Efforts to Wrap Professional Asset Management Structures Around Crypto Currencies Disguise Enormous Risks to Financial Advisors
If a client told you to put all of his or her long-term retirement assets into magic beans, at a moment when everybody has a “look what I grabbed from the giant’s castle” story – Would you?
Crypto assets are the financial advisor profession’s equivalent of magic beans.
Yep, I see the eye rolls already. “Crypto is mainstream. Crypto is here to stay. Financial advisors who don’t fully embrace crypto now stand to lose clients over missed opportunities.”
And maybe most frequently, “Don’t become the cliché of the conservative financial advisor who doesn’t move with the times.”
Give Me Cliches Over Magic Beans
Well, I’d like to say that clichés have stood the test of time for a reason… too often they have proven to be true in the face of change.
The financial services industry has more than its fair share of cliches when it comes to hot new asset classes that have blown up in everybody’s face just when it seems like nothing could possibly go wrong.
From tulips to Webvan, cliches have shown their wisdom in our industry.
When you put your money in an asset and your expectation is to derive profits solely because you expect someone to pay more tomorrow for the same investment that you did today, with no other intrinsic value or real value creation occurring, that is called speculating…not investing.
Who Cares About the Difference Between Investing and Speculating? Regulators!
If you’ve read this far, you might be asking “Who cares about semantics like speculating versus investing?”
Oh, I don’t know. Maybe, say, the SEC? FINRA? State securities regulators? All of the above?
Financial advisors who are “all in” with crypto are forgetting one vital fact: The entire wealth management industry today is based upon laws and regulations that are explicitly intended to encourage investing and discourage speculating.
Before we get into the finer points of portfolio construction, ETFs versus SMAs, potential crypto TAMP and custody solutions, it would be wise for financial advisors to remember that none of these details really matter if regulators view the entire asset class as highly speculative, at best.
If You Can’t See Regulators’ Perspectives, You Won’t Be Prepared For Penalties
And make no mistake about it, crypto today checks nearly all the boxes that precondition regulators to view an entire asset class on a prejudicial basis.
This is in part because regulators have a very keen sense of history, and they will draw connective tissue between what might appear to financial advisors and clients as entirely unrelated subjects.
Regulators are almost certainly not thinking about crypto in terms of “does this product make more sense in an ETF or in an SMA or TAMP?”
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Instead, they are thinking about “fear and greed” dynamics and correlating the market movements and consumer frenzy over crypto with similar bubbles around private placements, collateralized mortgage obligations, penny stocks and non-traded REITs.
The mechanisms of how so many of these securities are valued have been – and likely always will be – a mystery to everyone but the (relatively speaking) small group of people who have an outsized influence on a very niche asset class.
The fact that “FOMO” investing has gripped many segments of the investing public with crypto has certainly not escaped the notice of regulators.
What’s the Safe Limit of Crypto Holdings for Investor Portfolios?
The financial advisor profession exists, ideally, to provide expert guidance to retail investors so they can reach their broader financial goals, including retirement security.
Will crypto assets still be around a decade or more from now? Yes.
But like dot-com stocks in the late 1990s, the volume of different types of assets will almost certainly diminish, and when a flight to quality occurs, for every Amazon-equivalent crypto asset, you’ll have at least half a dozen Webvan scenarios. The brutal reality is that many crypto assets are probably going to be doomed.
So from a compliance best practices perspective, what is the maximum percentage of crypto assets that any investor portfolio advised by a professional should encompass?
My answer to this question would be the same if the product under review were a penny stock or an option: For a small percentage of a portfolio – less than 5% – some diversification into speculative products such as crypto as an asset class is acceptable (but not advisable).
Pessimism Versus Realism
As a professional compliance and supervision officer, I consider myself a realist who operates in a world where realism is frequently mistaken for pessimism.
But at the end of the day, financial advisors facing pressures to pursue crypto investing for clients need to ask themselves: If this asset blows up (in a negative way) and my clients are overly exposed, what is my professional downside risk?
There will always be stories of people who made a lot of money in the next big thing. But in reality and with a little perspective, it is easy to see that after a period of investor frenzy, the story is always the same, and it doesn’t end well for most.
And for financial advisors, the legal, regulatory and compliance consequences from putting clients into over-hyped asset classes that go badly south can be potentially career destroying.
Don’t trade your clients’ well-being – and your career – for that proverbial hill of magic beans.
Sander Ressler is Managing Partner of Essential Edge Compliance Outsourcing Services, LLC, a national consultancy that delivers comprehensive compliance supervision solutions to independent broker-dealers, Super-OSJ groups and hybrid RIA firms
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