[co-author: Katie Chaffer]
On January 23, 2024, the Financial Industry Regulatory Authority, Inc. (“FINRA”) published an update to the targeted exam it launched in November 2022, which was designed to review – for compliance with FINRA Rule 2210 – the practices of member firms that communicate with retail customers concerning “Crypto Assets” (generally, assets that are issued or transferred using distributed ledger or blockchain technology, whereby a particular crypto asset may or may not meet the definition of a “security” under the federal securities laws) and related services.
FINRA Rule 2210 (Communications with the Public) requires, among other things, that member firms’ communications with the public be fair and balanced and provide a sound basis for evaluating the facts regarding any product or service discussed. Moreover, the rule prohibits claims that are false, exaggerated, promissory, unwarranted, or misleading, and prohibits the omission of any material fact that would render a communication misleading. In addition, Article 10 of the Securities Investor Protection Corporation (“SIPC”) Bylaws (Member Advertising) prohibits references to SIPC that might reasonably be deemed misleading.
FINRA identified potentially substantive violations of FINRA Rule 2210 in approximately 70% of the communications it examined, which included communications concerning Crypto Assets that were offered by or through an affiliate of the member or other third party. Examples of those violations include:
- A failure to differentiate between Crypto Assets offered directly by the member firm and those offered by affiliates or third parties;
- False statements or implications that Crypto Assets function like cash or cash equivalent instruments;
- Comparisons of Crypto Assets to other assets without providing a sound basis to compare their features and risks;
- Unclear and misleading explanations of how Crypto Assets work, and their core features and risks;
- A failure to clearly explain how Crypto Assets are issued, held, transferred, or sold;
- Misrepresentations that the protections of the federal securities laws or FINRA rules apply to Crypto Assets; and
- Misleading statements about the extent to which certain Crypto Assets are protected by SIPC or under the Securities Investor Protection Act of 1970.
FINRA suggested questions member firms should ask when reviewing and supervising their client communications, including whether the communications fail to accurately state the risks and limitations of Crypto Assets, overstate the legal or regulatory protection provided to these assets, or fail to clarify which party is offering the assets for sale.
FINRA also suggested that firms take proactive measures in client communications, such as: explaining the commissions and fees incurred when trading in Crypto Assets; prominently disclaiming SIPC protection where it would not apply; and assuring all technical terms associated with Crypto Assets are adequately explained.
Firms should expect continued focus in this area, including communications related to recently approved ETFs associated with cryptocurrency.
The FINRA update can be accessed here.
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