Crypto in the crosshairs of SEC custody proposals

U.S. securities regulators are proposing to expand investment advisers’ custody obligations in a bid to enhance investor protection, particularly when it comes to cryptoassets.

The U.S. Securities and Exchange Commission (SEC) proposed changes to the existing custody rules that would, among other things, expand advisers’ custody obligations beyond client funds and securities to include any client assets.

“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 SEC said in a release.

The proposals would also enhance advisers’ recordkeeping requirements, bolster protections for certain assets that can’t be maintained by a qualified custodian and expand certain audit requirements.

“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 in a release.

These risks were highlighted in the Madoff scandal, and, more recently, custody practices in the crypto sector have come under increased scrutiny.

Gensler noted that, while some crypto trading platforms claim custody of clients’ assets, they aren’t qualified custodians.

“Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto,” he said. “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.”

“Make no mistake,” he added. “Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians.”

The new rule would also ensure that custody obligations cover all cryptoassets, whether they’re considered securities or not.

“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,” Gensler said.

However, the proposals raised some concerns with certain commissioners, particularly when it comes to the application to cryptoassets.

“How could an adviser seeking to comply with this rule possibly invest client funds in cryptoassets after reading this release?” commissioner Mark Uyeda asked in a statement.

“This approach to custody appears to mask a policy decision to block access to crypto as an asset class,” he said.

“Nevertheless, I prefer having a discussion about cryptoassets in the context of notice and comment rulemaking as opposed to enforcement actions,” he said. “For too long, the commission’s approach to cryptoasset regulation has been to use enforcement actions to introduce novel legal and regulatory theories.”

While Uyeda joined the majority and voted in favour of proposing the rule, commissioner Hester Peirce opposed the rule, outlining a number of concerns, including reservations about its potential effect on the crypto sector.

“Significant aspects of the proposed approach and its implementation timeline … raise such great questions about the rule’s workability and breadth that I cannot support today’s proposal,” she said.

The proposal will be out for comment for 60 days after it’s published in the Federal Register.