SEC Proposes More Stringent Rules for Crypto Custody Providers

The SEC on Wednesday voted in favor of proposed amendments to federal regulations “to expand and enhance the role of qualified custodians.” The proposed changes would extend the scope of rules to include “all crypto assets.”

The Chairman of the United States Securities and Exchange Commission (SEC), Gary Gensler, announced proposed changes to the rules set out by the “2009 Custody Rules” “to expand and enhance the role of qualified custodians.” Gensler’s proposed amendments would extend the scope of federal custody rules to cover “all crypto assets.” Gensler said that all asset classes, including cryptocurrencies, would be included in the extended custody rules. Companies offering crypto custody services to clients would now be required to obtain registration.

SEC Expands the Scope of Qualified Custodians

Under the newly proposed rules, for a firm to become a “qualified custodian,” both U.S. and offshore firms must ensure that all assets in custody, including crypto, are accurately separated. According to reports, such custodians must also comply with additional red tape, such as annual audits from public accountants. The proposal has not yet officially been approved by the SEC.

The SEC defined a qualified custodian:

A qualified custodian generally is 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 (“FFI”).

The agency also details the conditions a custodian must comply with:

Under the proposal, a qualified custodian would be required to have “possession or control” of advisory client assets. The proposal would require a more robust set of requirements for an institution to be an FFI that is eligible to serve as a qualified custodian. The proposal would also further specify the manner in which qualified custodian banks and savings associations must hold client assets.

Gensler Takes Aim at the Crypto Industry

Chairman Gensler’s proposed amendments would “expand the scope” to all asset classes but made specific reference to the crypto industry, saying:

Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets. […] Further, though some crypto trading and lending platforms may claim to custody of investors’ crypto, that does not mean they are qualified custodians. Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto.

He added:

When these platforms go bankrupt—something we’ve seen time and again recently—investors’ assets often have become the property of the failed company, leaving investors in line at the bankruptcy court.

Not All SEC Members Agree With Gensler

The SEC voted on Wednesday, 15 February, on the proposed rule changes. Although Gensler won the vote, he did not receive the support of the entire agency. Commissioner Hester Peirce, who has never been shy to voice her opinion of Gensler’s action, issued a statement in response to the SEC’s proposed rule changes in which she opposes the proposed amendments. Peirce said:

Safeguarding client assets is at the heart of investor protection. Accordingly, I had anticipated supporting a proposal to amend the custody rule, which, after fourteen eventful years, deserves another update. Significant aspects of the proposed approach and its implementation timeline, however, raise such great questions about the rule’s workability and breadth that I cannot support today’s proposal. 

Peirce further argued that, although the proposal is not “regulation by enforcement,” she argued that the agency’s statement appears to be designed to take down the crypto industry with immediate effect:

Such sweeping statements in a rule proposal seem designed for immediate effect, a function proposing releases should not play. These statements encourage investment advisers to back away immediately from advising their clients with respect to crypto.

Commissioner Piece further argues that the proposal would do more damage than it will do good:

The proposal would expand the reach of the custody requirements to crypto assets while likely shrinking the ranks of qualified crypto custodians. By insisting on an asset-neutral approach to custody, we could leave investors in crypto assets more vulnerable to theft or fraud, not less.

Peirce also takes issue with the timeline of the proposed changes. According to reports by Cointelegraph, members who voted in favor of the amendments would like to see them implemented within the next 12 to 18 months. Peirce opined that it was an “aggressive timeline” considering the changes’ severity.

As the proposed changes have not yet been officially approved, they are open to the public for comment for the next 60 days. It will be interesting to see if the SEC manages to implement such drastic changes and how the market will react should it realize.

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.