Financial Times – Bitcoin poses awkward dilemma for wealth managers

June 2018

The frenzy that in the past 12 months saw bitcoin soar to a record $19,500 in December and then touch below $6,000 this month has split financial advisers over whether to let their clients invest in cryptocurrencies.
In the brokerage space, both Merrill Lynch and Morgan Stanley are known to have banned brokers from recommending bitcoin and refuse to trade the instrument. In February, Bank of America began declining credit card transactions with known cryptocurrency exchanges.
Most registered investment advisers (RIAs) keep their clients away from cryptocurrencies for fear of falling foul of their fiduciary obligations.
The fiduciary duty means RIAs are required to put their clients’ best interests first, and it is widely held that cryptocurrencies are far too risky for most retail investors.
Underscoring that idea, Jay Clayton, Securities and Exchange Commission chairman, told CNBC earlier this month that the US regulator had no plans to reclassify cryptocurrencies as securities — a move that 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,” Mr Clayton said.
Jesse Clinton, a senior partner in the New York office of Snowden Lane Partners, an FT 300-ranked RIA, says he would do everything he could to talk clients out of investing in cryptocurrencies.
However, he says if a client had a strong case for “being involved in bitcoin”, Snowden would allow Mr Clinton as a fiduciary to monitor the client’s investment as part of their overall asset allocation — and even point the client towards public exchanges where the coins are traded. But neither the firm nor the adviser could be involved in the transaction itself.
Yet Mr Clinton is no cryptocurrency naysayer. He holds bitcoin in his personal investment portfolio and actively mines the instrument from a server he has set up in his home.
“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 Mr 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.”
Mr Clinton goes a step further and says RIAs who simply avoid cryptocurrencies by hiding behind fiduciary responsibility are taking the easy way out, rather than truly fulfilling their fiduciary duty to their clients and taking 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 and agrees they 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 Mr Spangler. “Chief among them is the perceived volatility and risky nature of the instruments, and the apparent possibility of fraud.”
Mr Spangler says these barriers are not necessarily regulatory in nature, but rather come from a lack of understanding of the market. From a fiduciary and risk perspective many other instruments — such as volatility indices and certain futures contracts — look just as hard to justify in a client portfolio.
As with any asset, RIAs should not put client money into investments they do not understand, says Mr Spangler. “We wouldn’t have had the Madoff scandal if people invested in instruments on which they’d done adequate due diligence,” he says, referencing the largest Ponzi scheme in history in which Bernard Madoff convinced clients to invest in an opaque and fraudulent investment fund.
One significant regulatory consideration for advisers operating under a fiduciary duty is their responsibility to clearly identify the electronic physical location and ownership of assets, says Mr Spangler, explaining that owners of bitcoin often leave their assets with an exchange or financial custodian.
Mr Clinton foresees a point in the next couple of years where RIAs may be forced to understand cryptocurrencies and ultimately trade them, as the instruments move further into the mainstream.
While the majority of RIAs are still hesitant to put bitcoin in client portfolios, Mr Spangler points to 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 advisers. Surely it makes sense to give these retail investors the benefit of good asset allocation advice and greater regulatory protection.”
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