BLOCKCHAIN—FINRA identifies potential violations of retail communications rules for crypto assets - 29 January 2024

FINRA said that 70 percent of the retail communications reviewed contained materials that could violate the regulator’s rules for broker-dealers.

The Financial Industry Regulatory Authority (FINRA) has updated its 2022 targeted exam review of how member firms talk to their retail customers about crypto assets and those firms’ related compliance with the communications rules contained in FINRA Rule 2210. FINRA said it reviewed 500 retail communications and found that 70 percent of these communications contained materials on crypto assets that could violate FINRA rules. A press release accompanying the update added that most of the potential violations were engaged in by only a “handful of firms.” The update on the exam review spotlights some “initial themes” regarding how the studied retail communications went awry and asks member firms to mull additional questions about their compliance with FINRA Rule 2210.

“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,” said Ira Gluck, Senior Director, Advertising Regulation Department, FINRA during a recent FINRA podcast. Gluck added that “[i]n 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.”

By way of background, the 2022 exam review asked certain member firms to provide details about: (1) all of their retail communications; (2) the firm’s written supervisory procedures for such communications; (3) the firm’s compliance policies and other related materials; and (4) and the firm’s contracts or other written agreements with affiliates regarding such communications. FINRA Rule 2210 defines “retail communication” as “any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.” The exam review also applied to video, social media, mobile applications, and websites in addition to written communications. Significantly, the exam review defined “crypto asset” broadly, but specifically excluded “a security registered under the Securities Act and transferred through the system of a registered clearing agency.”

The eight initial themes identified by FINRA in the update can be further condensed into four overarching categories:

Source of investment offering—FINRA said member firms failed to identify who was offering the crypto assets, the member firm or its affiliate or an affiliate of a third party.

False claims—According to FINRA, member firms often equated crypto assets with cash equivalents and/or made comparisons of crypto assets to other types of investments without a sound basis for the comparisons.

Crypto features—FINRA noted that many firms failed to explain the basics about the key features of crypto assets and how crypto assets work.

Misrepresentations about legal protections—FINRA reported instances in which member firms may have misrepresented the legal protections available to crypto assets under federal securities laws, FINRA rules, and from the Securities Investor Protection Corporation (SIPC).

As a result of the exam review, FINRA is now asking member firms to consider additional questions about their practices regarding the handling of retail communications for crypto assets. These questions largely reflect the eight specific initial themes identified in the update, but several of the questions suggest potential new areas of concern. For example, one question asks if firms overstate the safety of crypto assets by implying that these assets are “‘secured’ by a trading platform, or ‘backed’ by a clearing firm.” Another question asks firms to consider whether their retail communications may falsely imply that investments in funds that invest in crypto asset futures or in businesses that aid the crypto industry are direct investments in crypto assets.

With respect to making fair and balanced presentations to retail investors, FINRA asked firms to consider, among other things, whether they adequately convey the regulatory uncertainty regarding crypto assets and whether they adequately explain the fees and commissions associated with the trading of crypto assets.

Although the update does not create any new obligations for member firms, FINRA noted that “[m]ember firms may consider the information in this update in developing new, or modifying existing, policies and procedures that are reasonably designed to achieve compliance with relevant regulatory obligations based on the member firm’s size, business model, or practices.”

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