US securities regulator votes to expand custody rule to include digital assets

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The U.S. Securities and Exchange Commission (SEC) has voted for new changes to federal regulations requiring investment advisors to custody their digital assets with qualified custodians.

SEC commissioners voted 4-1 in favor of the new rule, with “Crypto Mom” Hester Peirce, the only commissioner who went against the vote.

“… today’s proposal, in covering all asset classes, would cover all crypto assets—including those that currently are covered as funds and securities and those that are not funds or securities,” SEC chair Gary Gensler commented.

Gensler added that with this amendment to the custody rule, digital asset investors will now receive the “time-tested protections that they deserve.”

The U.S. custody rule came into effect in 1962 and requires investment advisors to hold their assets with chartered banks and broker-dealers. It has traditionally only covered funds and securities, but in 2010, Congress gave the SEC new authority to expand the scope of the rule in the aftermath of the Bernie Madoff Ponzi scheme.

Digital asset custodians express concern

The new rule could be one of the most disruptive developments in recent times for the U.S. digital asset industry. For starters, it will disqualify most digital asset exchanges and wallets from offering custody solutions.

In his remarks, Gensler noted that “based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians.”

Jason Gottlieb, an attorney with New York-based Morrison Cohen LLP, is among those concerned that the new rule, while well intended, will only cause mayhem. Speaking to one news outlet, he noted that while the custody rule protects investors, the SEC will likely butcher the execution.

“My fear is that they will require qualified custodians to hold crypto, but then they will not create a real path for qualified custodians to hold crypto and as a result people won’t be able to find a qualified custodian and as a result they won’t’ be able to satisfy the custody rule,” the attorney noted.

Paul Grewal, the chief legal officer at Coinbase (NASDAQ: COIN), shares the concerns.

“Unfortunately, it’s our understanding that the SEC may wish to restrict the ability of states to charter institutions that are involved in this particular service, and we think that would be a huge mistake,” Grewal stated in an interview with CNBC.

However, despite the change, Grewal—and other players in the space like Bakkt—believe they will continue offering their services unabated.

Another busy morning. We’ve now dug through the @SECGov proposed rulemaking and I’m glad to see the SEC recognizes Coinbase Custody Trust Co. as a qualified custodian, and after today’s SEC proposed rulemaking, we are confident that it will remain a qualified custodian.

— paulgrewal.eth (@iampaulgrewal) February 15, 2023

In his remarks on the proposed rule, Bakkt general counsel Marc D’Annunzio expressed confidence that the NYSE-listed custodian will continue to serve its clients.

“While this is still a proposed rule, we are pleased that it provides an avenue for state-chartered trust companies, like our custodian, Bakkt Trust Company, to maintain qualified custodian status,” he stated.

While Gensler and four of his commissioners fully support the proposed rule, Crypto Mom Peirce voted against it. In her dissent, she expressed concerns that the new rule is more stringent on digital asset industry players than it has been on traditional finance.

Some requirements, such as a written agreement between custodians and advisers, “may be difficult for advisers and costly for clients. Small advisers may have a particularly difficult time complying with these requirements.”

Peirce further expressed concerns that the rule shrinks the rank of qualified digital asset custodians while expanding the reach of custody requirements to these assets. She believes this might force investors to withdraw their assets from qualified institutions altogether.

“By insisting on an asset neutral approach to custody we could leave investors in crypto assets more vulnerable to theft or fraud, not less,” she said.

Watch: SEC Commissioner Hester Peirce on Bitcoin Association’s Blockchain Policy Matters