The securities and futures industries have a long history of creating, distributing, and trading new and innovative products and asset classes. Innovation is not without risk and successful firms have typically introduced disciplined processes to achieve compliance within existing regulations, even when there are gray areas. For broker-dealers, the suitability rule (2111) is the guiding force. In the case of registered investment advisors, the SEC has made it very clear in the “Information for Newly-Registered Investment Advisers (November 23, 2010) that:
As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests.
For futures commission merchants and introducing brokers the National Futures Association (“NFA”) requires Members under Compliance Rule 2-4 “…to observe high standards or commercial honor and just and equitable principles of trade in the conduct of their futures business.” There is no explicit “suitability rule”.
But product due diligence should go beyond developing a reasonable basis to determine whether the instrument is suitable for at least some of your clients. This would include operational readiness within the exchange/firm/or other registered entity. Is the firm prepared for the new product? Too often, the answer is no, but firms think the answer is yes and proceed anyway. Understanding the operational risk, product and sales strategy, supervisory structure requirements, technology requirements, financial commitment, risk management, and compliance/anti-money laundering requirements, are as important to a successful implementation as understanding the product’s market and liquidity risk.
Credit default swaps, auction rate securities, and even the tech bubble are still fresh in the minds of seasoned investment professionals and institutional investors – and that is a good thing. Your firm will need that experience and more to understand the benefits and risks of digital assets and initial coin offerings. Evaluating and understanding exchanges, custodial wallet providers, and how mining works is also vital to your firm’s success in this niche venue.
