker-dealers, but as money transmitters in different states. To earn that designation, they must convince state regulators they will take extra precautions to ensure that crypto assets aren’t used for money laundering or other nefarious purposes. None of the firms contacted by FinOps Report wanted to discuss their training programs and insisted that any type of accreditation or certification requirement was unnecessary. They insist that their compliance programs provide a detailed analysis for what employees should and shouldn’t do; therefore, investors have nothing to worry about.
A testing or certification requirement is not as important as a carefully thought-out compliance program based on the specific risks to a firm’s business, according to Jeffrey Blockinger, chief legal officer for Jersey City, New Jersey-based CrossTower, a digital asset exchange operator. All employees should be trained on the basics of distributed ledger technology and cryptoassets with some receiving additional training depending on their specific function. “A chief information security officer would need to know all about the different types of storage of crypto assets and how to protect loss of the private key to access the assets,” says Blockinger. CrossTower is a registered exchange in Bermuda and a money transmitter in several US states. Alan Konevsky, chief legal officer for New York-based TZERO Group, whose broker-dealer subsidiary operates a trading platform for digital securities, worries that mandating certification or training will have an unnecessary chilling effect on innovation in the crypto asset market. “Investor protection is very important, but we also need to be mindful of balkanizing the industry based on technology and must balance the marginal costs and benefits of additional exams with encouraging innovation and growth,” he says. “The existing FINRA exams are comprehensive enough to license professionals based on the different functions involved and if appropriate they can cover operational and compliance topics flowing out of digital assets.”
Given that no one knows what the SEC will ultimately decide on how broker-dealers can safekeep digital securities, it is too soon to predict whether new certification or training programs will be required. “We can’t put the cart before the horse.” says Telpner. The SEC could decide to allow broker-dealers trading in digital assets to pick third-party custodians without creating SPBDs as many market players hope. In a worst-case scenario, broker-dealers will either bite the bullet and absorb the administrative burden and cost or forget about doing any custody work for digital assets.