SEC Cracks Down on Custody Rules Including Crypto

The Securities and Exchange Commission is proposing stricter custody rules on alternative investments, including cryptocurrency
SEC crypto assets
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The Securities and Exchange Commission (SEC) on Wednesday proposed tougher custody rules on assets including cryptocurrency, in a push against a market that saw several high-profile crypto crashes in 2022.

The proposed rules would force investment advisors to enhance protections on all client assets managed, including alternative investments such as crypto and art. The changes would amend certain provisions in the “custody rule” under the Investment Advisers Act of 1940 and offer “significant developments” in trading.

Under the proposal, institutions would need to hold charters or qualify as a registered broker-dealer, futures commission merchant, or a trust or foreign financial institutions in order to take custody of a client’s asset or be a qualified custodian.

While the SEC does not specify crypto platforms in the proposal, in separate remarks, SEC Chair Gary Gensler spoke on the potential risks associated with crypto trading, subtly alluding to last year’s FTX Chapter 11 bankruptcy scandal and the impact it left on investors trading with the crypto-exchange platform. Since the scandal, FTX’s former CEO and managers have been charged with misuse of investor funds.

“Though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians,” said Gensler in a statement. “Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto. When these platforms go bankrupt—something we’ve seen time and again recently—investors’ assets often have become property of the failed company, leaving investors in line at the bankruptcy court.”

In its proposal, the SEC also touches on the developments of crypto assets, including distributed ledgers and blockchain technology, and how such technology can present legal and regulatory risks to advisers and clients.  

“Unlike mechanisms used to transact in more traditional assets, this technology generally requires the use of public and private cryptographic key pairings, resulting in the inability to restore or recover many crypto assets in the event the keys are lost, forgotten, misappropriated, or destroyed,” the SEC wrote in its letter. “These specific characteristics could leave advisory clients without meaningful recourse to reverse erroneous or fraudulent transactions, recover or replace lost crypto assets, or correct errors that result from their adviser having custody of these assets.”

The SEC’s comment period on the proposal is now open and will remain so for 60 days after published in the Federal Register.

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Amanda Umpierrez
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Amanda Umpierrez is the Managing Editor of 401(k) Specialist magazine. She is a financial services reporter with over six years of experience and a passion for telling stories and reporting news. Amanda received her degree in journalism and government and politics at St. John’s University. She is originally from Queens, New York, but now resides in Denver, Colorado with her partner. In her free time, Amanda enjoys running, cooking, and watching the latest drama show.

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