Today the SEC published new proposed rules regarding the need for financial advisers to use qualified custodians to control customer assets. The proposal requires the custody rules to apply to all assets, not just securities and funds. Hence this would cover all crypto-assets, whether or not they are securities. Republican Commissioner Uyeda argued the new proposals make it hard for advisers to deal with crypto assets and be compliant.
“How could an adviser seeking to comply with this rule possibly invest client funds in crypto assets after reading this release?” asked Uyeda.
“This approach to custody appears to mask a policy decision to block access to crypto as an asset class. It deviates from the Commission’s long standing position on the neutrality of the merits of investments.” While Commissioner Hester Peirce is often forthright on these topics – and was the sole vote against moving forward with the proposal – Uyeda supported the proposal despite strong objections.
Uyeda was referring to several points in the 434-page document. Firstly, while banks have developed digital asset custody solutions, the paper mentions Federal banking regulators have raised safety and soundness concerns about banks getting involved.
He said the paper implies that state-chartered trust banks are less trustworthy than federally chartered banks. The proposals ask for feedback on whether qualified custodians should be restricted to federally regulated banks.
As an aside, several crypto custodians, including Coinbase Custody, Paxos and Fidelity Digital Assets, are New York state-chartered trust banks. We explored that further in an article yesterday.
And because most crypto trading platforms (exchanges) are not qualified custodians, if financial advisers use these platforms, they will be non-compliant. While this is true, many users have lost significant sums as crypto exchanges and lenders have gone bankrupt during the past year without properly segregating and safeguarding client assets.
Other custody highlights
In order for a bank or savings association to be a qualified custodian, it will have to hold assets in a segregated account “designed to protect such assets from creditors of the bank or savings association in the event of the insolvency.”
One of the proposal’s requirements is for a qualified custodian to have exclusive possession and control over assets. The challenge with crypto-assets is that if a custodian demonstrates a private key, they put the asset at risk of theft. Also, in some cases, sometimes the client and custodian have access to the private key, and so can both effect transfers.
The requirement to use a qualified custodian is waived in the case of privately offered securities. However, the proposal states that this exception is unlikely to apply to securities issued on a permissionless blockchain.
The comment period for the SEC proposal will run for 60 days from when the proposal is published in the Federal Register.