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SEC Proposal Could Bar Investment Advisers From Keeping Assets at Crypto Firms

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The U.S. Securities and Exchange Commission (SEC) proposed a rule that would effectively require registered investment advisors (RIA) to go outside the crypto industry for storing digital assets, according to its first formal policy push that leans heavily into the cryptocurrency sector.

The rule, approved in a 4-1 vote by the SEC on Wednesday, would expand the agency’s existing regulations that say an investment adviser needs to keep customers’ money and securities with a “qualified custodian.” The new version, if approved, would grow that safeguarding requirement to any assets that investment advisers are entrusted with – including crypto.

Right now, crypto trading and lending platforms routinely offer custody for crypto customers, but they’re not “qualified custodians” under this rule. An appropriate custodian under SEC’s regulations would generally mean 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).

While officials said the rule wasn’t specific to crypto, the industry featured heavily in formal remarks previewing it.

“Make no mistake: Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians,” SEC Chair Gary Gensler said in a statement. “Though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians.”

Apart from demanding that investment advisers trust only regulated financial institutions with their customers’ money – mostly leaving crypto businesses on the outside – the SEC’s proposal also says those qualified custodians would be subject to independent audits, regular disclosures and would need to segregate customer assets into accounts under the customers’ identity.

Gensler’s agency is exercising a power granted under the 2010 Dodd-Frank Act, an overhaul of the regulatory landscape ushered in after the last widespread financial collapse. SEC officials said the agency has been working on this proposal for a long time, not in response to any of crypto’s recent spectacles, though the SEC has reportedly been scrutinizing crypto custodial issues recently.

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

One of the commissioners, Mark Uyeda, raised a key point for crypto: If the agency is trying to force advisers to go to banks with their clients’ crypto assets, and the bank regulators are cautioning banks against crypto activity, is it making crypto investing impossible through the advisers? He said the proposal in multiple ways seems to “mask a policy decision” to block crypto activity, though he initially chose to support it.

Commissioner Hester Peirce opposed Wednesday’s proposal, finding fault with several aspects including its one-year implementation period for the largest advisers, which she argued “seems too short to accomplish all of it.” She also criticized potential harm to the crypto sector, saying one of the effects would be “likely shrinking the ranks of qualified crypto custodians,” and that the rule seemed designed to force advisers to back away from industry ties immediately.

When asked whether the regulator had gathered any data to illustrate the scale of digital assets tied to registered investment adviser clients, officials at the agency said they hadn’t. They could only confirm that advisers do represent some segment of the assets now held at crypto firms.

So the actual effect of the proposal isn’t clear. If it’s eventually approved as an official rule, it may not significantly change the industry’s status with the U.S. securities regulator, which already considers the sector’s trading platforms to be generally out of compliance.

In some ways, Gensler’s own crypto rhetoric makes this proposal less dramatic. The SEC chairman has already said most tokens are securities that should be registered. Under the existing rules for investment advisers, securities already need to be in the hands of “qualified custodians.” So in Gensler’s view, the current standards already affect the vast majority of digital assets.

If he’s right, this revision effort just swoops in and makes sure there’s no crypto asset left out.

The latest proposed rule leaves some questions about the role of companies like Anchorage Digital, which is a crypto-oriented trust regulated by the Office of the Comptroller of the Currency (OCC), or state-chartered institutions such as those in Wyoming. SEC officials said as long as a company can meet a list of requirements, they can seek to act as a qualified custodian.

Proposed rules don’t always make it to the finish line. The agency is scheduling a 60-day comment period during which the crypto industry is certain to make itself heard. The SEC will have to review and consider the outside input, which is typically a months-long process. The SEC will then have to write and approve a final version of the rule before it can be implemented.

The SEC has sought public input on custody issues before, such as a request for comment in 2020 after Wyoming said a state-regulated entity may be a qualified custodian. No formal policies were proposed at the end of that comment period.

UPDATE (February 15, 2023, 16:46 UTC): Adds commission’s approval of the proposal and comments from Commissioners Peirce and Uyeda.

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Jesse Hamilton is CoinDesk’s deputy managing editor for global policy and regulation. He doesn’t hold any crypto.

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Jesse Hamilton is CoinDesk’s deputy managing editor for global policy and regulation. He doesn’t hold any crypto.

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