Just days after a flurry of crypto-related enforcement actions, the SEC voted to propose the new “Safeguarding Rule” under the Advisers Act, a whopper of a rule proposal which would amend and replace the current Custody Rule (Advisers Act Rule 206(4)-2). If enacted, the Safeguarding Rule would create serious impediments to investments advisers’ ability to provide advice on crypto assets.
The current Custody Rule is only applicable to an adviser with custody of a client’s funds or securities. The Safeguarding Rule expands the scope by covering any “funds, securities, or other positions held in a client’s account,” (i.e. crypto assets). Further, under the Safeguarding Rule discretionary trading authority would cause an adviser to have custody, requiring the adviser to comply with the mandates of the Safeguarding Rule with respect to any funds, securities, or other positions.
Most significantly, this would require that crypto assets be maintained with a qualified custodian, something which has been difficult to find for certain crypto assets. Under the current Custody Rule and the Safeguarding Rule, a qualified custodian generally must be a federal or state-chartered bank or savings association, certain trust companies, a registered broker-dealer, a registered futures commission merchant, or certain foreign financial institutions. Federal banking regulators have done their best to keep federally chartered banks from becoming involved with any crypto-related activities, functionally shutting off access to many banks for crypto firms.
On top of this, the Safeguarding Rule requires that a qualified custodian maintain “possession or control” of client assets, meaning the qualified custodian is required to participate in any change in beneficial ownership of those assets. This has typically been shown by a qualified custodian having exclusive possession or control of client assets, however that is much more difficult with creation and use of private keys (something the SEC’s rule proposal notes).
As made clear by Chairman Gensler’s comments, many crypto trading platforms who currently custody client assets do not meet the definition of a qualified custodian. This is relevant because of the way cryptocurrencies trade, which requires funds or cryptocurrencies to be held at the applicable exchange. Commissioner Uyeda picked up on this, making remarks on how the release paints “a ‘no-win’ scenario for crypto assets” since crypto assets trade on platforms which are not qualified custodians, any adviser who trades crypto assets on the platform would be violating the rule. This is because the exchange (who is not a qualified custodian) would hold the adviser’s clients assets, which would be in violation of the Safeguarding Rule (since only qualified custodians can hold such assets).
Unanswered is the question whether state chartered institutions in places such as Nebraska or Wyoming, which have passed legislation permitting charters for digital asset depository institutions, will be able to fill the gap and act as qualified custodians for crypto assets. Firms such as Coinbase and Anchorage Digital have issued statements saying that they are qualified custodians under the SEC’s rules and would remain so. The SEC has scheduled a 60-day comment period for the Safeguarding Rule, which will begin after its publication in the Federal Register. The proposed rule would also have substantial impact outside of the cryptocurrency context, so we expect that the SEC may receive a significant amount of comments on its new rule proposal.
The proposed rule would also have substantial impact outside of the cryptocurrency context, so we expect that the SEC may receive a significant amount of comments on its new rule proposal.