FINRA, Following the SEC, Prioritizes Supervision of Digital Assets in 2019 “Priorities Letter”

By: Tom H. Wagner and Stephen A. Rutenberg

On January 22, 2019 FINRA, the self-regulatory organization for U.S. broker-dealers, released its “Risk Monitoring and Examination Priorities Letter” for 2019. A number of  of FINRA’s hot topics for 2019 should be of interest for players in the FinTech and digital asset space.

Notably, FINRA identified the “Supervision of Digital Assets Business” as one of the operational risks it will focus on in the New Year. Many traditional broker-dealers have avoided the digital asset and cryptocurrency industry but FINRA explains that it is prioritizing this topic because some of its member firms have expressed interest in participating in the digital asset industry. FINRA’s Priorities Letter further states that the regulator “will consider how firms determine whether a particular digital asset is a security and whether firms have implemented adequate controls and supervision over compliance with rules related to the marketing, sale, execution, control, clearance, recordkeeping and valuation of digital assets, as well as AML/Bank Secrecy Act rules and regulations.” FINRA’s Priorities Letter comes roughly one month after the release by the SEC’s Office of Compliance Inspections and Examination’s announcement of its own priorities for 2019. Like FINRA, the SEC Office of Compliance intends to place “particular emphasis on digital assets . . .” in 2019.

Given that both regulators are prioritizing digital assets in 2019, it is safe to anticipate heightened scrutiny of broker-dealers that may have participated in an initial coin or token offering particularly in any market making function. Areas of inquiry for those broker-dealers will presumably include: What analysis did the broker-dealer undertake to determine whether the coin or digital asset being offered would be considered a security under U.S. law? And given that FINRA ultimately reports to the SEC, and the SEC’s stated position that the vast majority of digital coins or tokens will be considered securities, firms that participated in an ICO, including FINRA members, can expect FINRA examiners to take a very close look at these activities.

FINRA also encourages firms contemplating activities related to digital assets to notify FINRA if they plan to engage in such activities, even where a membership application is not required. In this regard it’s important for such firms to realize that registering with FINRA will not allow them to engage in activities related to securities which were not registered with the SEC or sold under an exemption from registration.

FINRA is also prioritizing its scrutiny of Online Distribution Platforms for the selling of securities. These platforms are frequently used in the sale of digital assets. Although many of these platforms are not owned by broker-dealers, they frequently engage broker-dealers as selling agents. FINRA is concerned about these relationships between broker-dealers and online platforms and plans to given them increased scrutiny.   

Other FINRA priorities, including market manipulation and investor suitability, particularly for exchange traded assets, are also highly relevant to digital assets investors. Broker-dealers looking to expand their activities into the digital asset market should proceed with great caution and ensure they are in appropriate compliance with SEC standards and have undertaken internal measures to fully vet the digital assets as well as the partners and customers they may be getting involved with.