THE TAKEAWAY:

FINRA has sat for months on roughly 40 broker-dealer applications from companies dealing in crypto assets, denying them a broker-dealer license that would let these firms offer securities in the U.S.

Some think FINRA, a self-regulatory organization, is holding off on these approvals at the SEC’s request, as the agency has yet to offer clear guidance.

Frustrated crypto startups may look to abandon the U.S. entirely, and focus on launching in other jurisdictions.

Blockchain startups waiting for approvals from U.S. securities regulators are getting restless, and wondering what’s the holdup.

The Financial Industry Regulatory Authority (FINRA), Wall Street’s self-regulatory organization (SRO), has sat for months on some 40 applications from companies that touch cryptocurrencies, numerous people who deal with the agency told CoinDesk.

Some startups have been waiting at least a year, with a few standing by for as many as 14 months, without seeing any movement from FINRA, three of the sources said.

Several industry members believe the regulators have set an unofficial moratorium on these approvals. Among this group, some think that FINRA is waiting for clear guidance from the Securities and Exchange Commission (SEC) on how cryptocurrencies are to be treated under securities laws. Others are firmly convinced the SEC has explicitly told FINRA to hold off.

Still, others said the delays are not a sign of reluctance on the regulators’ part, but are likely unavoidable, and stem from the newness of this asset class. Either way, the result is that a few dozen companies are waiting in regulatory limbo, despite efforts to launch regulated blockchain products in the U.S.

FINRA director of media relations Ray Pellecchia said in response to our inquiry:

“Membership applications from firms proposing to engage in digital asset businesses present new, complex issues and we are in the process of working through them.”

The SEC did not respond to multiple requests for comment.

To be sure, the SEC has been actively engaged with the industry, with both commissioners and staff members repeatedly asking for input on various issues ranging from custody to market manipulation from the crypto community.

Still, nine individuals who spoke to CoinDesk on condition of anonymity to avoid jeopardizing their relationships with the SEC said that either FINRA or the SEC has been stonewalling company approvals.

These individuals include legal representatives of startups trying to acquire these approvals, employees of companies which interact directly with the SEC and other groups which conduct business with these firms.

Lay of the land

The crypto industry is still young, with a limited number of regulated financial products. Startups are looking to change that, by registering as broker-dealers to offer some form of tokenized securities to U.S. customers.

First, though, these companies must pass the gauntlet of regulators.

FINRA is a not-for-profit private organization which approves broker-dealers and licenses individuals to represent these firms. As an SRO, it is itself overseen by the SEC, the nation’s federal securities regulator.

By extension, FINRA also acts as a gatekeeper for qualified custodians and alternative trading systems (ATS), as companies hoping to become either must usually first secure a broker-dealer approval.

Broker-dealers in the U.S are able to buy and sell securities, both for themselves and for their clients. Qualified custodians are entities that safeguard these assets, while ATSs facilitate the trades.

Technically, FINRA only approves broker-dealers, not qualified custodians. However, companies are required to be a registered broker-dealer before they can apply for the latter registration, and while FINRA oversees the governance of ATSs, these entities must register with the SEC – which may publish the registration application for a public comment period before the companies can begin operations.

Crypto exchanges such as Coinbase have previously been interested in launching ATSs to list security tokens (or at least tokens that are explicitly securities) for clients.

Similarly, exchanges may look to become qualified custodians to store crypto assets on behalf of institutional investors, who are neither allowed to handle custody themselves nor inclined to deal with cryptographic private keys. Coinbase, Gemini and BitGo are regulated qualified custodians in the U.S. However, Coinbase and Gemini are licensed through the New York Department of Financial Services and BitGo is licensed through the South Dakota Division of Banking, meaning none of these firms went through FINRA.

As with ATSs, startups are hoping to hold security tokens or tokenized securities for institutional clients by becoming qualified custodians.

But even the prerequisite broker-dealer approvals has been elusive for them.

Approval moratorium?

One lawyer whose client has gone back and forth with the SEC and FINRA called the situation “frustrating,” as the holdup essentially prevents companies looking to conduct business in accordance with U.S. regulations from doing so.

To add insult to injury, the lawyer noted, the SEC has frequently expressed concerns with market manipulation and other fraudulent actions in the crypto space.

“On the one hand, you have the SEC complaining that there’s all this market manipulation and bad actors, but [on the other] they won’t let good actors come in and clean things up,” this person told CoinDesk, adding:

“We’re at a stage where we’ve provided absolutely everything we can … they’re not requesting anything else from us. They’re just saying they can’t approve because they’re uncomfortable with this asset class.”

The client company is now looking to conduct business outside the U.S. “It’s really sad, we’ve always prided ourselves [on operating within U.S. regulations],” the lawyer said. “[But] if we have to exclude U.S. citizens and U.S. companies and share our skills abroad, then that’s what we’ll do.”

This last point has been echoed by startups for months now – last September, ConsenSys’ Joyce Lai warned a group of lawmakers that other jurisdictions may be more attractive than the U.S. due to clearer regulatory statutes.

Lai told CoinDesk that regulatory inaction can prevent startups from getting off the ground.

“Regulatory clarification, or a lack thereof, is a huge hindrance that can weigh heavy on the minds (and potential purse strings) of founders,” she said in an interview last week.

Who’s the boss?

Though it is possible that FINRA is declining to approve most broker-dealers right now of its own volition, several individuals told CoinDesk that they believe the SRO is acting at the SEC’s request.

Legally, the SEC has the authority to reject any rules FINRA proposes, though the latter is usually allowed to operate autonomously, said Justin D’Elia, a partner at Duane Morris LLP.

Another attorney who spoke to CoinDesk was under the impression that FINRA was specifically waiting for guidance from the SEC. “The SEC sets the tone,” this person said.

The regulator has published or issued guidance in the form of speeches and a framework outlining how it would apply securities laws to tokens. However, to date, none of the issued statements have been legally binding, and some are even contradictory.

A senior executive at a firm that was not directly affected by the delays said he works with several companies that are.

“They’re filing as they’re supposed to and just getting stuck, endlessly, it seems,” this executive said. Like others, this person placed the ball in the SEC’s court, saying:

“A lot of times FINRA are the people in the system that are slowing things down but in this case what I’ve heard is that FINRA is waiting for clarity from the SEC so they can move some of these things forward and they’re actually being quite cooperative on working with people.”

One consideration that may give the SEC and FINRA pause is that a blockchain platform allows anyone to trade private placement securities that in the past would only be accessible to a select group of accredited investors.

“We’re blurring the lines now between what was a private non-traded instrument and a digital security,” said an executive at another firm.

However, another attorney in the crypto industry said applicants who plan to strictly deal with securities or would interact with tokens which are clearly not securities should be easy to approve or disapprove.

“It’s difficult to understand why ATS applications shouldn’t be approved if they are truly only transacting with something that is a security and it’s difficult to understand what FINRA’s jurisdiction, if any, over non-security assets should be so I’m hoping to see more clarity,” this lawyer said.

Uncharted waters

A few companies have managed to secure approvals, leading some to doubt that there is a moratorium. Another interpretation is that the slowness at FINRA could simply stem from the unique issues digital assets present regulators.

Juan Hernandez, CEO and founder of securities trading platform OpenFinance, told CoinDesk that FINRA has been slow, but that this did not necessarily indicate that there was any sort of order preventing approvals.

OpenFinance, tZERO, SharesPost and Templum Markets are ATSs that received approval to list digital assets last year – meaning they would have received their approvals while other companies were still waiting. These firms have already conducted some initial security token transactions.

SeedInvest, an equity crowdfunding platform acquired by crypto startup Circle last year, is also an ATS, though the platform cannot list cryptocurrencies for trading at this time, including security tokens.

Hernandez told CoinDesk that FINRA has “been slow to push forward a couple filings but … they did allow [SeedInvest] to push forward with the caveat that they need to do additional filings to be able to transact with digital securities.”

This is not unusual. OpenFinance has already undergone the same process, Hernandez explained, saying:

“But that’s the process we went through last year, we had to do additional filings [specifically] to be able to transact with digital securities.”

Under the regulations and operating procedures for FINRA and the SEC, even if a company is allowed to offer certain securities for trading when its ATS application is approved, there are limits. In other words, a company cannot offer every possible type of security for trading after receiving the ATS license.

Tokenized securities have essentially become a new category of potential offerings, joining bonds and stocks, for example.

Hernandez characterized the process of securing an ATS, broker-dealer or qualified custodian approval as lengthy, but not insurmountable. “Things take longer but it’s not been a freeze or a stop per se,” he told CoinDesk.

Patience runs thin

D’Elia, a long-time securities lawyer, told CoinDesk that he “wouldn’t be surprised” if some companies had to wait 18 months or more to receive the approvals, simply due to the novel issues presented by blockchain companies.

“You tell me you’ve got a blockchain technology, that’s going to be the underlying technology [to your platform] … that is complex, and that’s something FINRA is going to have more questions about,” he said.

The SRO typically examines the owners of an applicant, the source of its funds, its net capital, its funding, who the client base is, how the applicant will target this client base, and what experience its principals have, D’Elia said.

The fact that much of the advertising from an applicant touching cryptocurrencies is likely to be online is another issue (meaning that a much broader audience would be targeted than is typical), he explained. “I think it makes FINRA a little bit more cautious.”

While FINRA’s guidelines nominally give it a six-month deadline to approve or disapprove an application, the SRO can extend that well beyond this time period, D’Elia said. This deadline is further obscured if any part of the application is incomplete or filled out incorrectly.

Hernandez also noted that even incomplete details on the paperwork might result in delays.

One of the executives who spoke with CoinDesk believes the status quo will have to change soon.

“There’s so much industry pressure mounting, not just from the applicants but from the people who want to do ETFs or the people who want to do ATSs or like the Blockstack Reg A,” he said, concluding:

“All these things, there’s this pressure mounting … I’ve got to believe the [SEC] is going to have no choice but to step up. It’s a question of when, not if, but it’s a very big when.”

FINRA image via Andriy Blokhin / Shutterstock