More than ever before, financial services regulators must increasingly adapt to technological advances. Perhaps no other technological advancement is more important right now than crypto currency. Crypto currency is defined as digital assets issued or transferred using blockchain technology. Earlier this month, the SEC, despite SEC chairman Gary Gensler’s well-known skepticism of crypto, granted Bitcoin, the world’s largest crypto currency, approval to be the first crypto asset listed as an exchange traded fund (ETF). This defining moment for crypto currency further cements the relatively new technology into the financial services and securities landscape.
Anticipating the changing tides, FINRA recently declared in its 2024 Annual Regulatory Oversight Report that it would add a brand-new Crypto Asset Development section – dedicated to providing guidance for member firms engaging in (or expecting to engage in) the crypto economy. This new section includes reports from FINRA’s November 2022 targeted exam reviewing the practices of certain member firms that communicate with retail customers concerning crypto assets and crypto asset-related services. The relevant time period of the exam was from July 1 through September 30, 2022. On January 24, 2024, FINRA published an update to the targeted exam, claiming that approximately 70 percent of the more than 500 retail customer communications it reviewed contained potential FINRA Rule 2210 violations (communication with the public), including the following:
- Failure to clearly differentiate between crypto assets offered through an affiliate of the member or another third party, and products and services offered directly by the member itself;
- False, misleading and unclear statements about crypto assets generally, including false statements implying that crypto assets functioned like cash or cash equivalent instruments, mainstreeting protections of the federal securities laws, FINRA rules, and
- SIPC and SIPA; and Comparing crypto assets to other assets (e.g., stock investments or cash) regarding varying features and risks of these investments with no sound basis to do so.
This should not be surprising. “This happens when there is a new frontier of investment categories. A lot of folks get very excited. What that means is [compliance] policies and procedures don’t catch up with the business side of the house,” said Bill Simpson, Director of Compliance at Hearsay Systems. Unlike traditional cash and security assets, crypto currency still has a lot to prove, especially considering most Americans are skeptical about it. FINRA’s findings will certainly not help. To make sure member firms comply with FINRA Rules, FINRA suggests the following effective practices:
- Before recommending crypto asset securities to customers through an unregister offering, confirming that investments can be issued in the form of crypto assets and, if so, understanding where the assets are maintained, how will proceeds be raised, etc.
- Conduct risk-based on-chain assessments when the firm or its associated persons are accepting, trading or transferring crypto asset securities and non-securities, and establishing procedures that address when and how these on-chain reviews should be performed and documented based on the product or services being offered; and
- Ensure customers clearly understand the differences between their brokerage account and any linked/affiliated crypto account.
It is imperative that firms mind these suggestions, especially as FINRA keeps a closer eye on crypto currency and SEC enforcements in the space increased more than 50 percent in 2023. If you dare to play in the wonderful new world of crypto, you should make sure your broker-dealers know how to talk about it.
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