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The “Crypto Corner” – Did Your Broker Sell You Crypto-Securities in Your Best Interest?

BackgroundWhat is Crypto?

Cryptocurrency is a type of digital asset. Popular types of cryptocurrencies are Bitcoin and Ethereum, as they generally tend to hold the largest market capitalizations in the crypto asset class. It is important to note that cryptocurrency is the asset itself, and it may not be considered a security under relevant securities laws and the famous Howey test (see below).

Crypto-securities are securities regulated by the SEC, and potentially state regulators, that are tied to or related to other cryptocurrencies. These types of investments are considered securities under the Howey test, which enables the SEC to regulate them, many aare offered as unregistered private placements or exchange-traded ETFs. Crypto-securities may also be referred to as crypto asset securities or crypto-based securities.

Click here to see more on Malecki Law’s “What Are Cryptocurrencies?” page.

When Do the Federal Securities Laws Apply?

The Howey Test is applied to determine whether an investment is considered a security under federal securities laws.

SEC v. Howey is a landmark case that made its way up to the Supreme Court and set the stage in figuring out whether something constitutes an investment contract (a security for our purposes) under federal securities laws.

There are four elements that must be fulfilled for an investment to be considered a security: the investor (1) makes an investment of money, (2) in a common enterprise, (3) has an expectation of profit, and (4) the profits are to be derived from the work of others, in other words, the investor plays a passive role in the investment itself. Traditional investments, such as stocks and bonds, are considered securities under the Howey test. However, it is unclear whether cryptocurrency generally is considered a security. In the past few years, there has been a regulatory “gray area” regarding cryptocurrency. However, crypto-securities are generally considered securities under Howey, and therefore must be registered with and regulated by the SEC.

Currently, there are only a few ways you can invest in crypto-based securities in your brokerage account: (1) mutual funds that hold positions in cryptocurrencies, (2) private placements that hold positions in cryptocurrencies or track crypto indices, and (3) the newly approved Bitcoin Spot ETFs. If your broker recommended that you invest in any of the foregoing alternatives to have exposure to crypto-securities, those investment recommendations should have been made in your best interest under Regulation Best Interest.

Who Are the Big Players?Big players:

Some of the most popular crypto exchanges are Binance, Coinbase Exchange, Bybit, and Kraken. According to Reuters, Binance and Coinbase made up 60% of crypto based transactions in May 2023 alone.

There are some big players that sell cryptocurrency and also have an affiliated brokerage arm registered with FINRA, such as Coinbase and Robinhood.

There are also single purpose financial institutions that are also registered brokerage firms with FINRA (BD) or registered investment advisers (IA) with the SEC, and only sell their own private placements tied to crypto or crypto indices, such as, Galaxy Digital Partners LLC (BD), Grayscale Securities LLC (BD), Bitwise Investment Manager LLC (IA), and Pantera Capital (IA).

Lastly, traditional brokerage firms/platforms registered with FINRA, like Fidelity, have been joining this space gradually by offering products such as mutual funds that hold cryptocurrencies and/or the newly approved Bitcoin Spot ETFs.

Who regulates them?

If the investments at issue are considered securities under the Howey test, such as crypto-securities described above, the following regulators will likely oversee the transactions: SEC, FINRA, and state regulators such as New York Department of Financial Services (DFS) and NJ Bureau of Securities (NJBOS). However, if the investments at issue are not considered securities, then the CFTC and NFA will likely oversee the transactions. This is still a regulatory “gray area,” and continues to develop on a daily basis.

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I highly recommend Jenice and her team at Malecki Law. I had a challenging, and lengthly case. Jenice was professional, very knowledgeable, and a pleasure to work with. She managed to make the process far less stressful during a very difficult time. They care about their clients, and it definitely shows. Mario
Jenice is truly a miracle worker and one of the top securities lawyers. She handled a very difficult case for us, displaying her legal knowledge, intelligence, and savviness throughout the process. I cannot recommend her enough. The quality of work from her team rivals that of corporate law firms. She was always available, extremely professional, and made sure to know all the details of the case. We were very fortunate to have been referred to Jenice and highly recommend her for any securities related legal issues. Nathan A.
An excellent professional who represented us in trial regarding a bank fraud, an unexpected and difficult time. A professional that worked hard, persevering and who stood toe to toe against firms that had a team of excellent lawyers backing them up. Her unflinching determination really stands out, it makes you feel you have someone who really cares about trying to recover what you lost from the people that wronged you. Salomon Levi
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