SEC proposes conditional crypto custody rules for advisers

The SEC proposed new custody rules for registered investment advisers and regulated funds on Oct. 1, setting conditions for self-custody and adding state trust companies as possible custodians of crypto assets. The commission says the proposal is intended to address custody rules that can limit advisers’ ability to offer crypto-related advice and funds’ ability to pursue crypto investment strategies, according to the SEC’s proposal announcement.

Which crypto assets would the rules cover?

The proposal covers crypto assets within the federal custody rules’ existing scope, rather than every crypto asset. For advisers, the proposed amendments apply to crypto assets that are client funds or securities. For regulated funds, the rules apply to crypto assets that are securities or similar investments. The SEC’s proposed rule text says crypto assets may or may not meet the legal definition of a security.

The proposal amends the Investment Advisers Act custody rule and adds custody rules under the Investment Company Act. “Regulated funds” here means registered investment companies and business development companies. The proposal is not a final rule. The SEC says the public comment period will stay open for 60 days after the proposing release appears in the Federal Register.

When could an adviser hold crypto in self-custody?

An adviser could self-custody a client’s covered crypto asset only under proposed safeguards. It would first have to determine in writing, and again each quarter, that a permitted custodian is unavailable for that asset. The adviser would also need documented expertise and systems to protect the asset from loss, theft, misuse and misappropriation.

Those systems would have to address private key management, require at least two people to jointly authorize transactions, and keep each client’s assets in one or more network addresses corresponding only to that client’s assets. The proposal also calls for annual reviews of safeguarding and cybersecurity controls, an internal control report within six months of starting custody and annually after that, and account statements to clients at least quarterly.

What oversight would apply to funds and state trust companies?

A regulated fund could hold covered crypto assets through its adviser if the adviser met the self-custody conditions and the fund’s board oversaw the arrangement. The board would have to determine that the assets would receive reasonable care before self-custody began and annually afterward. It would also review the adviser’s finding that no permitted custodian was available before custody began and quarterly thereafter.

The proposal would make qualifying state trust companies another permitted custodian category for crypto assets and related cash or cash equivalents. Before hiring one, an adviser or fund would need a written, reasoned determination that the company is authorized by the relevant state banking authority to custody crypto and has safeguards addressing private keys and cybersecurity. The firm would also need to review the trust company’s audited financial statements and internal control report before engagement and annually afterward. For funds, the proposal requires segregated accounts and a written custody services agreement.