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SEC says most trading platforms are not qualified custodians as it proposes tougher rules for advisers


By Nerly Shammah Feb 16, 2023


SEC - Securities and Exchange Commission



The Securities and Exchange Commission(SEC) of the United States(US) has proposed new and tougher rules for advisers targeted at bridging the free holes of crypto custodianship, particularly crypto assets that do not qualify as “securities” as it continues its claimed movement to make the cryptocurrency ecosystem a more safe investment environment for individuals. According to SEC Chairman Gary Gensler, this proposal would help ensure that advisers do not inappropriately use, lose, or abuse assets.


Published as an immediate release for a 60 days window for comment, the Securities and Exchange Commission(SEC) with support from the SEC Chairman Gary Gensler look to expand the scope in regulating “qualified custodians” across “all investments assets and positions” and not so exclusive to funds or securities. The proposal looks to; Expand the current custody rule to protect a broader array of client assets and advisory activities to the rule’s protections; Enhance the custodial protections that client assets receive under the rule; and Update related recordkeeping and reporting requirements for advisers.




Since its initial adoption in 1962, Rule 206(4)-2 under the Advisers Act (the “current custody rule”) has required investment advisers to safeguard client funds and securities in their possession or where they have authority to obtain possession of them. The rule is designed to protect these assets from the adviser’s own insolvency or bankruptcy, and from the assets being lost, misused, stolen, or misappropriated. 


Since the current custody rule was last amended in 2009, changes in technology, advisory services, and custodial practices have created new and different ways for client assets to be placed at risk of loss. In addition, in 2010, Congress gave the Commission more expansive and explicit authority to protect client assets. Thus, the proposal would scope in certain other assets that do not receive custodial protections under the current custody rule.


The proposed amendments would strengthen the rule’s protections to address these developments. The amendments would also redesignate the current custody rule as new rule 223-1 under the Advisers Act (the “safeguarding rule”). Complementary changes to the Advisers Act books and records rule and Form ADV are designed to align reporting obligations with the proposed rule and to improve the accuracy of custody-related data available to the Commission, its staff, and the public.



The proposal thus far has been supported by 4-1 of the SEC leaving commissioner Hester M. Peirce standing against the proposal based on its questionable timeline for implementation and other things which raise concerns about its workability. Hester M. Peirce has publicly expressed concerns over the implications these proposed rules would have on investors, given the past effects of the SEC’s venture into regulating the cryptocurrency ecosystem, much of its actions have proven to hurt investors at a much more rapid pace.


Hester said in her statement;




My first set of concerns is around timing. This rule has broad implications for investors, investment advisers, and custodians. To get it right, we need the thoughtful input of commenters. Comments are due sixty days after publication in the Federal Register, which does not allow the public enough time to analyze all aspects of this proposal, particularly in light of the already loaded rulemaking docket. Moreover, the proposed implementation period—at one year for large advisers and eighteen months for smaller advisers—is too short. This rule will require a lot of work, and a year seems too short to accomplish all of it. I appreciate the extended time for smaller advisers, but even eighteen months seems like an aggressive timeline for the changes contemplated here.




She added as a third concern over the proposed rule that the approach to crypto custody would expand the reach of the custody requirements to crypto assets while likely shrinking the ranks of qualified crypto custodians. Pointing out that the SEC ruling in a law insisting on an asset-neutral approach to custody would leave investors in crypto assets more vulnerable to theft or fraud, not less. 




We run the risk, in the words of the proposing release, of “caus[ing] investors to remove their assets from an entity that has developed innovative safeguarding procedures for those assets, possibly putting those assets at a greater risk of loss.



That said, 3 other commissioners including the SEC chair, Gray Gensler have voted in support of this proposal which awaits finality in terms of approval. Commissioner Jaime Lizárraga who was sworn in on July 18, 2022, as nominated by President Joe Biden says that the proposal represents another important step in the Commission’s efforts to modernize and strengthen the implementation of our federal securities laws, adding that by expanding custody protections, the public can invest with the confidence that their assets, whether more traditional or novel, are appropriately safeguarded, saying that strengthened investor confidence also carries with it the potential for increased retail investor participation in the capital markets.



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