SEC and FINRA clarified positions on the approval of cryptocurrency brokers-dealers

The US Securities and Exchange Commission (SEC) and the Financial Institutions Regulatory Agency (FINRA) expressed their position in a joint statement made on Monday.

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1 Investor protection

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Regulators have noted that there are a number of issues that they need to solve before they can approve cryptocurrency companies’ applications for registration as brokers-dealers.

The SEC Trade and Markets Division and FINRA General Counsel’s Office described various factors that agencies take into account when deciding whether to approve a broker-dealer application from a company that is related to digital assets, including their storage, as well as assets that are considered securities in accordance with The Securities Investor Protection Act (SIPA) of 1970.

“The ability of the broker-dealer to comply with certain aspects of the Client Protection Rules is greatly facilitated by established laws and practices regarding the loss or theft of a security that may be ineffective in the case of certain digital assets,” the statement said.

Broker-dealers in the United States are legally registered and regulated organizations that can buy or sell securities both on their own behalf and for clients. Some companies want to use digital assets as securities, which allows them to enter the market for institutional investors who cannot own or directly buy these assets.

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While a broker can prove that he has a private key for a cryptocurrency wallet, it is difficult to confirm that no other entity has access to them, the statement said. Regulators explain:

“It is not always possible to prove that no other party has a copy of the private key and cannot transfer the digital asset without the broker-dealer’s consent.”

The joint statement was the result of questions from market participants. Companies applying for approval to work as a broker-dealer have been suspended for months, and some firms have been waiting for approval for more than a year. Many of these companies have argued that the SEC has introduced a moratorium on broker-dealer approvals for firms that work with digital assets. At the same time, other firms have stated that cryptocurrency-based securities simply carry new problems that regulators must first assess. The joint statement on Monday is essentially a confirmation of the latter theory.

Recently Cryptocurrency Exchange Gemini filed
application to FINRA for the purpose of obtaining a broker-dealer license.

Investor protection

In addition to issues related to private keys, SEC and FINRA also discussed how digital assets may not meet SIPA requirements for digital securities.

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SEC rule 15c3-3 requires that “a broker-dealer physically keeps fully paid and surplus margin securities of clients or keeps them without collateral in a safe place”. As a rule, securities stored in accordance with SIPA requirements have security measures to cancel erroneous and unauthorized transactions, as well as third-party custodians that hold actual securities.

However, when it comes to digital assets, the use of intermediaries can increase the risk of theft or loss of securities. The broker will not be able to cancel the transaction if the securities go to an unauthorized address:

“In the case of a digital security that does not meet the definition of a“ security ”by SIPA, and in the event of a broker-dealer error, SIPA protection will probably not be applied. The owners of these securities will receive only unsafe general lenders’ claims on the broker-dealer property. ”

Other problems are related to accounting and reporting rules. In particular, “the nature of distributed registry technology, as well as characteristics related to digital securities, may make it difficult for a broker-dealer to prove the existence of these securities for regulatory reporting and financial reports, including supporting statements,” the report says.

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Some digital asset companies are planning to use distributed registries with special functions designed to meet record keeping and retention requirements, although these firms still have to “consider how technology can affect their ability to comply” with the reporting rules.

Previously, lack of regulatory clarity did not prevent the SEC from penalizing lawbreakers. Last year, the Commission accused TokenLot LLC and its owners Lenny Kugel (Lenny Kugel) and Eli Lewitt (Eli Lewitt) that the company works as an unregistered broker-dealer. The owners of TokenLot did not confirm or deny the SEC order, but agreed to pay $ 471,000 of illegally obtained profits, as well as $ 7,929 in percent.