Bitcoin Fund Prospectus for those creating ‘investment funds’ focused on digital currency speculation is not something to take lightly. Now that cryptocurrency aka digital currency funds are all the rage, its no surprise that global accounting firm BDO International is extending its domain knowledge to those fund managers who are contemplating an ICO aka initial coin offering.
Here’s the opening extract from their recent report “Digital Currency Fund Preparation for Initial Year Audit and Tax Compliance.”
By Ignacio Griego, Sam Seaman, Jeff Barrett, Maurice Liddell
2017 has been an exciting ride in the world of digital currency, with historic returns attracting a slew of portfolio managers and investors to the space.
From Floyd Mayweather to Lloyd Blankfein to Jamie Dimon, everyone seems to have different opinions, but a theme everyone can agree upon is that the space is evolving at a rapid pace and participants are having a challenging time keeping up. Prior to 2017, many who chose to invest in the digital currency space chose to do so by directly investing in bitcoin and ether. The eye-popping returns during 2017 have attracted a wider group of investors, many with deep pocket books, looking to gain exposure to this new asset class by investing in or creating pooled private vehicles to invest in various new digital currencies and ICOs. During the year, it has been reported by various sources that over one hundred new digital currency funds have launched.
In addition to the challenges these funds will face in properly identifying investment opportunities and staying abreast of the dynamic market, the vast majority of these funds will also be dealing with financial statement audits and issuing tax returns for the first time. Within the digital currency space, this proves even more challenging compared to traditional investment funds because prior year precedents have not been set and there is a lack of authoritative guidance from audit and tax regulators.
With the aim of helping to improve the efficiency of year-end audit and tax services, we have summarized below key areas that digital currency funds and their service providers should be discussing during the planning phase of the engagement:
Audit
Currently, there are only a handful of assurance practices with experience auditing digital currency funds. Given the unique characteristics of these funds, having a foundation in both digital currency as well as investment funds will be key. Since this is a new space for most assurance practices, client acceptance can be a longer process compared to other new clients in traditional industries. Key areas to discuss with the auditors which can help in streamlining the client acceptance process and overall audit include:
- Entity structure ā Ensure your auditors have the ability to review draft fund legal documents before finalization. Key fund attributes such as fund risks, management and incentive fee structures, contribution and withdrawal details including timing and in-kind transactions, general fund liquidity features, different investor classes, fund level expenses, and partner allocation methodology will be areas of focus. Additionally, funds domiciled outside of the U.S. should discuss with their auditor additional reporting requirements that could beĀ triggered.
- Valuation policy– A fund should develop its valuation policy addressing key points of Topic 820 Fair Value Measurement. While some funds may work with their administrator to help develop their valuation policy, management bears ultimate responsibility for determining the fair value of its investments. Although many exchanges exist throughout the world which may serve as a pricing source, there are several important points a fund should address in its valuation policy when analyzing the market, including:
– Valuation: Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Since a fund may trade a single currency on multiple exchanges, it will need to identify the principal market or, in the absence of a principal market, the most advantageous market. The FASB defines the principal market as the market with the greatest volume and level of activity for the asset or liability. The FASB defines the most advantageous market as the one that maximizes the amount that would be received to sell the asset or minimizes the amount that would be paid to transfer the liability, after taking into account transaction and transportation costs. When identifying its principal (or most advantageous) market, the fund should ensure it has access to this market at the measurement date. Because different access may exist among different funds, this needs to be considered from the perspective of the reporting fund. A fund should take into account all information that is reasonably available as it attempts to identify markets it can access.
Whether your company is a fintech startup, or simply planning a private placement offering available to a select universe of friends and family, seeking to raise capital from qualified investors or accredited investors via a Initial Coin Offering (ICO), an initial public offering (IPO) via an exchange listing, a properly prepared offering prospectus or private placement memorandum is required by your investors and industry regulators that govern securities offerings. Issuers seeking affordable investor document solutions rely on experts at PPM.
A fundās valuation policy should also address key aspects of the fair value hierarchy, including determining if quoted prices are available, if adjustments need to be made to the quoted prices, and whether the market is considered active. If quoted prices are adjusted, it will be important for the fund to denote in its valuation policy when it feels adjustments are appropriate and apply a consistent policy in the treatment of these situations.
A fund should have proper monitoring controls in place to determine whether quoted prices from a specific exchange or source can be relied upon. Funds can consider discussing: Has diligence been performed on the pricing source to reflect upon how pricing is derived, or do the pricing sources have SOC reports explaining the process? Do significant spreads exist when comparing pricing sources? Many funds have chosen to compare their principal market pricing source with other pricing sources to demonstrate reasonableness.
–Ā Custody and existence: Proving existence and ownership is another area that if not discussed early and vetted properly, could create challenges during the audit. The portfolio should be examined and discussed with the auditor to determine which, if any positions, are held at a custodian. If a custodian is in place, auditors will typically confirm balances at a certain date. Understanding what balances and activity the custodian will confirm, whether the auditor can place reliance upon reports and confirmations received, and whether the auditor plans on performing additional procedures to test existence and ownership, will be key in reducing last-second fire drills. This will prove even more important for positions not held at a custodian and for positions that may have special privacy features. Ensuring the auditors are aware of these positions early will provide them with additional time to properly scope the verification of existence and ownership. When determining whether to invest in a new form of digital currency, fund portfolio managers should consider the above and actively discuss these points with their auditor. If the auditor is unable to develop a procedure to verify existence and ownership for a large position, the result could be a qualification to or potentially even a disclaimer of opinion. Important internal control considerations related to custody are discussed in further detail on pages 3 and 4.
Download the report here