SEC Self-Custody Rules for Crypto Assets Draws Divisive Reactions
The Securities and Exchange Commission has proposed changes to how crypto assets can be custodied in the wake of Congress’s failure last month to pass digital asset legislation.
Notably, the proposed changes the SEC unveiled on Thursday would allow RIAs to self-custody clients’ crypto assets under certain conditions.
The proposals garnered a range of reactions; one advisor advocacy group lauded the “positive framework” for crypto custody proposed by the rule, while an investor protection group said the proposal “subjects investors to the very high risk of loss the SEC exists to prevent.”
Under the rule, advisors must typically custody client assets with a regulated qualified custodian, which can range from the largest financial institutions (like Schwab and Fidelity) to banks.
However, the agency argued that typical custodians may not be willing or able to hold certain crypto assets; even custodians offering the service may not be able to support “the large and continuously growing number of crypto assets in the market,” including novel assets.
To be fair, Fidelity and Schwab offer crypto custody options. Earlier this year, Schwab unveiled direct trading access for Bitcoin and Ethereum, with Schwab acting as the client custodian.
Fidelity also provides cryptocurrency custody and trading through Fidelity Digital Assets.
In the new proposals, the SEC suggests that advisors be allowed to self-custody client assets if they determine that “a permitted custodian” is not available to do so (and must check whether this remains the case quarterly).
According to the SEC’s fact sheet on the proposed changes, the advisor must have “expertise” on safeguarding each crypto asset, and must review cybersecurity systems “no less frequently than annually.”
The safeguarding systems would need to address private key management and joint authorization of any crypto asset transactions by at least two people. Additionally, account statements would be sent at least quarterly to clients with self-custodied crypto assets, among other requirements.
The SEC initially proposed changes to custodying assets in 2023 that would likely have required crypto assets to fall under the custody rule’s requirements for a qualified custodian, but the new rules mirror the lighter-touch approach for the crypto space touted by Chair Paul Atkins and Commissioner Hester Peirce, a longtime advocate for crypto-friendly regulatory reform.
In a statement, Peirce (who is retiring from the agency), argued the 2023 rule “suggested that many advisors were already on the wrong side of the law” when navigating crypto custody, and hoped the new proposal “foreshadows that a calm end to the regulatory roller coaster ride is imminent.”
Since the start of President Donald Trump’s second term, the SEC under Atkins’ leadership has taken a different tack to the crypto space from Chair Gary Gensler’s tenure during the Biden administration. The president has increasingly supported the crypto industry (while he has become increasingly ingratiated in the space via memecoins and World Liberty Financial, a crypto venture firm backed by his family).
Meanwhile, the agency dropped several prominent enforcement actions against crypto-related firms and dismantled the agency’s Crypto Unit under Gensler by establishing the “Cyber and Emerging Technology Unit.” Last year, the agency launched its own Crypto Task Force, headed by Peirce, and rescinded prior SEC/FINRA guidance on digital asset custody.
The proposed SEC changes follow last month’s failure of the CLARITY Act. The mammoth digital asset market-structure bill would have detailed the regulatory responsibilities of the Commodity Futures Trading Commission and the SEC regarding cryptocurrencies.
The bill was possibly the last attempt by Republicans to pass a crypto market-structure law before Democrats potentially take back at least one chamber of Congress in this November’s midterm elections.
Josh Burton, the director of Silver Regulatory Associates, argued the new crypto rules were the “culmination of years of work,” rather than a direct response to the CLARITY Act’s failure, noting that custody has “long been the most challenging part of RIA compliance in crypto.”
“For a long time, holding crypto assets with a qualified custodian was close to impossible for many managers, because so few qualified custodians actually existed by definition,” he said. “Self-custody is often required for assets that qualified custodians don’t support, or to use crypto’s unique properties when participating in (decentralized finance) activities.”
The new rule would also allow advisors and regulated funds to maintain crypto assets with a chartered state trust company (again, under certain conditions). The rule would also have impacts beyond crypto custody if passed as is, including specifying circumstances under which discretionary trading authority could be exempt from custody rule requirements.
In response, the Investment Adviser Association, an advocacy group of RIAs, lauded the SEC for trying to “make the unnecessarily complex and burdensome custody rule more workable and effective,” and argued that providing more clarity in crypto custody “is essential to the safekeeping of clients’ crypto assets.”
However, Better Markets, an investor protection organization, excoriated the proposal. In a statement, Securities Policy Director Benjamin Schiffrin argued that there was “no reason for the SEC to endanger investors” by allowing advisors to hold client crypto assets, whereas traditional securities are typically held in custody at qualified custodians.
“The SEC acknowledges the ‘inherent conflicts of interest associated with self-custody,’” he said. “Yet it is so beholden to the crypto industry, and so desperate to give the crypto industry everything it wants, that it is willing to throw out the regulatory framework that has long protected investors and create a new regulatory regime with lax standards for the sole benefit of crypto companies.”
The proposed rules will be open to public comment for 60 days after publication in the Federal Register. Still, Burton cautioned investors that due diligence remains “paramount in a fast-moving industry like crypto.”
“Most of the notable problems in crypto have come from preventable compliance failures that reasonable counterparty diligence could have identified,” he said. “Regulatory clarity won’t remove the investor’s responsibility to verify the claims and practices of asset managers, vendors and the underlying crypto investments.”
