Finra finds many misleading claims about crypto assets

'This happens when there is a new frontier of investment categories,' a compliance expert says. 'A lot of folks get very excited. What that means is [compliance] policies and procedures don’t catch up with the business side.'

Brokerages aren’t telling the full truth about cryptocurrency assets when they discuss them with customers, Finra warned Tuesday.

The Financial Industry Regulatory Authority Inc. flagged potential violations of its rules in 70% of the materials it reviewed during a targeted examination of firm communications regarding crypto products and services, according to a report released Tuesday. The broker-dealer self-regulator probed 500 communications between brokerages and retail investors.

Brokerages failed to comply with Finra rules that require their communications with the public be “fair and balanced” and provide a sound basis for evaluating facts regarding products and services. Finra prohibits false, exaggerated and misleading claims.

Finra’s exam sweep, which began in November 2022, zeroed in on what brokerages said about crypto assets sold by or through an affiliate or other third party. Finra found that firms made false or misleading statements about how crypto assets work and their core features and risks; compared them inaccurately to other assets, such as stocks or cash; misrepresented that investor protections in federal securities laws applied to crypto; and made other misleading statements.

“With the growth in this market and increased interest in crypto assets, the potential harm caused by problematic communications has also increased,” Ira Gluck, Finra senior director of advertising regulation, said in a Finra podcast.. “[I]n order to have enough information to evaluate a crypto asset investment or service, communications need to clearly describe its risks and features.”.

Crypto assets, such as digital tokens, have become popular investments, but they’re laden with risks for ordinary investors. Finra and the Securities and Exchange Commission have made crypto an examination priority this year.

“Both Finra and the SEC are concerned about how this product is sold,” said Francois Cooke, managing director at ACA Group, a compliance consulting firm. “In particular, Finra is keeping a focus on potential bad actors.”

Even though the SEC approved a bitcoin exchange-traded fund earlier this month, SEC Chair Gary Gensler made clear that he still has doubts about the probity of many crypto offerings.

“Gensler has been pretty skeptical about crypto assets,” said Bill Simpson, director of compliance at Hearsay Systems, a software provider for digital communications compliance. “I think that attitude is going to carry forward. For retail investors, this is going to be a confusing and potentially landmine-ridden area.”

Regulators and compliance departments are trying to keep pace with the growing demand for crypto assets, which can sometimes get out ahead of firm’s internal controls.

“I am honestly not surprised” by Finra’s findings, Simpson said. “This happens when there is a new frontier of investment categories. A lot of folks get very excited. What that means is [compliance] policies and procedures don’t catch up with the business side of the house.”

Finra’s report on the crypto exam sweep gives firms guidance on how to stay in compliance on crypto pitches. But the broker-dealer self-regulator also warned that enforcement could be next.

One way to avoid a Finra crackdown is to ensure that crypto recommendations comply with Regulation Best Interest, the broker standard of conduct, Cooke said. Reg BI prohibits brokers from putting their revenue interests ahead of their customers’ interests in a strong investment return.

“They should heighten supervision over sales of these products, especially to retail customers because of the regulatory requirements of Reg BI,” he said.

Brokerages also should update their compliance systems so that they address crypto topics.

“Compliance teams should also be thinking about implementing an enhanced lexicon-based supervisory program for terms specifically related to crypto assets,” Simpson said.

Cooke said the fundamentals that apply to all investment products – such as the imperative to explain how they work and the risks they carry and only to recommend them if they’re in the best interests of the customer – also apply to crypto.

“It’s the basic blocking and tackling,” he said.