What Financial Advisors Need to Know

With cryptocurrency markets hovering at a global market capitalization of over $1.5 trillion, financial advisors are engaging with clients who already own crypto and others with questions about investing in digital assets. Unfortunately, uncertainties around crypto regulations could create dilemmas for financial advisors when they discuss or recommend crypto investments—for those that do.

A 2024 Cerulli Associates report found that 13.7% of financial advisors use or confer on cryptocurrency with their clients, including just 2.6% offering their recommendations. Meanwhile, more than a quarter of advisors expect to guide clients on cryptocurrency investments in the future, with more than half never expecting to do so. “Advisors are trained to dismiss shiny new alternative investments that boast spectacular returns, as such opportunities often prove too good to be true and unsafe for client funds,” Christina Lynn, a behavioral finance researcher and certified financial planner at Mariner Wealth Advisors, told Investopedia.

Crypto ETFs have emerged as the most popular choice for many who want to get into crypto, offering simplicity and integration with traditional brokerage accounts. These come in two forms: spot ETFs which directly hold cryptocurrencies, and futures ETFs, which use futures contracts to track crypto prices. Spot bitcoin and ether ETFs, given the go-ahead in 2024, provide direct exposure to these digital assets, while futures ETFs offer an alternative way to gain crypto exposure through standardized agreements. “The ETF wrapper increases ease of access to bitcoin and helps investors or speculators avoid some of the risks of direct, wallet-based crypto holdings,” said David Tenerelli, a certified financial planner at Strategic Financial Planning in Plano, Texas.

That makes it all the more crucial for financial advisors to know the regulatory landscape for cryptocurrencies well. Below, we’ll consider how the SEC regulates digital assets, the impact of recent court decisions, and what it all means for financial advisors who want to stay compliant with securities laws while offering clients the most complete and best advice.

Understanding Crypto Regulations

The crypto space is rife with cutting-edge legal cases, and advisors have a fiduciary duty to act in their client’s best interests, which means taking all reasonable steps to protect them from financial harm and legal problems. Educating clients about regulatory risks can help them avoid crypto practices that turn out to be scams, frauds, or market manipulation. Gary Gensler, the SEC chair, hasn’t minced words about the problem, saying in 2024 that “the whole field is rife with abuses and fraud.”

Despite all this, Lynn remains relatively bullish on crypto-related products overall. There’s genuine value to be found in this space, she said. “Crypto … represents the biggest technological and economic shift since the internet.”

Understanding regulations can also improve the quality of investment analysis a financial advisor provides crypto clients. Regulations offer a framework for evaluating the legitimacy of their financial portfolio and potential returns on digital assets. A crypto product or company with significant legal and regulatory risks is unlikely to perform well in the long term and hold stable financial and monetary value.

Unfortunately, with so much regulation around the cryptocurrency market remaining unsettled, financial advisors might feel like they’re walking a compliance tightrope regarding crypto assets.

Multiple financial regulators have developed existing regulations that may apply to crypto assets and allow them to be analogized to traditional assets. Each has a specific focus, set of responsibilities, and jurisdiction.

Crypto Financial Regulators

• Securities and Exchange Commission (SEC): The SEC oversees the issuance and sale of securities, including digital assets that meet the definition of securities. This means cryptocurrencies considered securities must be registered with the SEC and follow its regulations.
• Commodity Futures Trading Commission (CFTC): The CFTC regulates derivatives and futures contracts, including those based on cryptocurrencies. This means trading in crypto futures and options falls under the CFTC’s purview.
• Financial Crimes Enforcement Network (FinCEN): FinCEN is responsible for combating money laundering and terrorist financing, including regulating digital currency exchanges and other entities involved in crypto transactions.
• Internal Revenue Service (IRS): The IRS treats cryptocurrencies as property for tax purposes, meaning gains and losses from crypto transactions are subject to capital gains taxes.
• Office of the Comptroller of the Currency (OCC): The OCC regulates national banks and has issued guidance on how banks can engage in crypto-related activities.
• Federal Deposit Insurance Corporation (FDIC): The FDIC insures deposits of member banks, and it has issued guidelines on how banks can manage risks associated with crypto activities.
• Federal Trade Commission (FTC): The FTC protects consumers from unfair and deceptive practices, including those related to cryptocurrencies.

SEC’s Role in Crypto Regulations

While other agencies, such as the CFTC and FinCEN, play important roles in regulating crypto, the SEC has broad authority that gives it the power to influence judicial precedent and bring enforcement actions that make it the most consequential financial regulator for cryptocurrencies. These outcomes can cause uncertainty among investors, potentially leading to sell-offs and declining crypto asset prices, especially when the agency targets significant players in the industry or exposes fraudulent and manipulative practices.

The SEC has the authority to produce rules that govern the fair and orderly conduct of securities market participants, including digital currencies that meet the definition of securities, encompassing a significant part of the cryptocurrency market. Crypto banks, exchanges, broker-dealers, investment advisors, and other entities that handle crypto assets will be breaking the law and opening themselves up to costly and potentially operationally ruinous legal trouble if they violate these rules.

Among the outcomes available, the SEC can seek penalties and cease-and-desist orders, bring civil enforcement actions, refer cases for criminal prosecution, and issue discovery requests to examine records to look for violations of securities laws. The SEC can’t press criminal charges that extend to prison time, but it often refers cases to the Federal Bureau of Investigation and the U.S. Department of Justice for criminal prosecution.

On its own, though, it can only bring civil claims under lawsuits that seek monetary or injunctive relief. Injunctive relief could include seeking an administrative or federal court order that a crypto asset or company discontinue a product or shut down entirely.

SEC Crypto Rules

“There is no comprehensive federal regulation of any type of digital assets or cryptocurrency,” said V. Gerard Comizio, associate director of business law programs at American University’s Washington College of Law and author of “Virtual Currency Law: The Emerging Legal and Regulatory Framework.” What, then, are advisors and investors to go off of?

The SEC has taken a cautious approach to outlining new rules tailored specifically to cryptocurrency. Instead of producing new regulations, the SEC has used existing rules, often charging crypto issuers and companies for securities laws, recordkeeping, fraud, manipulation, trading, and custodian violations under federal acts and judicial codes already enshrined in civil law. Grewal said, “Some of our critics argue that new, bespoke rules and regulations are needed for this particular industry. They believe that this is best achieved either through notice and comment agency rulemaking or by Congress developing an entirely new regulatory framework for crypto assets. ” He defended the SEC’s enforcement of crypto as simply following the laws and regulations that work as they are. “The history of our securities laws makes clear that Congress always intended the definition of what is a security to be principles-based and flexible to cover the many kinds of schemes where promoters seek others’ money and promise profits in return.”

Here are some of the most relevant regulations:

• Securities Act of 1933 (Securities Act): The Securities Act regulates the issuing and selling of securities to the public, including registration requirements, anti-fraud provisions, and civil liability provisions.
• Securities Exchange Act of 1934 (Exchange Act): The Exchange Act regulates securities trading on exchanges and over-the-counter (OTC) markets, including anti-fraud provisions, insider trading prohibitions, and market manipulation rules.
• Investment Company Act of 1940 (Investment Company Act): The Investment Company Act regulates investment companies, such as mutual funds and hedge funds, including disclosure requirements, valuation standards, and investor protection provisions.
• Investment Advisers Act of 1940 (Advisers Act): The Advisers Act regulates investment advisers, who manage investment portfolios for clients, including registration requirements, fiduciary duties, and anti-fraud provisions.
• Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act): The Sarbanes-Oxley Act affected corporate ethics and enhanced corporate governance and accounting standards, including auditor independence requirements, financial reporting obligations, and corporate accountability provisions.
• Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act): The Dodd-Frank Act reformed the financial industry following the 2007-2008 financial crisis, including increased regulatory oversight of financial institutions, consumer protection measures, and derivatives market regulation.

The SEC relies on judicial precedent and legal interpretations of securities laws to enforce these laws and bring charges against violators. In addition to these federal laws, state securities laws and enforcement agencies often complement the work of the SEC.

One area of keen interest to investors has been whether cryptocurrencies are classified as securities. Securities are subject to SEC rules and disclosure standards, creating extensive legal liability. The SEC hasn’t declared all cryptocurrencies securities, opting to act in specific cases.

How the SEC Determines If Cryptocurrencies Are Securities

The SEC’s stance on the securities classifications of cryptocurrencies is based on the principles established by the Howey Test, a legal framework used to determine whether an asset is considered a security. Applying the Howey Test to cryptocurrencies, the SEC has determined that certain digital assets—such as those with clear ownership and control structures and where investor profit-taking depends on the efforts of others—may be considered securities.

The SEC has acknowledged that not all cryptocurrencies will meet the definition of securities. The SEC has also said that an asset with non-speculative uses, such as those used for paying for goods or services, is less likely to be a security. For instance, the SEC has deemed bitcoin, the most well-established cryptocurrency recognized by its trading ticker BTC, a commodity because of its decentralized nature and lack of a clear promoter or issuer.

SEC Disclosure Standards

As part of its wary stance on cryptocurrency assets, the SEC has yet to finalize disclosure standards tailored specifically to crypto enterprises. However, the SEC has outlined general disclosure principles that apply to all issuers, including those that offer crypto assets. Here are some key disclosure standards that the SEC expects crypto enterprises to follow:

Description of the Business

Issuers must clearly and concisely describe their business, including their products, services, and target markets. It should explain in detail how crypto assets are used in the business and the risks associated with these assets.

Risk Factors

Issuers must disclose all material risks associated with their business, including those specific to crypto assets. These risk disclaimers should mention technology, market volatility, regulatory uncertainty, and cybersecurity.

Financial Statements

Issuers must provide audited financial statements prepared following generally accepted accounting principles or other applicable accounting standards. Financial statements help investors understand the issuer’s financial condition and performance.

Management Discussion and Analysis (MD&A)

Issuers must give an MD&A that discusses the issuer’s financial condition, results of operations, and liquidity. An MD&A should discuss the issuer’s plans for future growth and how crypto assets will play a role.

Corporate Governance

Issuers must disclose their corporate governance practices, including the composition of their board of directors, executive compensation, and auditor independence. Governance practices help investors assess the issuer’s commitment to transparency and accountability.

In addition to these general disclosure principles, the SEC may require crypto enterprises to disclose additional information specific to their business models and crypto assets. Such information could include the tokenomics of the asset, the security of the underlying blockchain, and the issuer’s plans for future updates or changes to the asset.

The SEC’s goal in imposing disclosure standards on crypto enterprises is to ensure investors can access the information they need to make informed investment decisions. Unfortunately, FINRA has found that investors are often misled in this area.

Financial Industry Regulatory Authority’s Role

The Financial Industry Regulatory Authority (FINRA) is a self-regulatory organization that oversees broker-dealers in the U.S. while operating under the supervision of the SEC. FINRA creates and enforces rules for its members, while the SEC oversees FINRA’s operations and can override its decisions. For the most part, FINRA and the SEC have cohered in their approaches to crypto. FINRA, for example, has warned many times about the sales pitches it’s been seeing for crypto—many brazenly crossing the line from product enthusiasm into irresponsibility and then fraud.

For example, a 2024 FINRA study found that member firms were too often running afoul of FINRA Rule 2210 (Communications With the Public), which “prohibits claims that are false, exaggerated, promissory, unwarranted, or misleading.” FINRA found that seven of every 10 of the crypto-related retail communications it reviewed had substantive violations of FINRA rules.

“With the growth in this market and increased interest in crypto assets, the potential harm caused by problematic communications has also increased,” said Ira Gluck, FINRA’s senior director of advertising regulation, on a FINRA podcast related to the study. “We’ve been concerned about how communications discuss the protections offered through the federal securities laws or FINRA rules… However, there are no such protections for accounts held at crypto asset entities.”

FINRA’s study also found an extraordinary amount of crypto-related communications that suggested that FINRA or the SEC endorsed particular assets—not that the SEC simply allowed them to be traded. Here are the significant issues Gluck said FINRA found, a handy list of what not to do as a financial advisor :

• Blurred lines: Many communications didn’t distinguish between crypto offerings from affiliates and their own products, a clear conflict of interest.
• Cash confusion: Many falsely implied crypto assets are as liquid regular currency. They’re not.
• Dishonest comparisons: Crypto was also often compared favorably with stocks or cash.
• Distortions: Complex features and risks of crypto assets were often explained unclearly or incompletely.
• Missing material facts: Many communications lacked clear explanations of how crypto is issued, held, transferred, or sold.
• False security claims: Some misrepresented the level of regulatory protection for crypto investments.
• SIPC misinformation: Most FINRA-regulated brokerage firms must be members of the Securities Investor Protection Corporation (SIPC). This non-profit organization protects investors’ cash and securities should a brokerage firm fail. FINRA found many communications suggesting that SIPC covers the crypto assets marketed or discussed. It does not.

Crypto ETFs

The SEC approved the listing and trading of several spot bitcoin ETFs in early 2024, which allow these ETFs to trade and hold actual bitcoin tokens in their portfolios. This followed earlier approvals of crypto futures ETFs (2021 for bitcoin futures, 2023 for ether futures). As we reported in March 2024, the SEC followed up the spot bitcoin ETF approval by focusing on the difference between ether and bitcoin’s cryptocurrency models. By mid-year 2024, it had given the go-ahead to spot ether ETFs and was reviewing applications by Grayscale and other major fund managers.

Previously, investors could only purchase bitcoin and ether on cryptocurrency exchanges and hold them in a digital wallet. This approach offers direct ownership of the cryptocurrency but also involves securely storing and managing the private keys. Thus, 2024 was the year cryptocurrencies fully entered the mainstream, with investors able to buy exchange-traded shares of pools of crypto futures or those holding the crypto directly. Investing in spot ether or spot bitcoin ETFs offers a more accessible and regulated route. These ETFs provide investors with exposure to the price moves of ether or bitcoin without needing to hold the cryptocurrency directly.

SEC Crypto Investigations and Enforcement

Despite approving crypto ETFs the past several years, the SEC has been very vocal about its concerns about crypto-related frauds. Promoters are trying to “capitalize on the promise of easy money, without providing the detailed investor protection disclosures required by the registration provisions of the federal securities laws,” said Gurbir S. Grewal, director of the SEC’s Division of Enforcement.

In 2023, the SEC brought 46 enforcement actions related to cryptocurrencies, a 53% increase over 2022. High-profile cases included charges against Binance, Coinbase, and other major exchanges for operating as unregistered exchanges. These cases were part of the SEC’s efforts to regulate the growing crypto market, especially as its assets have been brought within regulated exchanges through the holdings of mutual and exchange-traded funds.

Advisors can address compliance requirements by becoming familiar with the circumstances of these actions and the cases we discuss further below. Below are just some of the recent cases the SEC has brought involving crypto assets and companies:

1. CryptoFX Ponzi Scheme (March 2024): A $300 million scheme targeting Latino investors led to charges against 17 individuals.
2. HyperFund (January 2024): Two individuals were charged with a $1.7 billion global crypto pyramid scheme.
3. Kraken (November 2023): The popular exchange faces charges for operating as an unregistered securities exchange, broker, and dealer.
4. SafeMoon (November 2023): The SEC alleged a massive fraud scheme involving the SafeMoon token and its creators. The name was part of its pitch: The SEC’s complaint alleged the defendants promised to take the token’s price “safely to the moon.” The price landed elsewhere, with $200 million in investor funds disappearing.
5. CoinDeal (September 2023): Two individuals were charged for a scheme promising over-the-top trillion-dollar returns. In July 2024, the SEC received default judgments worth $45 million in the case.
6. SEC v. Coinbase Global, Inc. (June 2023): The SEC charged Coinbase Global, Inc., one of the largest cryptocurrency exchanges, alleging that Coinbase was operating as an unregistered securities exchange and broker and for not registering its crypto assets as securities. The SEC also alleged that Coinbase was making false and misleading statements about its compliance with securities laws. The lawsuit is ongoing, and Coinbase has denied the allegations.
7. SEC v. Samuel Bankman-Fried (December 2022): The SEC charged Samuel Bankman-Fried, the founder of the collapsed FTX cryptocurrency exchange, with orchestrating several schemes to defraud investors in FTX. Bankman-Fried was convicted in March 2024, sentenced to 25 years in prison, and ordered to forfeit $11 billion.
8. SEC v. Kim Kardashian (October 2022): The SEC sued Kim Kardashian for promoting a cryptocurrency operating as a security on social media without disclosing that she had received a $250,000 payment for the promotion.

Impact of SEC Crypto Actions

The SEC has procedures it follows with every enforcement action, consisting of an investigation, an informal warning, a Wells notice, and so on, until formal charges and adjudication, if need be. The investigation could include issuing subpoenas for records and meeting with executives to discuss a company’s compliance with securities laws—called a Wells meeting.

If the SEC’s investigation uncovers potential violations of securities laws, the SEC may issue a Wells notice to the crypto business, outlining the SEC’s allegations and giving the company a chance to respond before the SEC takes any further action. In September 2022, the SEC sent the largest crypto exchange, Binance, a Wells notice, indicating it was considering an enforcement action against the cryptocurrency exchange. That same month, Coinbase, another major crypto exchange, said the SEC had “privately” threatened to sue the company for offering the Coinbase Lend program as an unregistered security. However, it also said it didn’t know why the SEC was taking any action at all. In any event, Coinbase later announced it would discontinue the release of the Lend program.

That didn’t stop the SEC’s investigations of the company. In March 2023, the SEC issued a Wells notice to Coinbase. The notice indicated the SEC’s consideration of potential enforcement actions against Coinbase, potentially leading to fines, disgorgement (repaying ill-gotten gains), and registration requirements. Here’s the Well notice the SEC provided to Coinbase:

While a Wells notice is usually sparing of details—it mentions the laws or regulations involved but little else to avoid giving the SEC’s case away too soon—a would-be defendant’s reply to the SEC, called the Wells submission, can number in the hundreds of pages. This is because defendants are often trying to catch all possible counters to potential cases the SEC might be considering.

Here’s the Coinbase submission provided to the SEC in April 2023:

The submissions did little to convince the agency, which filed formal charges in the case two months later.

Best Practices for Advisors After Recent Court Rulings and SEC Moves

While many advisors opt to steer clear of crypto, this approach could alienate potential or current clients seeking guidance in this rapidly growing realm. “Advisors and firms can avoid crypto altogether, but that approach fails to properly serve clients who want exposure to this asset class,” Ric Edelman, author of “The Truth About Crypto” and other personal finance books, told Investopedia. “It also places advisors and firms at risk of losing assets under management—and reputation—by failing to demonstrate to clients that they can rely on their advisors for up-to-date advice and investment opportunities.”

There are ways financial advisors can navigate the crypto waters safely, he suggested. Edelman said one way is to “provide clients with crypto exposure, but limit those investments to SEC-registered securities.”

These securities need not directly deal in the asset but could provide indirect exposure to crypto. Edelman pointed to examples like the stocks of companies engaged in the crypto industry, OTC-traded grantor trusts, crypto-themed stock ETFs, bitcoin and ether futures ETFs, and crypto-invested individual retirement accounts (IRAs). Here is a table of the options Edelman discussed:

“No compliance officer can legitimately object to the use of products like these,” said Edelman. “Crypto might be speculative, but an ETF that invests in publicly traded stocks of companies engaged in blockchain technology can hardly be called impermissible.”

Regardless of the strategy, financial advisors open to working with investors in the asset class will need to balance their clients’ desire for exposure with uncertainties over crypto given the SEC enforcement actions and recent court decisions. By understanding the existing regulatory groundwork and staying up to date on the latest court developments, advisors can better assess the pervasive risks of crypto investments, stay compliant with professional legal duties, help clients make informed decisions, and maintain clients’ trust and confidence.

Other than looking to legal rulings for regulatory direction, advisors can consult with the SEC’s Investor Advocate, review the SEC’s investor alerts, and read the SEC’s guidance on digital assets.

The Investor Advocate provides information and assistance to investors about many topics, including the SEC’s views on cryptocurrencies. Investor alerts and guidance materials discuss potential scams, frauds, and legal interpretations.

Outlook for SEC Crypto Regulations

In each crypto case, the SEC faces the challenge of proving that specific crypto offerings qualify as securities and should be regulated as such. In July 2023, a U.S. District Court ruled that Ripple’s XRP token is not a security, rejecting the SEC’s stance. This decision was part of a broader challenge to the long-standing “Chevron deference,” which typically grants federal agencies significant leeway in their interpretations and derives from a 1984 Supreme Court case.

An unrelated case, Loper Bright Enterprises v. Raimondo, would undo that deference altogether in 2024. The Supreme Court’s ruling in that case, paired with its majority opinion in SEC v. Jarkesy (also June 2024), could mean a very rocky road ahead for the SEC in regulating and bringing cases against cryptocurrency firms.

The End of Chevron: What’s Next?

The Supreme Court’s decision in Loper Bright Enterprises v. Raimondo marked a significant shift in the balance of power between federal agencies and the judiciary. By overturning the long-standing principle of “Chevron deference,” the court fundamentally altered how ambiguities in regulatory law are to be interpreted. Justice Elena Kagan’s dissent highlighted the far-reaching implications of the decision. “In one fell swoop, the majority today gives itself exclusive power over every open issue—no matter how expertise-driven or policy-laden—involving the meaning of regulatory law,” Kagan wrote.

The case directly affects the SEC’s ability to rule on what counts as securities since, under Chevron, courts have generally needed to find the regulator far afield of its other practices to rule against it. Courts have given the SEC, like other regulatory agencies, deference over its area of expertise. For example, in finding for the SEC in her March 2024 U.S. District Court ruling against Coinbase, Judge Katherine Polk Failla wrote, “The SEC has a long history of proceeding through such actions to regulate emerging technologies and associated financial instruments within the ambit of its authority as defined by cases like Howey [the Supreme Court case mentioned earlier]— a test that has existed for nearly eight decades.”

In ruling for the SEC, Failla noted how the SEC’s regulation of Coinbase and other crypto operators fits well with precedent—whether the SEC’s own rulings or court cases like Howey v. SEC (1946). As Failla archly puts it at the beginning of her ruling, it doesn’t matter if those offering the crypto suggest they are part of “a paradigm shift.” If they fit the Howey test, they merely provide another in a long line of securities regulated by the SEC. 

However, the following sentence in her ruling, written just three months before the Loper ruling, looks far shakier since: “Using enforcement actions to address crypto-assets is simply the latest chapter in a long history of giving meaning to the securities laws through iterative application to new situations.”

Cary Coglianese, professor at the University of Pennsylvania Carey Law School, said he agreed with other legal analysts that Roper and Jarkesy (also June 2024) radically shift the ground beneath the SEC’s foundations—perhaps bringing down much of what it does. In the latter ruling, the majority held that cases involving civil penalties for fraud must be brought in federal court, where defendants have the right to a jury trial—many SEC cases involving crypto are paired with accusations of fraud. The court’s majority opinion in Jarkesy is thus bound to reshape the SEC’s enforcement strategies, potentially impacting the efficacy and scope of its actions against crypto firms.

Taken together, these cases mean courts are far less likely to accede to regulators in their areas of purview, including the SEC’s “iterative application” of securities rulings to “new situations,” including crypto.

“In a way, the courts are inviting people now to come forward with broader challenges—we’ll see how far it extends,” Coglianese told Investopedia. “They are clearly signaling that the courts should be limiting administrative power more than they had.”

Coglianese was as reticent as many in the legal field to predict the potentially broad effects of these cases on the SEC. “All this stuff is kind of chaos because it is shifting a real settled understanding of how we operate as a government,” he said.

For his part, SEC Chair Gary Gensler tried to sound ready to do the work to keep chaos at bay, telling the Financial Times, “If the courts adjust, we adjust.”

The Bottom Line

While the SEC has increased enforcement actions against crypto companies and continues to apply existing securities laws to digital assets, recent court decisions have challenged the agency’s regulatory authority. The approval of spot bitcoin and ether ETFs marks a significant step toward mainstream acceptance of cryptocurrencies, but uncertainties persist regarding the classification and regulation of many digital assets.

Financial advisors talking to clients about crypto must balance their interest in crypto investments with regulatory compliance. Strategies could include limiting exposure to SEC-registered securities, such as crypto-related stocks or ETFs, and staying informed about ongoing legal and regulatory developments. As the crypto market continues to evolve, both advisors and investors should remain vigilant, understanding that the legal environment for digital assets is likely to undergo further changes.