The U.S. Securities and Exchange Commission (SEC) went too far when it proposed a new rule demanding investment firms safeguard all of their clients’ assets – including crypto – with approved custodians, according to an array of critics not often in alignment.
The securities regulator said the expanded requirement for how registered investment advisers keep customer assets should extend to pretty much everything the firms are in charge of. While the February proposal explicitly folded in cryptocurrency, it also included other assets in a move that drew loud objections from organizations that aren’t always on the same side as the crypto industry – financial giant JPMorgan and the Small Business Administration (SBA) among them.
As the two-month public comment period expired this week the SBA argued the SEC “drastically underestimates potential impacts” from its proposal, according to a letter from senior SBA lawyers who said the cost of the “sweeping changes” could threaten smaller investment advisers and force them to merge with others or get out of the business.
The proposed rule, which can’t be finalized until after the SEC has reviewed all of these outside comments, said any assets entrusted to investment advisers need to be held with “qualified custodians,” which generally means a chartered bank or trust company, a broker-dealer registered with the SEC or a futures commission merchant registered with the Commodity Futures Trading Commission (CFTC).
SEC Chair Gary Gensler, who said the rule “would help ensure that advisers don’t inappropriately use, lose, or abuse investors’ assets,” was quick to point out the crypto platforms that now maintain custody of investors’ assets don’t fit in.
“Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians,” Gensler said, suggesting the rule would effectively sever the investment firms from the crypto industry.
From Wall Street, executives at JPMorgan accused the SEC of taking an “overly broad approach” that “would disrupt a significant portion of the operations in the financial markets which have been well-functioning for many years,” according to their comment letter.
The U.S. securities industry’s chief lobbying group, the Securities Industry and Financial Markets Association, called it “jurisdictional overreach, resulting in indirect and inappropriate regulation” and argued a number of asset classes – such as repurchase agreements, securities loans, derivatives and annuities – may be fundamentally unable to meet some of the requirements the SEC has in mind.
And from the crypto sector, investment firm a16z said, “We believe this proposed prohibition to be illegal, infeasible, and dangerous.” The letter signed by several executives suggested investment advisers would find the rule almost impossible to comply with, because it “largely failed to consider the logistics of how custody works for many crypto assets, the economics underpinning crypto asset markets, and even the basic statistics and other data that should inform a considered regulatory approach.”
After the SEC first proposed the rule, statements from crypto platforms such as Anchorage Digital Bank and state-chartered trusts including Coinbase’s Custody Trust Co. and BitGo insisted they’d definitely qualify as proper custodians. The state-chartered trust companies in the crypto sector are still eager to find out whether they can get on the list as qualified custodians.
Marc D’Annunzio, the general counsel of Bakkt Holdings Inc., which has a trust subsidiary licensed in New York, said that if the state-chartered firms were excluded, “we fear that consumers and investors will be less protected and will have limited choices for custody services to protect their assets.”
The New York Department of Financial Services (NYDFS) also weighed in, pointing out that in the absence of similar federal oversight, its system for regulating trust companies that specialize in crypto is the best way to ensure they’ll be safe custodians.
“Preserving this structure would be in the best interest of consumers, allowing them to maintain existing relationships and current holdings with best-in-class custody providers, who in turn are subject to the industry-leading prudential regulation and supervision of DFS,” wrote the regulator’s general counsel, Peter Dean. Cutting those off “would run the risk of pushing novel activities into unregulated spaces, including offshore.”
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The recent drama of some crypto-affiliated banks shutting down and one of the industry’s major platforms – FTX – crashing into the ground may also leave traditional gatekeepers such as banks shy about crypto custody.
“We have serious concerns about the willingness of qualified custodians to custody digital assets – and those that are willing may charge prohibitive fees,” according to a comment submitted by Linklaters LLP. The narrowing choices for custody “will cause customers seeking exposure to digital assets to bear greater risks than they currently do.”
