FINRA Sheds Light on Path to Digital Asset Security Broker Registration | Works

Interest in engaging in a crypto business appears to be at an all-time high, including at or through regulated and compliant businesses in traditional financial services firms. Brokers are at the top of this list. The road to registration for digital or crypto stock brokers can be long and arduous. Just one example – FINRA considers the digital asset securities business lines material and, for existing members, requiring approval under FINRA Rule 1017 as a “material change in business operations.” To provide a modicum of clarity, a recent FINRA podcast described the FINRA Membership Application Program (MAP) approach to obtaining approval for a major business expansion in this area.

FINRA noted that there are approximately two dozen firms with an approved digital asset line of business and two dozen other firms with pending applications (split evenly between new member applications and applications of permanent members). FINRA has approved applications for activity in two types of non-custodial activities: (1) serving as a placement agent for digital asset securities and (2) operating an ATS that facilitates secondary transactions of securities. digital assets. These ATS must operate in accordance with what has come to be known as the “three-step” and “four-step” models described in an SEC No-Action Letter and Joint SEC/FINRA Statement (each discussed below). ). FINRA also discussed “guidelines for special purpose brokers,” although it notes that no firms have yet been approved for this type of activity.

Placement Officers

In 2019, the SEC and FINRA issued a joint statement on the custody of digital assets and the importance of the client protection rule in this context. The joint statement, among other things, outlines a private placement business model for digital assets (which is non-custodial in nature) where the broker-dealer sends trade matching details to the issuer and investor. , and the issuer and investor deal directly with each other or through the use of an escrow account established by the issuer. In this model, the activity of the broker-dealer is very limited and, importantly, the transaction occurs entirely away from the broker-dealer. Brokers using this model must also have a full understanding and disclosure of the particular risks involved. Additionally, companies should outline how they will review offering documents, be aware of their responsibilities under the advertising rules, and have detailed procedures outlining their oversight of all of these.


A 2020 SEC no-action letter outlined two potential ATS models that facilitate secondary trading in digital asset securities. In both models, the “broker-concessionaire operator” [must] does not guarantee or have any responsibility to settle transactions and [must] at no time exercise any level of control over the digital asset securities sold or the cash used to make the purchase. . . other than by notifying Buyer’s and Seller’s and Buyer’s and Seller’s agents of the match. A broker seeking to operate an ATS under this inaction exemption may operate under the “four-step” or “three-step” model.

According to the four-step model:

  1. Buyer and Seller send their respective orders to the ATS
  2. ATS matches orders
  3. The ATS notifies the buyer and seller of the matched transaction
  4. The buyer and seller settle the transaction bilaterally, either directly with each other or by having their respective custodians settle the transaction on their behalf

According to the three-step model:

  1. Buyer and Seller send their respective orders to the ATS, notify their respective custodians and instruct their respective custodians to settle trades in accordance with the terms of their orders when the ATS notifies the custodians of a match.
  2. ATS matches orders
  3. The ATS notifies the buyer and seller and their respective custodians of the matched transaction and the custodians execute the conditional instructions

The three-step model involves the broker-dealer a bit more, in that they influence the disposition of client funds and securities by providing settlement instructions to the buyer’s custodian. Therefore, brokers who operate ATSs in accordance with the three-step model must meet increased requirements compared to the four steps:

  • The broker must maintain at least $250,000 in net capital
  • Agreements between the broker-dealer and its clients should make it clear that the broker-dealer does not guarantee or have the responsibility to settle trades
  • The broker-dealer must establish and maintain reasonably designed procedures to assess whether a digital asset security was originally offered and sold pursuant to an effective registration statement or an available registration exemption, and whether secondary transactions of the title to a digital asset on or through the ATS is made pursuant to an effective registration statement or an available registration exemption
  • Transactions in digital asset securities must otherwise comply with federal securities laws

Specialized broker

A 2020 SEC filing and request for comment outlined this third business model for digital asset brokers. A “dedicated broker” provides safekeeping for funds and digital assets that are securities. The broker’s business must relate only to digital asset securities, that’s to say, neither traditional securities nor non-security related digital assets can be affected. The business model may include operating an ATS, provided that the ATS only trades Digital Asset securities or otherwise engages in other activities that only involve Digital Asset securities.

A special purpose broker must comply with nine specific requirements, including:

  1. It must have access to digital asset securities and the ability to transfer them to the underlying distributed ledger
  2. It must have policies and procedures reasonably designed to (i) analyze whether an asset is a security; (ii) evaluate the underlying distributed ledger technology and associated network before committing to retain custody of the Digital Asset; (iii) demonstrate how the Broker exercises exclusive control over the Digital Asset Securities and guards against theft, in accordance with industry best practices; and (iv) explain how the broker will respond to specific events that could affect custody, including but not limited to blockchain malfunctions, airdrops, hard forks, and 51% attacks.
  3. It must make certain required custody and risk disclosures and enter into a written agreement with each client institution for the terms and conditions regarding the receipt, purchase, holding, safekeeping, sale, transfer, exchange , custody, liquidation and any other transaction. in digital asset securities

Given the breadth and depth of these requirements, it’s no surprise that FINRA has yet to approve any company to operate a special-purpose digital asset broker. On the other hand, increased operational limitations create a high barrier to entry, and only allowing business in digital asset securities narrows the scope of permitted activity, likely limiting the number of companies that would apply for such permission. on guard.

A way forward

Few companies have made it through FINRA’s proverbial pearly gates to gain digital asset security brokerage status. Those have occupied space in a kind of gray area, especially given the lack of clarity about whether various digital assets are securities or non-security assets. To say the SEC hasn’t been helpful in this regard is a huge understatement.

On the bright side though, FINRA’s MAP group is beginning to focus more deliberately on applications for the digital asset security business lines. New or existing brokers applying for FINRA approval should ensure they have a complete application that clearly outlines how every aspect of the business complies with applicable guidelines. The frequent refrain from the SEC is “come in and register,” and at least for some types of industries, that’s slowly becoming more doable.

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