On March 12, the SEC’s Division of Investment Management (“Division”) published a letter from Paul G. Cellupica, Deputy Director and Chief Counsel of the Division, to Karen Barr, President and CEO of the Investment Advisor Association, laying out a number of issues under Rule 206(4)-2 (the “Custody Rule”). The letter included a request for information on possible revisions to the Custody Rule under the Investment Advisers Act of 1940 focused on a series of open-ended questions on the intersection between digital assets and the Custody Rule.
The Custody Rule requires all SEC-registered investment advisers that possess custody or access to client funds or securities to keep those assets with a “qualified custodian.” The Custody Rule defines a “qualified custodian” to generally include all banks, trust companies, SEC-registered broker-dealers, CFTC-registered futures commission merchants, and certain foreign entities. To date, the SEC has not clarified whether non-security digital assets could be “funds” for purposes of the Custody Rule.
The Division’s request for input includes several questions (some of which are not specific to the Custody Rule), including: (1) how advisers have been treating digital assets for purposes of the Custody Rule; (2) whether advisers have relied on state-chartered trust companies or foreign financial institutions for custody of digital assets and what their experiences with these custodians have been; (3) how concerns about adviser misappropriation of client digital assets can be addressed and the most effective ways technology can be leveraged to address such concerns; (4) how client losses due to misappropriation of digital assets may best be remedied; and (5) whether advisers construe digital assets as “securities” for the purpose of determining whether they meet the definition of an investment adviser (and therefore need to register with the SEC, absent an exemption).
The request for information does not specify a deadline for public input.
The letter helpfully sets out issues for public comment, while highlighting key issues the SEC considers to be crucial in applying the Custody Rule for digital assets. The SEC’s focus on custody is an important step forward because a sound foundation for custody is a key building block towards more stable digital asset markets. In other asset classes, institutional investors help provide liquidity and market stability. Institutional investors are much more likely to fully participate in a market with a sound institutional and regulatory foundation for custody services that is compliant with existing frameworks for such services in other markets. As a result, sorting out the questions that remain about the institutional and regulatory framework for custody services for digital assets is a crucial step forward in the maturation of the market for digital assets. In that regard, a helpful complement to the letter would be for the SEC to seek similar feedback regarding custody of digital assets by broker-dealers.