Considerations for FINRA Membership involving Digital Asset Securities

In November 2022, FINRA will podcast Discussed available guidance on several channels through which broker-dealers can be approved by FINRA for digital asset securities activity: 3) as a special purpose broker-dealer (SPBD) holding digital asset securities.

1) Offering agent in private digital asset security offerings

overview

Broker-dealers, like traditional private placements, send transaction matching details (such as the identities of the parties, price and quantity) to the purchaser and issuer of the digital asset security, and the issuer makes the transaction between the purchasers bilaterally. to pay. Issuers separate from broker-dealers. In this case, the broker-dealer instructs the customer to pay directly to the issuer and directs the issuer to issue digital asset securities directly to the customer (e.g., the customer’s “digital wallet”).

We do not control digital assets as everything occurs away from the broker-dealer. Broker-dealers do not process, control or receive client funds or securities. The issuer and the investor trade directly through an escrow account set up by the issuer.

Key Considerations for Deployment Agent Applications

1. Demonstrate that you understand the risks of digital asset security.
2. Communicate how risks are disclosed and how offering documentation is reviewed.
3. Evidence that you understand your obligations under FINRA’s advertising rules, including where the first-year settlement conditions apply.
4. It specifically describes the roles and functions of a broker-dealer.
5. We can show that there are procedures specific to digital asset securities and distributed ledgers.

2) ATS (2 types) to facilitate secondary trading of digital asset securities

ATS #1: Bilateral settlement without ATS involvement

overview

The ATS matches orders of buyers and sellers of digital asset securities, and transactions are either settled directly between the buyer and seller, or the buyer and seller direct their respective custodians to settle the transaction. In any event, the broker-dealer operator does not guarantee or assume responsibility for the settlement of transactions and does not exercise any level of control over the digital asset securities sold or the cash used for purchases. No (e.g. ATS does not hold the seller’s wallet or the buyer’s cash temporarily to ensure the transaction is complete).

• Step 1 – Buyer and Seller submit their respective orders to ATS.
• Step 2 – ATS matches the order.
• Step 3 – ATS notifies buyers and sellers of matched transactions.When
• Step 4 – Buyer and Seller settle transactions bi-directionally, either directly with each other or by directing their respective custodians to settle transactions on their behalf.

ATS #2: Administrators execute conditional instructions using information from ATS.

overview

In this case, there is a higher degree of control as the broker-dealer operator tells the buyer’s custodian where to send the funds and tells the seller’s custodian where to deliver the securities. As with the four-step process, the broker-dealer operator does not guarantee or otherwise assume responsibility for the settlement of trades, and does not represent the digital asset securities sold or the cash used to conduct trades. We do not exercise any level of control over (e.g., ATS will not temporarily hold the seller’s wallet or the buyer’s cash to ensure the transaction is complete), notify the buyer and seller’s custodian, and the buyer and seller of the match .

• Step 1 – Buyer and Seller submit their respective orders to ATS, notify their respective custodians of their respective orders submitted to ATS, and notify their respective custodians of their orders when ATS notifies the custodians. Instruct to settle the transaction according to the terms. of a match at ATS.
  • Step 2 – ATS matches the order.When
  • Step 3 – ATS notifies the buyer and seller and their respective custodians of the matched transaction, and the custodians execute their conditional instructions.

Important considerations for ATS applications

1. Describe in detail how your transaction flow and business model, including digital asset securities and ATS, adhere to a 3- or 4-step process.
2. Make sure other documentation matches that process, such as:
   1. User disclosure
   1. draft form ATS
   1. agreement
   1. Custodian Disclosure
   1. Disclosure with Other Third Parties

3) Special Purpose Broker-Dealer (SPBD) holding digital asset securities

overview

Special purpose broker-dealer business activities are limited to digital assets that are also securities (this includes operating ATSs that only trade digital asset securities or engage in other business related to digital asset securities). may occur). You may not engage in business activities involving non-security digital assets or securities that are not digital assets (such as traditional securities).

Important considerations for SPBD applications

1. Show that you understand how your business model is impacted by the nine conditions detailed in the SEC statement dated April 27, 2021.
2. Describe how each of the nine conditions is met.
3. Clarify where staff can find information for each of the nine criteria.

Finally, the FINRA podcast also identified some common issues with membership applications related to digital asset securities.

• Demonstrates applicant’s ability to comply with FINRA rules and U.S. federal securities laws and regulations.
• No details. for example:
  • What is your business plan?
  • What are the relationships between the various parts of a broker-dealer’s business?
  • How do transaction flows and business models involving digital asset securities fit into the available guidance?
  • How does a broker-dealer ensure that it functions in a manner that complies with applicable guidance?
  • How does your transaction flow address compliance and legal requirements?
  • Is there documentation to confirm that each step in the transaction flow meets these requirements?
• Inconsistent descriptions of proposed business activities involving digital assets, cryptocurrencies, distributed ledgers, or related products.

The CRC has extensive experience helping companies successfully navigate the application process for new and continuing members using FINRA. We are particularly well versed in the fintech space and provide our clients with experienced C-suite level personnel to quickly scale and support their applications. Contact us today to find out how we can help you right-size when considering setting up a broker-dealer.

For more information, please contact:

Mitch Avnet

p. (646) 346-2468

mavnet@compliance-risk.com

David Amster

p. (917) 568-6470

damster@compliance-risk.com