Nearly all claims of breach of fiduciary duty against trustees and others are, in one way or another, fights about money.
As a practical matter, any claim or controversy that arises about money is resolvable - if the money is there to make a settlement. In simple terms, the fiduciary duty and liability exposure predominantly can be summed up in four words, “Don’t Lose The Money.”
Wealth managers and asset protectors through the ages have always known that above all else any investment must protect the return of investment. Only secondary is the concern for a return on investment. Castles and fortresses were built to keep the wealth safe.
The spectacular rise of cryptocurrencies and crypto assets created mew risks for mainstream traditional wealth managers as trustees, and others like banks who accept responsibility and liability for other people’s money and assets.
Compared to traditional assets and money, cybercurrencies and crypto assets are, as they say, a horse of a different color. They are only virtual and have no recognizable rational legal existence. They come from nothing. There is no economic productivity involved. And if they have a use or worth in cyberspace, it is only because they are tied to existing assets for value.
If the computer is ever turned off, cybercurrency and crypto assets disappear into the nothingness from which they came.
Wall Street, crypto internet site creators, digital wallet hosts, crypto exchanges, non-fungible token promoters, and money launderers all hype the benefits of cyber assets and currency. It’s a medium of exchange, a store of value, and an alternative investment. For modern portfolio management and prudent investor rules it is a diversification of investments.
But, the fact is that red flags on virtual assets in cyberspace are popping up everywhere.
It becomes contentious is when a trustee takes lawful money, then acquires digital assets, and there is subsequently a loss.
Willful blindness is not a defense to a claim of breach of fiduciary duty. A few professional journals have published articles supporting the ability of a trustee to make cyber asset and cybercurrency investments. Other than the article author’s own opinion there is no citation to any specific authority that can be relied upon to bless even a tiny digital transaction.
To the contrary, warnings against crypto-assets and cryptocurrency from official sources abound.
The Federal Reserve, FDIC, and Comptroller of the Currency have issued a joint statement regarding crypto-asset risks to banks. Stating that the crypto—asset sector experienced significant volatility and vulnerabilities and listed just some of the risks.
“Heightened risks associated with open, public, and/or decentralized networks, or similar systems, including but not limited to the lack of governance mechanisms; establishing oversight of the system; the absence of contracts and standards to clearly establish roles, responsibilities, and liabilities and vulnerabilities related to cyber-attacks, outages, lost or trapped assets, and illicit finance…”
President Biden signed an executive order “Ensuring Responsible Development of Digital Assets” requiring relevant federal agencies to submit reports on various aspects of digital asset regulation and administration.
It also provided non-binding non-enforceable definitions as illustrative definitions. This highlights the significant risk of digital type assts. That is, there are no standard legally enforceable definitions. If a trustee invests in a digital type asset, what exactly is being bought?
The Securities and Exchange Commission and the Commodity Futures Trading Commission appear to take the position of regulating by performance. That is, whether something is a security or commodity depends on circumstances. Whether digital assets are a security, commodity, or something else, the SEC and CFTC see these as highly complex questions for which they are not providing answers anytime soon.
The IRS takes the position that digital assets (including cryptocurrency, NFTs, stablecoins) are property not money for tax purposes. Tax professionals are properly concerned that holding digital assets is a potential red flag drawing the attention of IRS audit enforcement efforts.
The Financial Accounting Standards Board proposed that digital assets like cryptocurrencies be measured at fair market value. That means that a virtual asset is measured according to a hypothetical model. How does a trustee prove up for providing financial information to beneficiaries measured by a standard when there is no recognized standard?
Crypto companies are not able to obtain audited financial statements because the asset or inventory is not provable. Consequently, crypto companies have gotten some third-party firms, including CPAs, to issue Proof of Reserves (PoR). In March 2023 the Public Accounting Oversight Board (PCAOB) issued an Investor Advisory warning. While crypto companies may tout a PoR as comparable to an audit, the Advisory warns that a PoR,
“are not equivalent or more rigorous that an audit, and they are not conducted in accordance with PCAOB auditing standards…customers should exercise extreme caution when relying on them to conclude there are sufficient assets to meet customer liabilities”.
The recent FTX debacle is a stark example of what happens whether through theft or illiquid assets there is not sufficient liquidity available to pay customers back their money.
Trustees are held to high standards since they hold and invest other people’s money. In the financial markets, digital assets like cryptocurrencies, stablecoins, and non-fungible assets, and derivatives based on them are getting a lot of press and hype from financial talking heads.
But popularity is not credibility. Virtual means a simulation not reality.
What is clear is that trustees and others who do not want to lose the money, the best investment strategy to follow is avoid investments where the red flag warning are flying high and clear.
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Denis Kleinfeld is known as a strategic tax and wealth protection lawyer, widely published author and creative teacher.
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