Member Firms’ Nexus to Crypto

Regulatory Obligations

Crypto assets—also known as digital assets—are assets that are generated, issued or transferred using a blockchain or similar distributed ledger technology network. While many kinds of market participants engage in crypto asset activities, FINRA has jurisdiction only over its member firms and their associated persons. Federal securities laws and FINRA rules generally apply to member firm activities involving crypto assets that are securities, including those that are offered and sold as an investment contract (which is a type of security). In addition, certain FINRA rules apply to the activities of firms and their associated persons irrespective of whether the activity involves a security.

FINRA is actively monitoring and responding to market, legislative and policy developments in this rapidly evolving area and encourages member firms to do the same. Examples include the following:

Findings

  • FINRA Rule 2210 (Communications with the Public):
    • Not including appropriate disclosures in communications with the public about relevant risks.1
    • Disseminating promotional materials in connection with securities offerings involving crypto assets that contained false and misleading statements or material omissions.
    • Comparing the crypto asset to other assets (e.g., stock investments or cash) without providing a sound basis to compare the varying features and risks of crypto assets.
    • Making misleading statements about the extent to which certain crypto assets were protected by the Securities Investor Protection Corporation (SIPC) under the Securities Investor Protection Act (SIPA).
    • Social media communications posted by influencers on a firm’s behalf that were not fair and balanced or made claims that were promissory or misleading.
    • Not disclosing that the crypto assets were not offered through the member firm (e.g., promoting crypto assets offered by an affiliate without disclosing that they were not offered by the member firm).
  • FINRA Rule 3110 (Supervision): Not conducting appropriate due diligence on the crypto asset securities, crypto asset-related private placements of securities, and crypto asset-related securities products that the firm recommends to customers.
  • FINRA Rules 3270 (Outside Business Activities of Registered Persons) and 3280 (Private Securities Transactions of an Associated Person): Failures related to the disclosure of crypto asset outside business activities and the approval and supervision of private securities transactions for selling compensation (e.g., soliciting investments in, and receiving selling compensation for, securities issued by a company claiming to operate crypto asset mining and investment programs without prior written notice to or approval from the associated person’s employing firm).
  • FINRA Rule 3310 (Anti-Money Laundering (AML) Compliance Program): Not establishing and implementing AML programs reasonably designed to detect and cause the reporting of suspicious crypto asset transactions occurring by, at or through the broker-dealer.
  • FINRA Rule 11870 (Customer Account Transfer Contracts): Improperly rejecting customer requests to transfer assets within their brokerage accounts via the ACATS process if the customer also maintained a separate account that had a crypto asset balance at the firm’s affiliate.
  • FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade): Negligently causing the dissemination of promotional materials that the member firm or associated person should have known contained material misstatements and omitting material facts related to the member firm’s crypto asset business.

Effective Practices

  • Due Diligence on Unregistered Offerings:2 Before crypto assets that are securities or that are offered and sold as securities are recommended to customers through an unregistered offering, understanding:
    • the exemption from registration on which the unregistered offering will rely;
    • whether the offering is a contingent offering, and, if it is, the relevant contingencies and how the funds or assets will be returned in the event of a contingent offering not meeting the minimum contingency;
    • description of the business and how the raised proceeds will be used;
    • risk factors and conflicts of interest disclosed in the prospectus, offering documents or other promotional materials; and
    • the specific mechanics associated with the crypto asset that is a security or that is offered or sold as a security, including:
      • the identities and background of the initial development team (e.g., to review for potential conflicts);
      • the total supply of the underlying crypto assets, whether there is a cap on supply and what the minting and burning schedule is, as well as any material events impacting the supply of the crypto assets such as halving events and protocol modifications;
      • any markets associated with the crypto asset(s);
      • any smart contract features or functionalities (including related cybersecurity risks);
      • how and when the security will be delivered to customers; and
      • how the security will be custodied by or for customers.
  • On-Chain Reviews: Conducting risk-based on-chain fraud and anti-money laundering reviews when the firm or its associated persons are accepting, trading or transferring crypto assets, and establishing procedures that address when and how these on-chain reviews are performed and documented.
  • Informing Customers: Ensuring customers are informed about:
    • the differences between their brokerage account and any linked or affiliated crypto account; and
    • differences in:
      • protections of assets in the accounts via SIPC under SIPA;
      • regulatory oversight;
      • firm supervision; and
      • avenues of communications for customers’ concerns, questions or complaints.

FINRA continues to encourage firms to notify FINRA about new and planned activities related to crypto assets:

  • FINRA has issued guidance encouraging firms to notify FINRA about new and planned activities related to digital assets:
    • Regulatory Notice 21-25 (FINRA Continues to Encourage Firms to Notify FINRA if They Engage in Activities Related to Digital Assets)
    • Regulatory Notice 20-23 (FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets)
  • Additionally, firms can contact their Risk Monitoring Analyst if they have questions about their engagement, or potential engagement, with crypto assets.

Additional Resources

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Member Firms’ Nexus to Crypto
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1 See FINRA Provides Update on Member Firms’ Crypto Asset Activities.

2 See the Report’s Private Placements topic for additional guidance related to conducting reasonable due diligence on unregistered offerings.