The Financial Regulatory Authority (FINRA) recently identified the “initial themes” observed in a targeted examination of retail communications by member firms with respect to crypto assets. The headline grabbing statistic: FINRA assessed approximately 70 percent of the retail communications reviewed as being potential violations of FINRA’s communication standards. The significant violation rate is likely founded in the relative novelty and complexity of crypto assets. It is unclear if this stat is bolstered by the fact that regulators continue to utilize a guarded, critical approach to all crypto related activity. One thing is clear – financial advisory firms must expect ongoing, strong scrutiny of communications as to crypto assets and services. In this article, we explore FINRA’s conclusions and discuss key questions posed by FINRA to support firms' ongoing compliance and remedial efforts.
Key Initial Findings
FINRA listed the following themes and findings in its recent release:
- Failure to clearly differentiate in communications, including those on mobile apps, between Crypto Assets offered through an affiliate of the member or another third party, and products and services offered directly by the member itself.
- False statements or implications that Crypto Assets functioned like cash or cash equivalent instruments.
- Other false or misleading statements or claims regarding Crypto Assets.
- Comparisons of Crypto Assets to other assets (e.g., stock investments or cash) without providing a sound basis to compare the varying features and risks of these investments.
- Unclear and misleading explanations of how Crypto Assets work and their core features and risks.
- Failure to provide a sound basis to evaluate Crypto Assets by omitting clear explanations of how Crypto Assets are issued, held, transferred, or sold.
- Misrepresenting that the protections of the federal securities laws or FINRA rules applied to the Crypto Assets.
- Misleading statements about the extent to which certain Crypto Assets are protected by SIPC or under SIPA.
We suspect at least some of the misrepresentations and misleading/false statements assessments by FINRA are likely the product of internal misunderstandings and miscommunications. Crypto assets are still relatively new, often present nuanced features/use cases and may be difficult to compare to other products available at traditional financial services firms. In fact, “Crypto Assets” are comprised of different types of digital assets, including but not limited to stablecoins, non-fungible tokens (NFTs), bitcoins and other cryptocurrencies. Each of these assets have distinct characteristics and uses, which cannot lead to a one-size-fit-all type of communication.  These issues may complicate the ability to translate concepts understood by the firm and financial advisors into communications for retail investors. Moreover, supervisory personnel involved in the review and approval processes may not yet have enough exposure and experience with crypto assets to adequately scrutinize the communications. For these reasons, in preparing retail communications with respect to crypto assets, firms should take steps to reasonably ensure persons with deep knowledge of crypto assets are included in the development and review phases.
However, even diligence in preparing communications may not be sufficient to address the risks presented by nuanced product differences, ongoing regulatory scrutiny and evolutions in the application of fundamental principles to crypto assets. Take, for example, FINRA’s observation that certain crypto assets were incorrectly identified as cash equivalents. Certain stablecoins – crypto assets whose value is often pegged to a fiat currency, such as the U.S. dollar – may indeed appear to function as “cash equivalents.” But accounting principles as well as regulatory positions evolve. For example, auction rate securities (ARS) were regularly identified as “cash equivalents” by reputable accounting firms in reliance on existing accounting standards. Until they were not. Then, after wide-spread failures in the ARS market, securities regulators sanctioned numerous brokerage firms, in part, because of how they classified ARS in client communications. Firms should consider the value associated with utilizing terms such as “cash equivalent” when discussing crypto assets and, if they chose to do so, implement processes to ensure their use of such terminology is not later second-guessed.
Undertake Practical Assessments Regarding Crypto Asset Communications
FINRA’s release also offers specific queries that firms can use as they consider whether statements in communications are both accurate and are presented in a fair and balanced manner. For example, a firm should assess whether certain crypto assets are offered by the firm itself or an affiliate and, relatedly, whether the firm’s communications sufficiently identify which entity is providing each product or service.
An interesting point for self-assessment is whether SIPC protection applies to crypto assets sold by the firm. The Securities Investor Protection Act does not define “security” to include “investment contracts” as a general matter. Of course, a key reason espoused for treating a cryto assets as a “security” is that the asset or service involves an “investment contract,” which itself remains a point of contention as to numerous crypto assets. As a general rule, firms offering crypto assets should note this point with respect to how they identify SIPC coverage in connection with communications to clients, including account statements specifically.
Finally, FINRA included several considerations firms should employ to ensure statements about crypto assets are presented in a “fair and balanced” manner as required by FINRA Rule 2210. The outline of considerations noted by FINRA appear to be useful in preparing risk disclosures and crafting clear communications regarding crypto assets.
In sum, FINRA’s update serves as a cautionary, but informative, notice to financial services firms as they increasingly explore if, and how, to incorporate crypto assets into their businesses. FINRA will continue to inquire into Crypto Assets as the assets continue to evolve and new products become available. Employing diligence, knowledgeable persons and – frankly – caution will be essential in managing the associated business and regulatory risks.
 FINRA defines “Crypto Assets” as an asset issued or transferred “using distributed ledger or blockchain technology, including, but not limited to, so-called ‘virtual currencies,’ ‘coins,’ and ‘tokens.’” https://www.finra.org/rules-guidance/guidance/targeted-examination-letters/crypto-asset-communications
 “Auction-Rate Securities: Short-Term or Long?,” Stephen Taub, CFO.com, March 25, 2005.
 Testimony Concerning The SEC’s Recent Actions With Respect to Auction Rate Securities, Before the Committee on Financial Services, U.S. House of Representatives, by Linda Chatman Thomsen, Director, Division of Enforcement (September 18, 2008)
 15 U.S.C. 78lll(14)(Definition of “security” under SIPA limits investment contracts included to “any investment contract or certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or mineral royalty or lease (if such investment contract or interest is the subject of a registration statement with the Commission pursuant to the provisions of the Securities Act of 1933…”)