Compliance and Communication: An Update on FINRA’s Crypto Asset Targeted Exam
FINRA recently wrapped up a targeted review of the practices of certain member firms when it comes to communicating with retail investors regarding crypto products and services. On this episode, Ira Gluck, Senior Director, Advertising Regulation at FINRA, joins us to share the results of that crypto asset communications sweep that began in November 2022.
Resources mentioned in this episode:
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00:00 - 00:20
Rita De Ramos: In November 2022, FINRA launched a targeted exam to review the practices of certain member firms that actively communicate with retail customers concerning crypto assets and crypto asset-related services. On this episode of FINRA Unscripted, we'll be learning about the results of that crypto asset communications sweep.
00:20 – 00:29
00:29 - 00:54
Rita De Ramos: Welcome to FINRA Unscripted. I'm your host, Rita De Ramos. I'm delighted to welcome Ira Gluck, Senior Director, Advertising Regulation at FINRA, to discuss the results of the crypto asset communications sweep. Ira, I know you've been at FINRA for 27 years, but you're new to our FINRA Unscripted audience. Could you introduce yourself and tell us about the Advertising Regulation department and your role?
00:54 - 01:38
Ira Gluck: Sure. Rita, it's really a pleasure to be here. I've been with Advertising Regulation for 12 of those 27 years, but I've also done stints with our Member Supervision and Enforcement groups. Currently, I primarily oversee Advertising Regulation's Investigative Programs, but I also get to work on rulemaking and guidance related to communications issues. The department's primary function is to protect investors by ensuring that broker-dealers' communications are fair, balanced and not misleading. The content standards in the rule apply broadly to broker-dealer and representative communications. Anything from a 90-minute podcast by the firm, or a 15-second spot during the Super Bowl.
01:38 - 01:52
Rita De Ramos: It's interesting that what you're looking at in terms of ad reg compliance is that diverse. Before we dive into the crypto asset communications targeted exam, could you talk a little bit about the crypto asset related work that FINRA is doing?
01:52 - 02:27
Ira Gluck: Yeah, absolutely. FINRA has been building our expertise and leveraging innovation and technology to enhance our regulatory capabilities. I know the audience has heard about our Crypto Hub, which includes representatives throughout the organization, including Advertising Regulation. The Hub works as a nerve center to manage FINRA's regulatory work related to crypto assets, and our regulatory departments are applying that work and the expertise of the Hub to examine member firms and associated persons who engage in crypto asset activities to ensure compliance with existing rules and regulations.
02:27 - 02:58
Rita De Ramos: For more information about FINRA's crypto asset-related work, we have resources that our audience can check out on our website, including a Crypto Assets Key Topics page on FINRA.org, a blog post, podcast episodes about FINRA's Crypto Hub, Crypto Asset Investigations Team and the Blockchain Lab, as well as investor education resources. Now let's go back to the crypto asset communications targeted exam. What was the reason for conducting the sweep?
02:58 - 04:33
Ira Gluck: With the growth in this market and increased interest in crypto assets, the potential harm caused by problematic communications has also increased at the same time. For example, we've been concerned about how communications discuss the protections offered through the federal securities laws or FINRA rules, including SIPC coverage. And for listeners unfamiliar with SIPC, S-I-P-C stands for the Securities Investor Protection Corporation. It's a not-for-profit corporation that works to restore investors' cash and securities if their brokerage firm fails. However, there are no such protections for accounts held at crypto asset entities, and that's why we want investors to understand when they're operating through a regulated entity and when they are not. Customers can also be misled if the communication falsely states, or implies, that the SEC or FINRA has endorsed or guaranteed a particular crypto asset.
In order for investors to have enough information to evaluate a crypto asset investment or service, communications need to clearly describe the product's risks and features. Advertising Regulation has some history with crypto asset-related filings, as well as crypto-related investigative matters. Before the sweep, we were seeing a non-compliance rate for crypto asset filings of about 40%, and that compares to about 8% for all products. So, given all those factors, we believed a targeted exam was the most efficient way to get some insights into how firms are using these communications and their relative level of compliance.
04:33 - 04:38
Rita De Ramos: When was the sweep conducted and how many firms were included in the sweep?
04:38 - 05:13
Ira Gluck: Over the past few years, FINRA has asked member firms to notify us if they or their affiliates engage or plan to engage in crypto asset-related activities. So, working with our colleagues in Member Supervision, we use that data to narrow down our list to firms whose activities would likely involve communications with retail investors. We specifically excluded firms that we already had a touchpoint with regarding crypto asset communications. So, Rita, after completing that analysis, we identified 17 firms and sent the letters out in November of 2022.
05:13 - 05:18
Rita De Ramos: What did you ask the firms to provide?
05:16 - 06:10
Ira Gluck: Well, first, we asked firms to provide us with all retail communications that were distributed or made available by the firm, or its affiliates on its behalf, that related to a crypto asset or a service involving a transaction or holding of a crypto asset. Second, where applicable, we asked if a registered principal of the firm had reviewed and approved the communication to verify that the firm had seen and supervised its use. Third, we requested any contracts or written agreements between the firm and any affiliate concerning the creation or dissemination of crypto asset communications. Finally, we asked for copies of each firm's written supervisory procedures that related to communications with the public, as well as any compliance guidance that had been distributed by the firm regarding crypto assets. Our review period was from July 1st, 2022 through September 30th, 2022.
06:11 - 06:17
Rita De Ramos: How many communications and what types of communications did you receive by the end of the sweep?
06:18 - 06:36
Ira Gluck: We received about 500 communications from 11 firms. The other six did not have responsive documents or had never gone forward with their crypto business plans. But fortunately, we got a good cross-section of communications, including websites, mobile apps, social media and email.
06:36 - 06:42
Rita De Ramos: When you receive the responses from the firms, what did you review? What were you looking for, specifically?
06:42 - 07:41
Ira Gluck: Our analysts were asked to focus on substantive violations of applicable rules as opposed to technical violations. So, these included looking for false, misleading or promissory statements, such as did the communications falsely imply that crypto assets were offered through the broker-dealer? Did communications misrepresent the extent to which the federal securities laws or SIPC applied, and did the communications exaggerate or misrepresent features of the investment? We also asked our analysts to look for adequate risk disclosure or balancing language. And we really wanted just to ensure that communications included the applicable risks associated with crypto assets, specifically risks associated with the manner in which crypto assets are issued, sold, held or transferred. Finally, we also asked analysts to review firms' written supervisory procedures, controls and training regarding crypto asset communications to ensure that they are supervising this business appropriately.
07:41 - 07:45
Rita De Ramos: What were the most significant findings from the sweep?
07:45 - 08:01
Ira Gluck: Well, given our experience prior to the sweep, we did expect a relatively high rate of noncompliance. And unfortunately, what we found was almost 70% of the communications we reviewed did not comply with FINRA Rule 2210 in some substantive manner.
08:01 - 08:05
Rita De Ramos: To refresh our audience, could you talk about Rule 2210?
08:05 - 08:52
Ira Gluck: Happy to do so. FINRA Rule 2210, or our communications with the public rule, sets principles-based content standards that are designed to apply to communications, regardless of the medium that they are sent through. The rule also includes requirements regarding firms’ approval, review and recordkeeping procedures, as well as provisions that require firms to file certain communications with FINRA. And while the rule includes others, there are two primary content standards in FINRA Rule 2210. The first requires that communications be fair and balanced and provide a sound basis for evaluating the facts related to the investment. The second prohibits false, misleading, promissory, or exaggerated statements as well as projections of performance.
08:52 - 09:01
Rita De Ramos: Let's go into some specifics. What communications and communication practices did you find that were inconsistent with FINRA Rule 2210?
09:01 - 09:53
Ira Gluck: Perhaps most problematically, we saw instances of false or misleading statements, such as stating that crypto assets were secure, protected or regulated. We also saw statements implying or stating that SIPC coverage applied to crypto investments, and we also saw statements that overstated the capabilities or experience of the firm in the area of crypto assets. We also found comparisons of crypto assets to other investments that didn't describe the significant differences in functionality, safety and regulatory protections between them. We found unclear and misleading explanations of core features and risks of crypto assets. Finally, we also saw instances where the firm did not adequately explain which entity was offering the crypto products, and it was unclear who customers should contact if they encountered a problem.
09:53 - 10:03
Rita De Ramos: Why should member firms, even those who may not yet be involved in crypto asset-related activities, pay attention to the results of this sweep?
10:03 - 10:55
Ira Gluck: I think the sweep demonstrates that firms need to consider communications compliance when they enter a new area of business. And sometimes those rules apply in ways that firms might not expect. A good example from this sweep was that some firms thought that communications involving crypto assets were not subject to the rule. And while it's very much a facts and circumstances determination, in many of our cases, communications were distributed to brokerage clients or involved cross-marketing of brokerage products and services along with the crypto asset offering. In some cases, firms required you to have a brokerage account in order to transact in crypto assets, even when the crypto is traded through an affiliate or a third party. This nexus of brokerage clients or brokerage activities often resulted in communications that needed to comply with FINRA Rule 2210.
10:55 - 11:07
Rita De Ramos: Member firms may be wondering, will the findings of the sweep lead to new rules about communications with retail customers concerning crypto assets and crypto asset related services?
11:07 - 11:25
Ira Gluck: So, that's certainly one possibility, Rita. The rulemaking process is very structured. Firms would have the opportunity to study any proposed rules and provide comment, and the SEC would also have to approve any final rule. Accordingly, rulemaking typically takes a significant amount of time.
11:24 - 11:53
Rita De Ramos: We'll be watching out for that, Ira. That's it for today's episode of FINRA Unscripted. Ira, thank you so much for joining me to talk about the results of the crypto asset communication sweep. Listeners, if you don't already, be sure to subscribe to FINRA Unscripted wherever you listen to podcasts. Today's episode was produced by me, Rita De Ramos, engineered by John Williams and coordinated by Hannah Krobock. Until next time.
11:53 – 11:58
11:58 - 12:26
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