(Kitco News) The U.S. Securities and Exchange Commission (SEC) has proposed a rule change related to how registered investment advisors (RIA) handle the custody of their client's funds that would essentially require them to go outside of the crypto industry to store digital assets.
The proposal for the rule changes, which are intended to “enhance protections of customer assets managed by registered investment advisors,” was approved in a 4-1 vote by the SEC on Wednesday. If passed, the new rules set the stage for an expansion of the agency’s existing regulations to require that all assets held by an RIA – including crypto – must be entrusted with a “qualified custodian.”
A comment period for the proposal is now open, giving the public 60 days to offer their input on the rule change.
Currently, the majority of crypto trading and lending platforms offer custody services to their crypto customers, but as far as the SEC is concerned, they are not “qualified custodians,” and thus do not meet the requirements of the new rule.
According to the SEC, a qualified custodian generally refers to a chartered bank or trust company, a broker-dealer registered with the SEC or a futures commission merchant registered with the Commodity Futures Trading Commission (CFTC).
“I support this proposal because, in using important authorities Congress granted us after the financial crisis, it would help ensure that advisers don’t inappropriately use, lose, or abuse investors’ assets,” said SEC Chair Gary Gensler.
The ultimate goal of the proposed changes is to help ensure that qualified custodians provide certain standard custodial protections when maintaining an advisory client’s assets, the press release from the SEC said. “These protections are designed, among other things, to ensure client assets are properly segregated and held in accounts to protect the assets in the event of a qualified custodian bankruptcy or other insolvency.”
The proposed rule would also improve protections for certain securities and physical assets that cannot be maintained by a qualified custodian, and would update and enhance related recordkeeping requirements for advisers “to improve the accuracy of custody-related data available to the Commission, its staff, and the public.”
While the announcement from the SEC didn’t specifically mention cryptocurrencies, Gensler addressed the industry specifically in his remarks about the rule change.
“Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets,” he said. “As the release states, ‘most crypto assets are likely to be funds or crypto asset securities covered by the current rule.’ Further, though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians.”
The SEC chair went on to describe how crypto platforms have failed to properly segregate investors’ crypto, and instead, have comingled those assets with their assets and the assets of other crypto investors.
“When these platforms go bankrupt—something we’ve seen time and again recently—investors’ assets often have become property of the failed company, leaving investors in line at the bankruptcy court,” Gensler said. “Make no mistake: Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians.”
According to the chief regulator, the proposed rule change will cover all crypto assets, “including those that currently are covered as funds and securities and those that are not funds or securities.”
“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,” he concluded.
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Under the expanded rules, qualified custodians would be subject to independent audits, regular disclosures and would need to segregate customer assets into accounts under the customers’ identity.
Not all commissioners are fully on board with the proposed rule change, including Mark Uyeda, who said the proposal seems to “mask a policy decision” to block crypto activity. Uyeda highlighted the fact that if the agency is trying to force advisors to custody their client’s crypto assets while bank regulators are cautioning banks against participating in crypto activity, it’s essentially making investing in crypto through RIAs impossible.
Commissioner Hester Peirce also levied criticism at the proposal, questioning the timing and workability of the rule, and warned that one of the effects would be “likely shrinking the ranks of qualified crypto custodians.” According to Pierce, the rule seems designed to “encourage investment advisers to back away immediately from advising their clients with respect to crypto. More generally, the sweeping “just about every crypto asset is a security” statements also seem to be part of a broader strategy of wishing complete jurisdiction over crypto into existence.
It remains to be seen how impactful the proposed rule change would be if implemented, as the SEC does not currently have any data which illustrates the scale of digital assets tied to registered investment adviser clients. Once the 60-day comment period finishes, the SEC will review and consider the input it receives before making a final decision, which can take several months.
