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Why Merrill Lynch’s Bitcoin Ban Is Likely to Continue

By Miriam Rozen August 13, 2018

Last week, the SEC delayed any ruling that would let Cboe Global Markets offer shares of a Bitcoin ETF. The news followed the regulators’ rejection in late July of a Bitcoin-related ETF proposed by the Winklevoss twins.

Both outcomes precipitated further declines in the cryptocurrency’s price. Bitcoin has fallen from a high of $19,000 in December 2017 to under $5,000 at press time.

That price-tumbling makes Merrill Lynch Wealth Management managers appear prescient since the wirehouse, in a policy decision first disclosed in January, barred its roughly 17,000 advisors from pitching investments related to Bitcoin. Nothing that has happened in the past six months has prompted Merrill Lynch to alter that ban.

“We have not made any changes to our policy,” a Merrill Lynch spokesperson wrote in response to an FA-IQ inquiry this week.

For some independent advisors, Merrill Lynch’s ban makes perfect sense. “They are wisely avoiding potential liability for recommending something that is obviously speculative, exceeds the risk tolerance of most investors and has no underlying value,” J. Brent Everett, the chief investment officer for Talis Advisors in Plano, Texas.

Other independent financial advisors, however, take a more nuanced view. They, at the very least, discuss Bitcoin with clients, although most steer clear of recommending it as an investment.

Some even view the plummeting prices as an opportunity -- not for investing in Bitcoin, but for educating clients.

“I think the teachable moment is the price dropping,” says Dryden Pence, the chief investment officer of Pence Wealth Management in Newport Beach, Calif., who strongly discouraged clients from investing in Bitcoin.

“I did have a few clients that went against our advice and bought Bitcoin and now they are crying the blues. Most of them just come in sheepishly and say, ‘Boy, you were right,’” Pence says.

His reaction: “They are still our clients. We love them and we will take care of what’s left of their portfolio,” Pence says.

For months now, so he has more to say than just “no” to Bitcoin enthusiasts, Pence has sought out investments that will benefit from applications of its underlying technology: blockchain.

With just a few lines of code, blockchain allows two parties, who may remain anonymous to each other, to execute a so-called "smart contract," record it in a digitally distributed ledger, and monitor their contractual obligations 24/7 – confident the technology will bar any unilateral changes or premature terminations.

Blockchain’s potential applications extend far beyond cryptocurrency.

In June, Morgan Stanley issued a report identifying big banks testing blockchain applications. The North American banks included in the report’s list were: Bank of America, using blockchain for trade finance; Bank of New York Mellon, for U.S. Treasury bond settlement; Citigroup, for private securities digital payment solutions; Goldman Sachs, for equity swap trading; J.P. Morgan, for cross-border payments; and Wells Fargo, for private label mortgage back securitizations.

The same Morgan Stanley report, however, also stressed that cryptocurrencies’ volatility has created unintended consequences. The currencies lack regulatory oversight, safety and soundness measures, recourse in the event of mistaken or misallocated transactions, and deposit insurance, and also faced high cyber risk, according to the Morgan Stanley report.

“We have avoided all Bitcoin-related things because it’s a Wild West mashup of currency, technology and custodianship,” says Joe Birkofer, a financial advisor at Legacy Asset Management in Houston.

As an alternative, Birkofer has instead recommended his clients invest in an ETF with “a sizable position” in companies developing blockchain, he says. For that purpose, Birkofer has chosen the ARK Innovation ETF, but other funds with similar focus on disruptive technologies include iShares Exponential Technologies ETF, which is based on the Morningstar Exponential Technologies Index.

“Bitcoin was a bubble, but the blockchain is a long-term story,” Birkofer tells his clients.

Notably, neither Birkofer nor securities lawyers rule out the prospect of the SEC blessing a cryptocurrency-related ETF in the future, despite the regulators’ recent rejection of the Winklevoss twins’ proposal.

“The SEC is taking a second look, that is a good thing,” says Birkofer.

M. Ridgway Barker, a partner at the Greenwich, Conn. offices of law firm Withersworldwide, has clients who are interested in eventually sponsoring some sort of cryptocurrency-based ETF. So he reviewed closely the SEC’s rejection of the ETF proposed by Cameron and Tyler Winklevoss, who founded the crypto exchange Gemini.

With its rulings, the SEC is attempting to strike a balance between protecting all investors from too much undisclosed risk and not stopping “mom and pop investors” from benefiting from the early gains of a disruptive industry in their retirement accounts, Barker says.

What the SEC aptly identified as missing from the Winklevoss twins’ proposal was enough trading and volume data for Bitcoin, Barker says.

“The decentralization of the Bitcoin market makes it hard to show data,” Barker says.

The SEC “has been looking at anything and everything” related to cyptocurrencies “extremely closely,” for the past 12 to 18 months, says Nick Losurdo, who is counsel at the Boston office of the law firm Goodwin Procter, and who advises financial industry clients, including about seeking SEC approval of rule filings. “That’s extremely encouraging from my perspective,” he adds.

The SEC Commissioners rejected the Winklevoss twins’ proposal with a 3-1 vote; only four votes were cast since the agency is down one commissioner, Losurdo notes. He also wonders what will change in the dynamics when a commissioner is added to fill the vacant slot.

“I do think we will see some cryptocurrency ETF receive approval soon. I just don’t know what ‘soon’ is,” Losurdo says.

But for financial advisors who want clients to steer 100% clear of the cryptocurrency, the fuzziness of forecasts matters little. “I don’t think many of our clients even know who the Winklevoss twins are, but they certainly see news stories on the volatility and recent price declines in cryptocurrencies,” Talis Advisors’ Everett says. As a result, they have no interest in Bitcoin anymore, which suits Everett, who never encouraged them to pursue it in the first place.