An Update on FINRA’s Crypto Asset Work and the Crypto Hub

Last summer, we introduced listeners to FINRA' Crypto Hub and enterprise-wide strategy for keeping up with the evolving crypto asset regulatory landscape. A year later, this remains an important area of focus for investors, the industry and FINRA.

On this episode, Jamie Udinson, senior director of the Cyber and Analytics Unit, Michael Yuan, a director with FINRA's Risk Monitoring program, and Jason Stralka, an examination manager with the Exam program, join us to provide an update on FINRA's crypto asset work, to dig into the results of a recent survey of member firms regarding their crypto-asset touchpoints, to tell us about the new spot Bitcoin ETP market and more.

Resources mentioned in this episode:

2024 Regulatory Oversight Report: Crypt Asset Developments

Crypto Assets Key Topic Page

Episode 136: An Introduction to FINRA's Crypto Asset Work and the Crypto Hub

Episode 137: The Crucial Role of FINRA's CAI Team

Episode 138: FINRA's Blockchain Lab

Episode 145: An Update on FINRA's Crypt Asset Targeted Exam

Listen and subscribe to our podcast on Apple Podcasts, Google Podcasts, Spotifyor wherever you listen to your podcasts. Below is a transcript of the episode. Transcripts are generated using a combination of speech recognition software and human editors and may contain errors. Please check the corresponding audio before quoting in print.

FULL TRANSCRIPT

00:14 - 00:24

Kaitlyn Kiernan: Last summer, we introduced listeners to FINRA's Crypto Hub, an enterprise-wide strategy for keeping up with the evolving crypto asset regulatory landscape. On this episode, we have three members of the hub join us to provide an update on that work to dig into the results of a recent survey of member firms regarding their crypto asset touch points to tell us about the new spot Bitcoin ETP market and more.

00:33 - 01:15

Kaitlyn Kiernan: Welcome to FINRA Unscripted. I'm your host, Kaitlyn Kiernan. I'm pleased to welcome three guests to the show today to provide an update on FINRA's crypto asset work. Joining us, our returning guest, Jamie Udinson, a senior director with Member Supervision Cyber and Analytics Unit, and joining us for the first time are Michael Yuan, a director with FINRA's risk monitoring program, and Jason Stralka, an examination manager with the exam program. Last summer, we did a three-part series looking at FINRA's work in the crypto space, which we'll link to in our show notes. But it's been a year and a lot has happened, so Jamie, Mike and Jason, thanks for joining me today to provide an update.

01:15 - 01:16

Jason Stralka: Thanks for having us.

01:16 - 01:17

Michael Yuan: Thank you for having us.

01:17 - 01:27

Kaitlyn Kiernan: So, to kick things off, can you each introduce yourselves and tell us more about your role at FINRA as it relates to crypto? Mike, as one of our newcomers, can we start with you?

01:27 - 01:44

Michael Yuan: Sure. I'm a risk monitoring director in our risk monitoring program responsible for a group of firms that are in the subgroup of fintech and also retail clearing, carrying and clearing activities. And I'm also representing risk monitoring in the crypto hub.

01:45 - 01:47

Kaitlyn Kiernan: Great. Thanks, Mike. And, Jason, how about you?

01:47 - 02:00

Jason Stralka: Sure. Thank you for having me. My name is Jason Stralka. I'm an examination manager in FINRA's Diversified Carrying Clearing Firm Grouping. I'm also a member of FINRA's Crypto Hub, representing all the firm examinations.

02:01 - 02:06

Kaitlyn Kiernan: Great. Thanks, Jason and Jamie, as our returning guest. Can you remind us a little bit about your background?

02:07 - 02:48

Jamie Udinson: Sure. Thanks for having me back. I'm the senior director leading the Crypto Asset Investigations team. And as a reminder to those who listened to the last episode where we talked about that team, the team is an investigative group that assists with complex or high-risk investigations related to crypto asset securities. We also assist the firm examination program in instances where firm exams contain businesses that may be a little bit more complicated. We do a lot of other work to support the regulatory operations and training of FINRA staff as well.

02:49 - 03:07

Kaitlyn Kiernan: Great. Thanks, Jamie. And Mike FINRA's Risk Monitoring team recently completed a survey of FINRA membership regarding their crypto asset activity. To start, can you tell us a little bit more about the survey? Who did it go to and what was Risk Monitoring looking to learn?

03:08 - 04:03

Michael Yuan: The survey is really a continuation in an effort that began back in 2018, where FINRA had asked member firms to notify their risk monitoring analysts if the member firm, their associated persons or affiliates engage or plan to engage in crypto asset activities. So, in 2023, we supplemented these engagement efforts by asking selected member firms to complete a crypto asset questionnaire. FINRA selected nearly 600 member firms to receive the crypto asset questionnaire. Member firms were selected based on FINRA's previous knowledge of the member firms' activities in this area, and also our internal data, which indicated that member firms, their associated person, affiliate or parent companies may be engaged in crypto asset activities or have a touchpoint to a crypto asset business.

04:04 - 04:13

Kaitlyn Kiernan: And so that survey went to maybe like a little over a sixth of FINRA's membership then. And what were the key takeaways of the survey?

04:13 - 05:02

Michael Yuan: Well, the goal of the crypto asset questionnaire was to capture information related to member firms' crypto asset activities and touch points in a consistent and centralized manner, and to allow member firms an opportunity to provide current and planned crypto asset activities in a uniform way. So, some of the key takeaways is it provided helpful insights and allowed FINRA to identify trends related to crypto asset activities that FINRA member firms are engaged and their touch points to the broader crypto asset industry. Notably, many of the touch points identified are indirect, meaning that they relate to the activity being conducted by associated persons, affiliates or parent companies, rather than directly by the member firms.

05:03 - 05:10

Kaitlyn Kiernan: So how does this compare to information FINRA has gathered previously when looking at firm activity in the space?

05:10 - 05:35

Michael Yuan: It was in line with what we knew. There weren't any big surprises. Since 2018, we had heard from firms that are involved or the parent or associated person's touchpoints in the crypto asset space so the survey responses were really in line with what we knew about those engagements. But of course, our survey shed additional insights into those activities.

05:36 - 05:42

Kaitlyn Kiernan: And what can you say about the rate new firms are beginning to dip their toes in this space?

05:42 - 05:52

Michael Yuan: I would say it's all in the exploratory and testing phase. Firms are definitely interested in this space, but many of them are in the exploratory and testing phase.

05:53 - 05:59

Kaitlyn Kiernan: And where did you see the biggest changes with the results of this survey compared to outreach you've done in the past?

05:59 - 06:15

Michael Yuan: I would say the biggest changes are really seeing number of associated persons, reps having a crypto asset business disclose as an outside business activity. So, these are outside business activity done away from the broker-dealer that has crypto touch points.

06:16 - 06:54

Kaitlyn Kiernan: But something firms definitely need to be aware of. And in November 2022, we had an episode talking about firms applying to FINRA membership with crypto specific business models. And so, these are more direct touchpoints with crypto. At the time, we had two dozen firms that had been approved by FINRA to provide services and securities backed by crypto assets, either as a placement agent in crypto security, private placements or as an alternative trading system, or ETS facilitating secondary transactions in crypto securities. What's the latest count? Has there been any change there?

06:54 - 06:58

Michael Yuan: There has. We've seen an increase. That number is up to 37 now.

06:58 - 07:09

Kaitlyn Kiernan: Wow. That is a significant increase. And Jamie what is the Crypto Assets Investigation Team looking at when it comes to these crypto touch points.

07:10 - 08:16

Jamie Udinson: We see with the more direct touch points related to crypto assets, potential issues that we're investigating or assisting an examination for more due diligence types of reviews that could be due diligence related to products, due diligence activities that firms engage in to understand what registered representatives are doing. That's also due diligence related to vendors that firms are engaging to do activity in the crypto asset space. We also see issues related to anti-money laundering and section five cyber security. And we've talked a lot throughout the last year about the advertising and disclosure sweep that's been ongoing and issues that CAI either looks at or assists with relate a lot to identifying some of the same types of issues related to advertising and disclosure.

08:16 - 08:52

Jamie Udinson: We also continue to see the need for firms to have strong supervisory controls in place to monitor their employee activities. We talked a little bit just now about the increase in outside business activities related to crypto. We've seen this as well, and one of the things we continue to stress and we continue to look for, is the actions firms are taking to really understand what registered representatives outside business activities are and if there are products involved, whether those activities could be private securities transactions.

08:53 - 09:14

Kaitlyn Kiernan: Great. Thanks, Jamie. And we did have a podcast at the beginning of the year about that crypto asset communications sweep. So we can also link to that in our show notes for folks that miss that. And are there any new risks in focus right now for CAI or the crypto hub more broadly?

09:15 - 10:30

Jamie Udinson: It's interesting. I don't think we've identified new risks. A lot of times we have been talking about and seeing the same types of risks, and the way that we go about investigating or examining for those risks just has a little bit of a different spin on it. We are seeing firms who engage, either directly or indirectly, having touch points with the crypto ecosystem. And I think what that does, from our perspective, is emphasize how important it is to be diligent in understanding who the players are or who vendors are, what services are being offered, how firms are engaging with the ecosystem in general, and then what does it mean for their customers, for their business, for their internal risk management processes. This migration into the crypto world is an exercise in everyone just taking the time to really understand deeply what it means for their business and what is happening when they engage in these products, and whether or not the industry and the public understands everything that's going on.

10:31 - 10:41

Kaitlyn Kiernan: That is interesting that the risks haven't really changed, but are there any best practices you'd want to share with listeners as they explore this space?

10:41 - 11:51

Jamie Udinson: We have a great report that's available: the 2024 Regulatory Oversight Report. And in that report, there's a new section for crypto specifically. It's great for understanding some of the questions that you might be asking if you're firm compliance, some of the best practices that we have identified. And it also provides some information that can bridge any gaps between firms that are used to operating in the traditional space that we all know very well, and where there could be increased need for understanding unique terms or relationships that engaging in crypto asset securities business introduces to firms and what they all know as far as compliance and supervisory controls. It's a great resource for firms to use. I'd also encourage people to use the key topics page that FINRA.org offers related to crypto assets. There's fantastic information there available as well.

11:52 - 12:16

Kaitlyn Kiernan: Great. And we'll link to those in our show notes as well. And Jason, another new piece of the puzzle since we last focused on crypto on the podcast, was the approval by the SEC of various spot bitcoin ETPs and subsequently spot Ethereum ETPs. Can you tell us at a high level what these products are and how they work?

12:18: - 13:00

Jason Stralka: Well, there's no single definition of an exchange traded product or an ETP. In general, an ETP is a security that's listed on a U.S. exchange and seeks to provide exposure to the performance of a benchmark index or an actively managed strategy. In the case of spot Bitcoin ETPs, these are investments that track the price of Bitcoin, and they are the first exchange traded products that hold actual Bitcoin as their underlying asset instead of, say, Bitcoin futures or another Bitcoin derivative. In terms of how these products work Bitcoin ETPs track the performance of their underlying asset, in this case Bitcoin, and are investment vehicles that are listed on an exchange and can be bought and sold throughout the trading day like a stock.

13:00 - 13:10

Kaitlyn Kiernan: And these products are still relatively new. But what is FINRA seeing so far in terms of trading activity in these products? How big is the market?

13:11 - 13:36

Jason Stralka: Since the SEC approved spot Bitcoin ETFs on January 10th of this year, we've seen a steady increase in broker-dealer activity, albeit somewhat concentrated in the number of firms that have sought to engage in such trading. At the end of May, we've seen just under 6 billion, with a B, shares across 11 listed symbols, totaling approximately $58 billion in value in just over 1 million individual customer accounts.

13:37 - 13:42

Kaitlyn Kiernan: So that's from when these were approved through the end of May?

13:43 - 13:43

Jason Stralka: That's correct.

13:44 - 13:49

Kaitlyn Kiernan: And what are some of the risks and challenges associated with these products?

13:49 - 14:15

Jason Stralka: There are several. With any investment there is always market risk. So, there would be market risk associated with purchasing ETPs. Regarding spot Bitcoin ETPs, there would be enhanced sales risk considerations due to the highly speculative and volatile nature of the underlying asset in addition to customer portfolio concentration risk and those risks can be further elevated when these products are leveraged.

14:17 - 14:25

Kaitlyn Kiernan: And how is FINRA thinking about these products in terms of its risks to investors or to the market or in firms?

14:26 - 14:57

Jason Stralka: FINRA is certainly thinking about these products in a variety of different ways. From an investor firm standpoint, ee see these risks associated with these products in the same way we would see other highly speculative, highly volatile products, with the focus being on the firm's supervisory procedures and processes for complying with our standards related to Regulation Best Interest, Communications with the Public, to include appropriate risk disclosures and advertising, supervisor and registered rep training, as well as new product onboarding.

14:58 - 15:23

Jason Stralka: From a market surveillance standpoint, FINRA is focused on identifying trends and patterns with these products amongst the membership and ensuring that such information is shared amongst the appropriate internal stakeholders. It should be noted that FINRA will be conducting a select number of thematic reviews related to spot Bitcoin ETP activity firm examinations in 2024 to better understand how our member firms are thinking about these products.

15:24 - 15:42

Kaitlyn Kiernan: And thematic reviews are a new type of exam that the examination program is exploring and will be the topic of an upcoming podcast, so stay tuned for more information on those. And you mentioned working with internal stakeholders. How are you working with CAI when looking at these products?

15:43 - 16:08

Jason Stralka: Firm exams collaborates with CAI on a frequent basis. CAI is occasionally asked to provide assistance to firm exams in the form of risk review execution for high-risk and high complexity crypto asset examination work, but also to provide expert consultation or advisory services to exam staff on some of the low to moderate risk crypto asset business models that we may come across.

16:10 - 16:19

Kaitlyn Kiernan: And is there anything firms should be thinking about as they consider making these crypto ETPs available to their customers?

16:21 - 17:09

Jason Stralka: As with new business of significance, it's always a best practice to discuss these intentions with our risk monitoring and advertising regulation staff, if applicable. But beyond that, firms should certainly be assessing their individual training needs for both registered representatives soliciting such products at the point of sale, as well as supervisory and compliance staff to better ensure that the firm remains compliant with all applicable securities rules, in particular their obligations under Regulation Best Interest. In addition, firms should be considering whether their current supervisory and compliance infrastructure, to include written supervisory procedures and trade surveillance tools, is capable for reasonably monitoring the firm's activities with respect to these products.

17:10 - 17:27

Kaitlyn Kiernan: Thanks, Jason. And just to wrap up, there's been a number of recent changes in the space. I'm sure there will be more to come. How can firms stay up to date with the latest information on crypto asset regulation and FINRA's work in the space?

17:28 - 17:59

Jamie Udinson: The 2024 Regulatory Oversight report is great and provides some information. That's obviously going to be a little bit dated as we continue through the year. However, it's an exercise that we will continue to do is put together an oversight report to be published on a yearly basis. Folks can look out for the next oversight report. We also do make updates to FINRA.org's various crypto asset-related pages. So that's key topics. There may be blog posts.

17:59 - 18:43

Jamie Udinson: One thing I want to emphasize here is that we are always engaging with the membership to understand the challenges that they're facing and the questions that they have, and any impacts to business that we might be anticipating based on changes to our programs or changes to the regulatory landscape. Engaging with us regularly, reaching out to risk monitoring will also help firms to stay abreast of changes that might impact their business, as well as help us understand where we might have an opportunity to put out more resources or information in a timely manner.

18:43 - 18:54

Jamie Udinson: So, information sharing with FINRA, information sharing with peers in the space is really helpful to make sure that everyone is kept up to date on changes.

18:55 - 19:33

Kaitlyn Kiernan: Thanks, Jamie. That's it for today's episode. Thanks, Jamie, Mike and Jason for providing that update on FINRA's crypto asset work. I'm sure there will be additional developments in the months ahead, so I'm sure we'll touch on this topic again soon. Listeners, if you don't already, you can be sure to subscribe to FINRA Unscripted wherever you listen to podcasts. You can now even find us on YouTube. And if you want to get in touch, you can email us at [email protected]. Today's episode was produced by me, Kaitlyn Kiernan, edited and engineered by John Williams, and a special thanks to Costis Waltz. Until next time.

19:38 - 20:05

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