The Financial Industry Regulatory Authority (FINRA) started a Crypto Hub, also known as the Hub, in October 2022. Jason Foye, Chief of the Hub, offered an update to its activities on the organization’s website last week.

The Hub is designed to ensure the agency is prepared to fulfill our regulatory mission regarding the crypto asset-related activities of member firms and associated persons. It includes representatives from nearly every FINRA department, working with a mission to manage FINRA’s regulatory work related to crypto assets.

That includes conducting risk-based examinations and investigations of crypto asset activities being conducted by FINRA member firms and associated persons; building for the future and enhancing capabilities in this area, and engaging in blockchain innovation to support and enhance FINRA’s regulatory capabilities across all product types, including crypto assets.

Crypto landscape

The crypto market has rapidly grown over the last decade, with a current capitalization of just north of $1trn, down from a high of approximately $3trn in 2021.

This growth has included increased product offerings and retail investor participation, especially among younger investors. It has also included instances of bad actors exploiting the crypto market to steal significant sums from investors – from smaller pump-and-dump schemes to larger and longer-running ones – such as the fraudulent raising and misuse of funds that led to the collapse of asset trading platform FTX.

The promise and the risks involved in crypto are undergirding the Hub’s work as it works with FINRA’s Blockchain Lab, Crypto Asset Surveillance Team and its standard Examination team.

FINRA follows the SEC’s guidance in assessing a firm’s proposed digital asset securities business line under applicable rules, such as the SEC’s financial responsibility rules and customer protection rule.

Crypto asset activities

FINRA requires approval by its Membership Application Program for firms’ material crypto asset securities business lines. Firms seeking approval for such a business line must provide specified information to FINRA and meet the applicable requirements under the securities laws and FINRA rules.

FINRA follows the SEC’s guidance in assessing a firm’s proposed digital asset securities business line under applicable rules, such as the SEC’s financial responsibility rules and customer protection rule.

There are currently 26 firms approved solely to engage in crypto asset securities business, including:

• nine firms approved to engage in private placements involving crypto asset securities,
• nine firms approved to operate an Alternative Trading System (ATS) for crypto asset securities,
• seven firms approved to both engage in private placements involving crypto asset securities and operate an ATS for crypto asset securities, and
• one firm approved to be a Special Purpose Broker-Dealer (SPBD) under the SEC’s December 2020 statement regarding Custody of Digital Asset Securities by Special Purpose Broker-Dealers (the SPBD Policy Statement.

Violations identified by FINRA

When it comes to surveilling the crypto marketplace, FINRA has identified potential violations of its rules, and some themes identified with respect to these potential violations.

• FINRA has identified potential violations of FINRA Rule 3110 (Supervision) for failures to conduct due diligence on crypto asset private placements sold to investors.
• FINRA has issued disciplinary actions finding violations of FINRA Rules 3270 (Outside Business Activities of Registered Persons), 3280 (Private Securities Transactions of an Associated Person), and 3110 for failures related to the disclosure, approval, and supervision of crypto asset-related outside business activities and private securities transactions.
• FINRA examinations and investigations have also identified potential violations of FINRA Rule 3310 (Anti-Money Laundering Compliance Program) related to failure by member firms to establish AML programs reasonably designed to detect and cause the reporting of suspicious activities in situations where crypto asset activities are occurring by, at, or through the broker-dealer.
• FINRA has also identified potential violations of FINRA Rule 2210 (Communications with the Public) related to crypto asset communications. FINRA’s Advertising Regulation department performed a targeted examination of 17 member firms’ crypto asset-related communications to assess compliance with Rule 2210. It included examining whether advertising materials appropriately and accurately address relevant risks and contain appropriate disclosures related to safety and custody.

Enhancing capabilities

FINRA is engaging with state, federal, and international regulators and agencies to discuss crypto asset regulatory efforts and developments, as well as with member firms and other industry participants. A special summit attended by crypto asset subject matter experts from FINRA and the National Futures Association is one example of this collaboration.

FINRA is also developing blockchain-related regulatory initiatives to explore on-chain data, and building tools and exploring vendor solutions that can support and enhance FINRA’s regulatory capabilities.

As part of these efforts, FINRA has established nodes on the Ethereum and Bitcoin blockchains and explored the use of publicly available crypto asset market data.

And it has created a method for verifying that member firms or certain associated persons (eg, those managing investor funds away from their employing broker-dealer in crypto asset private securities transactions) have control over crypto asset wallets they purport to control.