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SEC Moves on Crypto Custody
Gary Gensler is moving on making sure client assets are kept safe with a qualified custodian pretty much no matter what they are ... crypto, DLTs or RWAs like art.
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The Securities and Exchange Commission proposed new regs on Wednesday afternoon that would make it incumbent on advisors to have all client assets — not just funds or securities — held by a qualified custodian. The new rules explicitly cover crypto and DLT-based assets and are a reaction to changes in the financial industry, and the growth of crypto technology. Lawmakers have put pressure on SEC chair Gary Gensler to better protect investors after the collapse in value of a number of crypto assets and the bankruptcy of Samuel Bankman-Fried-led FTX.
The new regs [full text here, fact sheet summary here] are subject to a sixty-day comment period. The changes to the custody rules are the first since 2009 when the SEC amended the rules in reaction to the Bernie Maddoff and Allen Stanford frauds. The rules were first created 1962.
At their essence, the rules expand the definition of what client assets must be segregated by advisors and held by qualified custodians from “client funds and securities to “any client assets”. That definition could include everything from crypto assets to physical assets such as gold and grain.
Gensler said in a statement that Congress gave the SEC "authority to expand the advisers’ custody rule to apply to all assets, not just funds or securities.
“Further, investors would benefit from the proposal’s changes to enhance the protections that qualified custodians provide. Thus, through this expanded custody rule, investors working with advisers would receive the time-tested protections that they deserve for all of their assets, including crypto assets, consistent with what Congress envisioned,” stated Gensler.
Growing use of crypto assets by advisors
The value of crypto assets grew 1,000 times from $1 billion in 2018 to $1 trillion in 2021, according to the SEC staff. The staff researched the use of crypto assets by the 50 largest RIAs and found that 21 are offering or planning on offering some services related to digital assets, nine are giving or planning on giving investment advice related to digital assets, 13 provide or are planning on providing custody of digital assets or custodial services of digital assets and seven advise or are planning on advising a pooled investment vehicle (like a fund or commodity pool) that holds some digital assets.
The SEC staff also estimates that one OCC-regulated national bank, four OCC-regulated trusts, approximately 20 state-chartered trust companies and other state-chartered, limited purpose banking entities, and at least one FCM currently offer custodial services for crypto assets. They also found that most current trading of crypto assets is taking place on pre-funded platforms where customers must deposit monies before executing trades. They found that a limited number of SEC-registered crypto asset securities trade on alternative trading systems (ATSs) that do not require pre-funding of trades.
The SEC Seek Comments on Crypto Assets Custody.
The comment period may be especially critical in shaping the final form these rules take. The SEC staff asks in the proposed regs for comments addressing specific concerns:
In particular, would the proposed segregation requirements present challenges with respect to crypto assets?
Should we address crypto asset segregation and/or custody with separate requirements?
Do crypto assets raise specific segregation issues not presented by other assets? If so, what are they and why?
Would the proposed requirements offer substantial protections in the event of a bankruptcy or financial losses involving an adviser or custodian with custody of crypto assets?
Would the proposed segregation requirements present challenges with respect to other types of assets?
The SEC is also asking for comment on how the privately offered securities custody rules should be applied with regards to crypto assets.
Do commenters agree with our belief that ownership of crypto asset securities that is evidenced through public keys or wallet addresses on public blockchains would not qualify for the proposed privately offered securities exception? If not, why?
Could the rationale for the privately offered securities exception – namely, that impediments to transferability present with certain privately offered securities mitigate some of the risks and provide some external safeguards against the kinds of abuse the rule seeks to prevent (loss and third-party theft) when those assets cannot be maintained by a qualified custodian – also apply to the custody of crypto asset securities, the ownership of which is evidenced through public keys or wallet addresses on public, permissionless blockchains?
If so, how do the protections work? How do they mitigate some or all of the risks the rule is designed to address – loss, theft, misappropriation, misuse, and adviser insolvency or bankruptcy
Gary Gensler, chair of the U.S. Securities and Exchange Commission
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