The Financial Industry Regulatory Authority announced, on November 14, 2022, a targeted exam focusing on broker-dealers’ practices for communications with retail investors regarding Crypto Assets (as defined below). Specifically, FINRA’s targeted exam letter requests, among other information, all of the recipient firms’ retail communications concerning Crypto Asset products and services in order to assess the industry’s practices in complying with FINRA Rule 2210.1 Unless a targeted firm is informed otherwise, the exam covers the period from July 1, 2022 through September 30, 2022 (Relevant Period).
Scope of Request
FINRA’s request for information covers retail communications2 concerning Crypto Asset products and services. FINRA defines Crypto Assets as assets that are issued or transferred using distributed ledger or blockchain technology, and includes virtual currencies, coins and tokens. Although FINRA stated that a security registered under the Securities Act of 1933 and transferred through a registered clearing agency is not a Crypto Asset, a Crypto Asset “may or may not” meet the definition of security, according to FINRA.
In addition to evaluating a firm’s compliance with Rule 2210 in connection with its communications to retail investors, the exam could lead to FINRA reviewing whether: a firm’s crypto-related activities are disclosed on its Form BD; and the firm is in compliance with other FINRA rules, as well as federal securities laws, with respect to these activities.
The exam letter requests the following information and materials:3
- Numbered Tabular List of Communications. A targeted firm must provide a tabular list of the communications described above. The list also must specify:
- The date the communication first was made available to the public;
- Whether the communication was filed with FINRA’s Advertising Regulation Department and, if so, the reference number for such communication;
- Whether the communication was approved by a registered principal of the firm and, if so, the date of approval (with records that reflect such approval required to be provided separately); and
- The relevant Crypto Asset and/or service that is the subject of the communication.
- Written Supervisory Procedures. The firm must provide all written supervisory procedures (in effect during any portion of the Relevant Period) concerning the review, approval, record keeping and dissemination of communications.
- Compliance Policies, Training Materials and Other Written Guidance. The firm also must provide any compliance policies, manuals, training materials, compliance bulletins and other written guidance concerning communications that were in effect during any portion of the Relevant Period.
- Written Agreements. The firm must provide any contracts or other written agreements in place between the firm and its affiliates concerning:
- The creation or dissemination of communications on behalf of the affiliate or concerning services offered by the affiliate; and
- The affiliate’s use of customer information to determine who will receive communications.
FINRA Rule 2210 governs broker-dealers’ communications with the public and places on firms: general content standards; supervisory review and approval requirements; and, in certain cases, FINRA filing requirements. Rule 2210 is intended to ensure, among other things, that communications include “‘material fact[s] or qualification[s] necessary to ensure such communications are not misleading.”4 Broker-dealers’ activities with respect to Crypto Assets have been a focus of FINRA’s Examination and Risk Monitoring Program. In particular, the 2021 and 2022 Reports on FINRA’s Examination and Risk Monitoring Program stated that FINRA would evaluate whether a firm or its affiliates:
- Provide a “fair and balanced presentation in marketing materials and retail communications, including addressing risks presented by digital asset investments, and not misrepresenting the extent to which digital assets are regulated by FINRA,” or are subject to the federal securities laws, or eligible for protections thereunder (e.g., Securities Investor Protection Corporation (SIPC) coverage);
- Misleadingly imply in communications “that digital asset services offered through an affiliated entity are offered through and under the supervision, clearance and custody of a registered broker-dealer;”5 and
- Maintain and implement procedures for Crypto Asset communications, including risk disclosures, communication reviews and communications to differentiate crypto assets from securities.6
FINRA’s exam is one of many regulatory responses to recent events. It is also a reminder of FINRA’s overarching concern about the accuracy and content of retail communications, especially those related to novel and complex products that may be difficult for retail investors to understand, such as Crypto Assets. In light of the exam letter and current market conditions, broker-dealers may want to review their communications related to Crypto Assets7 to assess whether such communications reflect material risks, including the extent to which traditional investment protections (e.g., SIPC coverage) are not applicable.
*The authors would like to thank Magdalene Lam for her contributions to this OnPoint.
1) See Crypto Asset Communications, FINRA (Nov. 2022) (Exam Letter). In some instances, this Dechert OnPoint tracks the Exam Letter, as well as FINRA rules, without the use of quotation marks.
2) Retail Communication is defined as “any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.” FINRA Rule 2210(a)(5).
3) Exam Letter.
4) See Communications with the Public: Regulatory Obligations and Related Considerations, FINRA. See also 2022 Report on FINRA’s Examination and Risk Monitoring Program, FINRA (Feb. 9, 2022) (2022 Report); 2021 Report on FINRA’s Examination and Risk Monitoring Program, FINRA (Feb. 1, 2021) (2021 Report).
6) Specifically, the 2021 Report and 2022 Report note that effective practices in these areas include:
- “Risk Disclosure – Prominently describing the risks associated with digital assets, including that such investments are speculative, involve a high degree of risk, are generally illiquid, may have no value, have limited regulatory certainty, are subject to potential market manipulation risks and may expose investors to loss of principal.
- Communication Review – Reviewing firms’ communications to confirm that they are not exaggerating the potential benefits of digital assets or overstating the current or future status of digital asset projects or platforms.
- Differentiate Digital Assets [Securities] – Identifying, segregating and differentiating broker-dealers’ traditional products and services from those offered by affiliates or third parties, including digital asset affiliates; and clearly and prominently identifying entities responsible for non-securities digital assets businesses (and explaining that such services were not offered by the broker-dealer or subject to the same regulatory protections as those available for securities).”
7) See Regulatory Notice 22-08, FINRA (May 9, 2022) (noting the discussion of sales practice obligations relating to various crypto-related investments).