SEC proposes conditional crypto custody framework

The SEC proposed a new framework on Oct. 1 for how investment advisers and regulated funds may hold certain crypto assets, potentially creating a route to self-custody when no qualified custodian is available. The proposal matters because crypto ownership is recorded on a distributed ledger, while control of an asset depends on its private key: whoever controls the key can transfer it. The SEC’s announcement of the proposal says the changes would also allow state trust companies to provide custody services.

Which crypto assets would the proposal cover?

The proposed rules cover crypto assets that fall within existing custody laws for client funds or securities, and for regulated funds, securities or similar investments. They do not apply to every crypto asset simply because it is recorded on a blockchain. The SEC’s proposal explains that an asset’s treatment depends on the relevant statutory category and whether it is held for an advisory client or a regulated fund.

In the usual arrangement, a qualified custodian holds the assets and controls the private keys needed to move them. The proposal would add state trust companies as a possible custody option, subject to conditions. Advisers and funds would have to review a state trust company’s safeguards, including its policies for private-key management and cybersecurity, and examine its audited financial statements.

When could an adviser hold crypto itself?

An adviser could self-custody a covered crypto asset only after determining in writing that no qualified custodian is available to maintain it. The adviser would have to revisit and record that determination at least quarterly. Bloomberg Law’s report on the proposal likewise describes self-custody as conditional on the absence of another qualified custodian.

The proposal would require the adviser to show expertise in safeguarding the asset and maintain systems to protect it from loss, theft, misuse and misappropriation. Those systems must address private-key management, require at least two people to authorize transactions, and keep each client’s assets in separate blockchain addresses. Advisers would also need cybersecurity controls, annual reviews and an independent accountant’s internal-control report. If a qualified custodian becomes available, the adviser would have to move the asset there as soon as reasonably practicable.

What oversight would regulated funds need?

A regulated fund could keep a covered crypto asset with its adviser only if the adviser met the self-custody conditions and the fund’s board oversaw the arrangement. The board would review the adviser’s written case that no qualified custodian is available before self-custody begins and at least quarterly afterward. That adds a second decision-maker to the process.

The proposal is not yet a rule. The SEC said comments will remain open for 60 days after the proposing release appears in the Federal Register. Until the commission adopts a final rule, advisers and funds remain subject to the current custody requirements.

Sources

• announcement of the proposal — sec.gov
• report on the proposal — news.bloomberglaw.com