A Closer Look At Crypto: The Crucial Role Of FINRAs CAI Team FINRA Unscripted podcast

We also work closely with the Corporate Finance Department and with Advertising Regulation in that, Corporate Finance is reviewing private placement filings that are submitted to FINRA and Advertising Regulation is reviewing communications. I think there’s some discussion previously about Advertising Reg’s sweep related to crypto asset communications, and so that very much impacts us and their findings will impact what we’re doing in the future. So, we keep a close eye on what they are doing in that space and just try really at all times to help other departments as we learn new things. 1For purposes of this update, a crypto asset is an asset that is issued or transferred using distributed ledger or blockchain technology, including, but not limited to, so-called “virtual currencies,” “coins,” and “tokens.” A particular crypto asset may or may not meet the definition of a “security” under the federal securities laws. Additionally, the communication methods and terminology used in the crypto ecosystem can be unique.

We can definitely provide links to some of the relevant guidance documents in the show notes, and the audience can also check out that recent FINRA Unscripted episode that you all did with the MAP program that really digs into the process for reviewing and approving firms with material crypto asset securities business lines. Prior to the Hub being established, FINRA also established the Crypto Asset Investigations (CAI) team and Blockchain Lab, which are specialized units staffed with crypto asset subject matter experts. CAI conducts complex investigations related to crypto asset fraud and collaborates with FINRA’s exam program to conduct risk-based examinations of firms’ compliance with FINRA rules and federal securities laws and regulations related to crypto assets. The Blockchain Lab serves as a central point within FINRA for the development of blockchain-related regulatory initiatives and helps build or source technology solutions to facilitate oversight of blockchain-related activities. Additionally, FINRA recently established a Crypto Asset Surveillance Team, which works in collaboration with the Hub and supports FINRA’s ability to conduct surveillance of the crypto asset markets. An important example of this mission in action is our work to address the unique regulatory challenges presented by the activities of our member firms that relate to crypto assets—also known as digital assets—which are assets issued or transferred using distributed ledger or blockchain technology.

We’ve also looked at our technology needs and are actively assessing and developing new investigative tools specific to crypto asset activities in order to enhance our capabilities in that area. The Blockchain Lab that Omer mentioned earlier is one of the leading groups within FINRA on that front, and I don’t want to spoil the future podcast on that one, so I’ll just encourage the audience to tune in to that future episode to hear more about the ongoing work that they’re helping to lead internally here at FINRA. We’ve also engaged in a broad effort with our partners in market regulation and transparency services to assess and, where needed, enhance FINRA’s market surveillance capabilities with respect to crypto assets. And the third objective is to engage in blockchain innovation to support and enhance FINRA’s regulatory capabilities across all product types, including crypto assets, as well as exploring the utilization of blockchain solutions in financial applications. And so, to accomplish this objective, FINRA established the Blockchain Lab within the Office of Financial Innovation, whose mission is to work in partnership with Reg Ops, which, I believe, Kaitlyn, has been a subject of a previous podcast, and refers to our operational departments, which are Member Supervision, Enforcement and Market Regulation.

• And then lastly, another area of focus from a fraud perspective for CAI is misrepresentations and omissions of material facts regarding crypto assets or the crypto asset exposure that’s being offered or provided by a firm or a rep to customers.
• Arbitration and mediation case participants and FINRA neutrals can view case information and submit documents through this Dispute Resolution Portal.
• However, FINRA is committed to this work and ensuring that whatever the future holds, we are prepared to fulfill our regulatory mandate and advance our core mission to protect investors and safeguard market integrity.
• Having that collaboration helps us to come into those meetings and really have good conversation with firms about what they’re doing.
• This training program, more so than a lot of the other projects that are ongoing, is one that we expect to continue to pay dividends for FINRA as we think about building up our capacities and enhancing our abilities to fulfill our regulatory mission with respect to crypto assets.

Even with the recent decline in assets, the size of the crypto asset market, retail investor participation in it, and recent events, such as the collapse of FTX, underscore the importance of our work in this area. This training program, more so than a lot of the other projects that are ongoing, is one that we expect to continue to pay dividends for FINRA as we think about building up our capacities and enhancing our abilities to fulfill our regulatory mission with respect to crypto assets. 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. And each of these departments has at least one subject matter expert represented on the Hub.

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. So again, back in 2018, and I think what was different about that group and what we’re doing now with An Inside Look Into Finras Crypto Asset Work CAI is that the Digital Asset specialist team was a non-dedicated group, which really just meant that the people on that team also maintained our normal roles within Member Supervision. And then we would conduct the crypto-related reviews alongside our dedicated roles. But with CAI now, we are full-time staff members that are solely focused on the crypto-related work that we’re doing.

SIPA also provides criminal penalties for false representations that a person or account is protected by SIPC where made with actual knowledge of their falsity and intent to deceive or cause injury. 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. Jason Foye, chief of FINRA’s Crypto Hub, offers an inside view of the agency’s crypto asset oversight activities.

At the same time, FINRA is engaged in a variety of initiatives designed to build for the future and enhance our capabilities. Key aspects of this work are our efforts to engage with other state, federal, and international regulators and agencies to discuss crypto asset regulatory efforts and developments, as well as our efforts to engage with member firms and other industry participants to better understand current crypto asset activities and issues. A special summit attended by crypto asset subject matter experts from FINRA and the National Futures Association is one example of this work. We recently formed a dedicated crypto asset surveillance team that’s going to be leading our efforts on this front in coordination with different groups across the organization and with the Hub. There’s so much going on right now at FINRA with respect to crypto assets, I certainly can’t cover all the incredible work that’s being done across the organization in such a short amount of time.

9 See the Report’s Private Placements topic for additional guidance related to conducting reasonable due diligence on unregistered offerings. 8 See the Report’s Cybersecurity and Technological Management topic, and FINRA’ Cybersecurity Key Topics page and Industry Risks and Threats – Resources for Member Firms webpages, for additional guidance related to effective cybersecurity practices and controls. 7 See the Report’s AML, Fraud and Sanctions topic for additional guidance related to developing and implementing a reasonably designed AML compliance program.

And the Blockchain Lab will also partner with our technology department and the Crypto Hub to develop blockchain-related regulatory initiatives, identify new technology opportunities and build blockchain expertise. 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. So, I think some controls to consider with this misappropriation of asset risk with crypto assets specifically are to get a strong understanding of who has access to the private keys used in offerings, establish strong cyber and operational controls to govern how and when crypto assets are being accepted, stored and accessed.

It’s important to note for the audience that FINRA requires approval by our Member Application Program for firms engaging in material crypto asset securities business. Firms seeking approval for such a business line must provide specific information to FINRA, demonstrating that the firms meet applicable requirements under the securities laws and FINRA’s Rules. And FINRA follows the SEC’s guidance in assessing these proposed businesses involving crypto asset securities under applicable rules, such as the SEC’s financial responsibility rules and customer protection rule.

But I think if you pay attention to the news, there are some questions about what it means to actually segregate customer assets, what it means to know what your customers are doing and what it means for AML controls when you have crypto assets moving in a way that we’re not typically used to seeing. The crypto market has rapidly grown over the last decade, with a current capitalization of just north of $1 trillion, down from a high of approximately $3 trillion in 2021. This growth has included increased product offerings, retail investor participation (especially among younger investors), and related activities by our member firms. In some instances, bad actors have exploited the crypto market to steal significant sums from investors, such as through phishing scams seeking payment in cryptocurrency and fraudulent offerings.

And for those who are interested, you can find the November 2022 Crypto Asset Communications Exam letter on the FINRA website. This examination looked at different aspects of the advertising materials to evaluate disclosures in these materials, and the preliminary results have shown certain patterns. On this episode, the first in a three-part series, we sit down with Omer Meisel, Senior Vice President of the Complex Investigations and Intelligence Group, Jason Foye, Senior Director and Head of FINRA’s Crypto Hub, and Reema Abdelhamid, a Director with FINRA Enforcement to learn more about the strategy and the role of the Hub and FINRA’s work to advance its mission of investor protection and market integrity. 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 in that group, we conducted reviews to understand what the members and reps were doing in the crypto asset space at that time. This growth has included increased product offerings and retail investor participation, especially among younger investors.

Crypto assets—also known as digital assets—are assets issued or transferred using distributed ledger or blockchain technology. 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. Notably, an “investment contract” that is a “security” under other federal securities laws is not a “security” under SIPA unless it is the subject of a Securities Act registration statement.

This website is using a security service to protect itself from online attacks. There are several actions that could trigger this block including submitting a certain word or phrase, a SQL command or malformed data. And so, firms moving into this space is an opportunity for us to collaborate as they go to the Membership Application Program, to explore an application to add those services to their membership. It gives us a great opportunity to keep ahead of what’s happening and really prepare for those changes as they start to unravel within our membership.