The Financial Industry Regulatory Authority asked all member firms voluntarily to notify their FINRA Regulatory Coordinator in writing if they, any of their associated persons, or any of their affiliates currently engage or intend to engage in any activities related to digital assets, including cryptocurrencies and other virtual coins or tokens, even if such assets are not securities. FINRA encourages all member firms to provide such information “promptly” and to update their Regulatory Coordinator through July 31, 2019, if they, their APs or their affiliates begin or intend to begin engaging in any new activity related to digital assets that was not previously disclosed.
The scope of activities FINRA seeks information regarding is quite broad. Among the activities covered by FINRA’s request are:
- purchases, sales or executions of transactions involving digital assets, including derivatives or in a pooled fund investing in such assets;
- creation, management of, or providing advisory services for, a pooled fund;
- creation or management of a platform for the secondary trading of digital assets, or to provide or facilitate clearance and settlement services for cryptocurrencies and other virtual coins or tokens;
- accepting cryptocurrencies from customers or mining cryptocurrencies;
- recommending, soliciting or accepting orders for cryptocurrencies or other virtual coins or tokens; and
- recording cryptocurrencies and other virtual coins and tokens using any type of blockchain technology.
FINRA does not seek information from member firms that previously was provided to their FINRA Regulatory Coordinator in response to a direct request, through a Continuing Membership Application, or through their 2018 Risk Control Assessment Survey (click here for background regarding RASs). FINRA also reminded member firms that they must file a CMA and receive FINRA approval whenever they seek to materially expand their business operations or activities (click here for background regarding CMAs).
In other unrelated developments regarding digital assets:
- Centra Tech Private Litigation: In a class action lawsuit against Centra Tech, Inc. and three individual defendants initially filed in a federal court in Florida in December 2017, a magistrate issued a report concluding that the digital tokens issued as part of the initial coin offering – Centra Tokens – were securities. The magistrate determined that all three prongs of the Howey test were met by the Centra Tokens: (1) investors invested money (even if not necessarily in fiat currency but in the form of Bitcoin or Ether); (2) in a common enterprise (e.g., the fortunes of individual investors were “directly or indirectly tied to the failure or success of the products the Defendants purported to develop”); (3) with the expectation of profits solely through the efforts of others. (Click here to access the W.J. Howey1946 Supreme Court decision.) According to the magistrate, “the success of [Centra Tokens and the Centra Tech projects] was entirely dependent on the efforts and actions of the Defendants.” Earlier this year, the Securities and Exchange Commission brought civil actions against Sohrab Sharma, Robert Farkas and Raymond Trapani in connection with Centra Tech’s ICO, while the US Attorney’s Office in New York filed criminal charges against the same individuals. (Click here for background in the article “SEC Seeks to Halt Another ICO” in the April 8, 2018 edition of Bridging the Week.) A magistrate’s report is not considered precedent in judicial proceedings. (Click here for a copy of the magistrate’s report.)
- Malta Adopts Laws to Promote Distributed Ledger Technology: Malta adopted three laws to provide a legal framework regarding distributed ledger technology. One law establishes the Malta Digital Innovation Authority whose function is to support technology innovation, including distributed or decentralized technology. The MDIA will be the grantor of innovative technology licenses. Another law, termed the “Innovative Technological Arrangement and Services Act,” generally governs the recognition of innovative technology arrangements and services such as software which may be used to design and implement distributed ledger technologies as well as smart contracts and related applications, including decentralized autonomous organizations. The third law, named the “Virtual Financial Asset Act,” establishes a framework for initial coin offerings. It requires companies involved with ICOs to issue detailed white papers including financial information. The VFA also deals with cryptocurrency exchanges and wallet providers. The new Malta laws generally prohibit insider dealing, market manipulation, and making misstatements in ICO white papers either willfully or in consequence of gross negligence. (Click here for a copy of the MDIA, here for a copy of the ITAS, and here for the VFA.)
- IRS Looking for Virtual Currency Cheats: The US Internal Revenue Service indicated that its Large Business and International Division would be looking for taxpayers with unreported virtual currency transactions. According to the IRS, virtual currency is property for federal tax purposes. Taxpayers must report gains in connection with virtual currency transactions and are “urged” to correct returns “as soon as practical” if they previously failed to report required transactions. (Click here for details; click here for additional background regarding the IRS's position regarding the tax treatment of income from virtual currency transactions in the article, "The US Taxman Cometh – for Cryptocurrency Income" in the March 25, 2018 edition of Bridging the Week.)
Compliance Weeds: Under FINRA rules, no registered person may be directly or indirectly employed in any other capacity in a business activity outside the scope of his or her relationship with his or her member firm unless he or she has given prior written notice to the member. (Click here to access FINRA Rule 3270.) Additionally, a person associated with members must also provide advance written notice to his or her member employer if he or she may engage in a securities transaction outside the regular course or scope of his or her employment, including new offerings of securities which are not registered with the SEC, subject to various exceptions and conditions. (Click here to access FINRA Rule 3280.)
Earlier this year, Arthur Meunier a/k/a Arthur Breitman agreed to be suspended for two years from association with any FINRA-regulated broker-dealer to settle FINRA charges that, from February 2014 to April 2016, he participated in the development of Tezos, a blockchain technology project, without notifying the broker-dealer he was then employed by of such activity, as required by FINRA rules. (Click here for background in the article “FINRA Fines a Tezos Co-Founder” in the April 22, 2o18 edition of Bridging the Week.)
FINRA implied in a footnote to its voluntary request for information related to digital asset activity that it is not imposing a new obligation on member firms proactively to seek out information related to its associated persons’ outside digital asset activities. Instead, it is solely “interested in learning from firms how they currently handle notifications regarding participation in activities related to digital assets, such as cryptocurrencies and other virtual coins and tokens.” However, FINRA has previously noted that firms that maintained "effective programs" regarding their relevant APs' outside business activities and private securities transactions "typically implemented proactive compliance efforts" to remind such persons of their obligations, including through frequent training and a requirement to complete open-ended questionnaires. (Click here to access a December 2017 FINRA Examination Findings regarding this subject.)
Unlike in the futures industry, the term “associated person” under FINRA rules embraces persons who are not solely registered with the SEC. The term includes, among others, any employee, except persons whose functions are solely clerical or ministerial. (Click here to access FINRA Rule 1011 and the definition of “associated person.”)