SEC Proposal Would Apply Custody Rules to Crypto

The Securities and Exchange Commission voted Wednesday to expand asset custody rules for investment advisors to cryptocurrencies and require financial institutions overseeing crypto assets to obtain federal and state registrations to do so.

The proposed rule, approved by a 4-1 vote of SEC commissioners, would mandate that investment advisors maintain custody accounts for crypto similar to those for other client assets, such as stocks, bonds or mutual funds.

Investment advisors retain banks, broker-dealers and other financial institutions to "hold" client securities and related assets in custody accounts. Those institutions receive a fee for their services and must follow certainly regulatory guidelines.

The SEC proposal comes amid a wave of crypto exchange bankruptcies, including FTX's, that have spawned calls for a regulatory crackdown on a nascent industry that has faced limited federal and state oversight. Custody becomes an issue during such bankruptcies if there is no separation between investors funds and the assets of the custody platform. During the bankruptcy proceedings of Celsius Network, a federal bankruptcy judge ruled that customer deposits on the network belonged to Celsius and not the customers.

Gary Gensler, the SEC's chairman, said the changes would help ensure that investment advisors don't "use, lose or abuse" investors' crypto assets.

"Investors working with advisors would receive the time-tested protections that they deserve for all of their assets, including crypto assets," Gensler said.

However, Hester Peirce, the lone SEC commissioner to vote against the proposal, said she's worried that small investment advisors may have difficulty complying with the changes and may reduce the number of qualified crypto custodians.

Some regulators have discouraged banks from maintaining custody assets for crypto accounts, with crypto exchanges often acting as the custodian for their investors.

Peirce said that most crypto assets with investment advisors already are contained within broader funds or accounts already covered by existing custody regulations. She added that SEC statements equating crypto assets to securities are misleading.

"These statements encourage investment advisors to back away immediately from advising their clients with respect to crypto," Peirce said. "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."

Max Schatzow, co-founder and partner of RIA Lawyers LLC, a firm that represents investment advisors, downplayed Peirce's concern pertaining to custodians. Most crypto exchanges, he said, have registrations similar to federally- and state-chartered banks.

"So there is a path forward for (crypto exchanges) to meet the definition of a qualified custodian under the (proposed) rules," Schatzow said.

While a number of crypto-custody firms said they were reviewing SEC's new rules, Coinbase (COIN) that has been critical of the SEC's recent regulatory actions, has backed the regulator's move today.

"We fully agree investors deserve to feel confident their assets are safe – as a reminder, our clients’ assets are segregated and secured. We support the Commission’s efforts to provide all investors with the protections already available to CCTC clients," Coinbase's Chief Legal Officer Paul Grewal said in statement.

However, crypto investors should recognize that Wednesday's proposal would not pertain to their assets if they don't use an advisor, said Schatzow.

"The rule that was proposed today only would impact crypto investors to the extent they work through a registered investment advisor (RIA)," he said. "If they're not working with a registered investment advisor, that proposal has absolutely no bearing on them."