The Financial Industry Regulatory Authority (FINRA) is continuing its bizarre transformation into a crypto asset regulator with the recent publication of its Crypto Assets Communications Sweep (Sweep) results.
FINRA lacks regulatory authority over non-securities crypto assets. Despite this fact, FINRA continues to display an unwavering, albeit misguided interest in the non-securities crypto asset activities of its members, affiliates, vendors and personnel.
FINRA initiated the Sweep more than 14 months ago: It consumed significant time, resources and attention for those subjected to the Sweep. But even with the significant allocation of valuable member resources, the Sweep findings are lackluster at best, and at worst highlight FINRA’s continued struggle to make sense of a complex industry outside of its regulatory gambit.
While the Sweep reflects further intrusion into the non-securities crypto asset regulatory space by an unqualified regulator, the broader implications for current FINRA members and those hoping to achieve membership are strikingly discouraging.
Where does the Sweep come from?
FINRA debuted its foray into the non-securities crypto asset regulatory space in 2018 with the publication of Regulatory Notice 18-20 (RN 18-20).
This notice “encouraged” FINRA members to notify FINRA if the member, any of its affiliates or associated persons engaged or intended to engage in any activity related to crypto assets.
FINRA’s curiosity extended beyond crypto asset securities, and requested details regarding any and all manner of crypto asset activities. FINRA effectively re-issued this reporting request in Regulatory Notice 20-23 in 2020 and Regulatory Notice 21-25 in 2021, the latter of which remains in place to this day.
Not content with its far-reaching and blunt reporting “request,” FINRA then initiated a targeted exam of FINRA member retail communications concerning crypto asset products and services in November 2022.
Sweep findings
FINRA reviewed more than 500 crypto asset-retail communications, dedicated valuable FINRA resources and no doubt consumed countless FINRA member manhours in conducting the Sweep.
The result?
Opaque references to having identified “potential” violations of FINRA advertising rules.
The reality?
If our experience representing FINRA members subject to the Sweep is any indication, the Sweep appears to have effectively served as an out-sourced, self-serving educational program of sorts, paid for and imposed on FINRA members by regulatory fiat.
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The Sweep found, among other things, FINRA member communications that included “unclear and misleading explanations of how crypto assets work and their core features and risks” as well as “comparisons of crypto assets to other assets […] without providing a basis to compare the varying features and risks of these investments.”
Unfortunately, these “findings” raise more questions than answers.
For instance, by what standard does FINRA possibly determine whether the core features and risks of a non-securities crypto asset product is appropriately explained? Most non-securities crypto asset products are regulated by the states and/or the Commodity Futures Trading Commission and facilitated by appropriately (and separately) regulated FINRA member affiliates. To what extent are FINRA members expected to conform their affiliate marketing to satisfy the uninformed views of a securities regulator as to the operation of a non-securities, separately regulated financial product?
Put bluntly, does FINRA have the capacity to know whether a non-securities crypto asset is in fact accurately explained, or the risks accurately presented?
The issue of cross-affiliate marketing is far from novel. In fact, many of the nation’s largest broker-dealers market securities products side-by-side with traditional and sophisticated non-securities financial products offered by their affiliates.
Does FINRA hold itself out as the arbiter for determining whether precious metal futures or indexed universal life insurance products are “unclear and misleading” over the judgment (and regulatory oversight) of the company’s expert in such products? We suspect not.
Implications for the securities industry
FINRA’s seeming compulsion to insert itself in matters further and further afield from its regulatory mandate presents real-world consequences for both operating broker-dealers as well as those companies looking to establish securities firms.
For operating broker-dealers, they are increasingly required to dedicate time and resources to navigate intrusive and often non-sensical FINRA crypto asset regulatory inquiries. These inquiries are often focused on products or services that are not even offered by the FINRA member itself.
This state of affairs places unnecessary burdens on internal compliance teams, hinders product development and obfuscates the separate and well-established regulatory regimes within which many broker-dealers and their affiliates operate.
For crypto asset companies intending to establish separate, FINRA member broker-dealers, FINRA’s preoccupation with non-securities crypto assets has expanded in scope. What was once simply a nuisance is now a fundamental misalignment of regulatory functions and priorities that often effectively serves to prohibit new member applicants with crypto asset affiliates from obtaining membership.
As an example, we have seen firsthand FINRA’s Membership Application Program Group (MAP) import the Sweep examination criteria directly into the new membership process. This action fundamentally and improperly re-characterizes the MAP function from one of membership evaluation to exam enforcement. MAP is not equipped to serve this function, nor should it be. Unfortunately, innovative, tech-focused investment platforms continue to bear the brunt of FINRA’s continued imprudence in this respect.
Until FINRA abandons its misguided attempt to seek indirect oversight over non-securities crypto assets and the activities of separately regulated financial institutions, market integrity and the investing public will undoubtedly continue to suffer.
Ethan L. Silver is Chair of the FinTech and Broker-Dealer Practices and Co-Chair of the crypto practice at law firm Lowenstein Sandler. Ethan is a recognized leader in the representation of broker-dealers in regulatory, enforcement, and compliance matters related to federal and state securities laws and regulations; and the rules of self-regulatory organizations such as Financial Industry Regulatory Authority (FINRA). He also spearheads the firm’s crypto and FinTech practices, representing wide-ranging crypto-focused businesses and regulated financial technology companies including mobile-first brokerage platforms and digital-advisers.
William Brannan is a partner and Vice Chair of Lowenstein Sandler’s crypto practice. He provides counsel regulated financial technology companies navigating complex securities, derivatives, and cryptocurrency regulatory issues. Will regularly advises digital asset exchanges, multi-asset trading platforms, robo-advisers, market makers, liquidity providers, custodians and digital asset services providers with respect to federal and state cryptocurrency regulations, securities laws, FINRA rules, security-based swap rules, state money transmitter licensing requirements and the New York BitLicense.
