There is no doubt that under the current Trump administration, cryptocurrency is enjoying a more hospitable environment. The environment not only affords crypto firms increased business opportunities, such as, for example, with respect to exchange-traded digital assets, but the environment may lend itself to opportunities for D&O insurers as well. In the following guest post, Sarah Abrams, Head of Claims Baleen Specialty, a division of Bowhead Specialty, reviews some of the details about the current crypto environment, as well as the opportunities and risks that the environment may represent for D&O insurers. I would like to thank Sarah for allowing me to publish her article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Sarah’s article.
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On July 1, the SEC’s Division of Corporate Finance issued a statement (July SEC Statement) on the application of Crypto Asset Exchange-Traded Products (Crypto Asset ETPs) disclosure requirements. While the SEC staff’s expectations stated therein have “no legal force or effect,” the continued messaged guidance by the SEC and the passage of the GENIUS Act optically bolster support for cryptocurrency as a legitimate market, asset, and currency. But will the emerging sponsor organizations and potential new business opportunities in the crypto marketplace lead to increased D&O underwriting exposure?
Part of that vetting process includes the regulatory framework recently suggested in the July SEC Statement. The following discussion outlines the recent views provided by the SEC staff on Crypto Asset ETPs, including what ETPs and Crypto Asset ETPs are, and the potential impact on D&O underwriters seeking to capitalize on the rapidly evolving cryptocurrency landscape.
As an initial matter, concerning the Crypto Asset ETPs, the July SEC Statement solely addressed guidance for complying with SEC filing Regulation S-K (Reg S-K) and Regulation S-X (Reg S) disclosure requirements. Reg S-K outlines how registrants, like any crypto asset issuer filing with the SEC, should disclose material qualitative descriptors of their business, like the brand or platform engagement. Reg S-X, on the other hand, outlines how registrants should disclose quantitative descriptors, such as in financial statements with use of mathematical models to make investment decisions. Reg S-X compliance commonly arises in the context of drafting a Form S-1 , Form 10-K , or Form 8-K .
The SEC staff acknowledges that the Crypto Asset ETP issuers do not always identify risks specific to the crypto product being offered and commonly use technical jargon to “explain” the Crypto product being registered. After the new administration was sworn in earlier this year, the SEC received over 70 crypto exchange-traded fund (ETF) filing applications for review and approval. These filings include altcoins (cryptocurrency other than Bitcoin), meme coins, and blockchain infrastructure tokens. Most likely, the July SEC Statement was meant to provide waiting ETPs with guidance on what information would help speed the agency’s review.
While mentioned briefly above, understanding what Crypto Asset ETPs are may help D&O insurers consider risks when underwriting in this emerging marketplace. Generally, ETPs are financial instruments that are traded on stock exchanges and track the value of an underlying asset, index, or group of assets. ETPs include ETFs, which track an index, sector, commodity, or asset; Exchange Traded Notes (ETNs), debt securities linked to an index or asset performance; and Exchange Traded Commodities (ETCs), single commodities like gold or oil. ETPs are typically traded like stocks, bought and sold throughout the trading day, and offer exposure to the underlying assets without directly owning them.
Crypto Asset ETPs are typically structured as trusts that hold assets, which consist of spot crypto assets or derivative instruments that reference crypto assets. These trusts are considered by the SEC to be issuers of securities who must register their offerings and classes of securities under the Securities Act of 1933 (“Securities Act”) and Securities Exchange Act of 1934 (“Exchange Act”). The Crypto Asset ETPs referenced in the July SEC Statement, however, do not need to be registered as investment companies under the Investment Company Act of 1940.
In addition, Crypto Asset ETPs, such as the 72 ETFs currently filed and pending approval, are subject to an SEC review process to ensure they meet anti-fraud provisions of federal securities laws before being approved for trading on a regulated securities exchange. In part, this explains why the July SEC Statement noted the importance of using plain language when discussing the technical aspects of a crypto investment, to help prospective investors understand the profile of the asset. As readers of the D&O Diary know, crypto itself as a digital currency, how it is valued, and its utility are complicated.
Furthermore, the cryptocurrency industry as a whole has been viewed in recent years, particularly after FTX, as volatile and ripe with fraud. Thus, it is understandable that the July SEC Statement noted that a Crypto Asset ETP issuer’s risk disclosure includes, if material, the characteristics of the security, limited rights of holders, insurance coverage, valuation and liquidity risks, technological risks, cybersecurity risks, and legal, regulatory, and tax risks. The statement further encouraged applicants to provide details about the underlying crypto assets, the index or benchmark methodology used, and the methodology to calculate the net asset value of the shares ahead of offering.
The potential upshot for those Crypto Asset ETPs approved by the SEC includes the ability to be traded on major exchanges (like NYSE or Nasdaq), regulatory oversight, and taxation. Approved Crypto Asset ETPs will also be measured against the requirements of the Exchange Act, which, in theory, means the assets will still have to show that they’re sufficiently resistant to manipulation. Notably, the July SEC Statement signals a willingness to work with parties seeking asset approval to ensure clarity, accuracy, and completeness. For D&O underwriters, increased transparency and an SEC partnership with issuers may, on paper, sound like a good business opportunity.
As is clear from the number of filings, there is an increasing availability of deal opportunities in the crypto-verse. Particularly when it comes to D&O liability coverage for sponsors. One of the July SEC Statement disclosure requirements specifically speaks to Directors, Executive Officers, and Significant Employees who make a significant contribution to the Crypto Asset ETP issuer’s business. The SEC acknowledges that Crypto Asset ETPs typically have a sponsor whose directors and executive officers perform functions like a board of directors and executive officers for the trust. D&O underwriters are familiar with underwriting coverage for executive leadership and boards.
To the extent that a sponsor performs policy-making functions, the July SEC Statement suggested disclosure discusses a framework for reporting on the function and performance of the directors, executive officers, or other employees of the sponsor. The SEC further noted the application of its conflict-of-interest policies, which outline the rules requiring disclosure of material information about transactions with related persons and policies and procedures related to the review, approval, or ratification of transactions. Conflicts of interest can result in allegations of mismanagement and fraud, leading to exposure for D&Os. A regulatory affirmation may push ETPs awaiting approval to examine existing sponsor relationships.
Given the above, will there be more D&O deal opportunities for crypto-related coverage? Perhaps. It has been clear from inauguration day that this administration is a fan of crypto and wants to regulate and tax the industry. Increased regulation may also lead to increased exposure should the D&Os of issuers run afoul of suggested parameters or increased SEC scrutiny over filings. In addition, the issuer of a currency, like a meme coin, that may be manipulated, could also trigger D&O coverage should shareholders allege fraud.
Even though D&O crypto coverage may feel unwieldy as the market quickly appears to be standing up, appreciating what crypto assets are and the associated underwriting risks may become a future difference maker for D&O insurers looking to capitalize on new industry opportunity.
The views expressed in this article are exclusively those of the author, and all of the content in this article has been created solely in the author’s individual capacity. This article is not affiliated with her company, colleagues, or clients. The information contained in this article is provided for informational purposes only, and should not be construed as legal advice on any subject matter.