SEC steps up crypto crackdown with proposed tough rules for asset managers

• The SEC’s crypto crackdown has extended to fund managers, and could stop them from holding such assets on behalf of clients.
• Proposed rule changes would require crypto to be registered with state-certified banks or brokers.
• That can make crypto harder to hold, as the asset can fail traditional compliance measures.

The Securities and Exchange Commission (SEC) has stepped up its crackdown on the crypto sector with a proposed rule change that could block investment advisers from holding cryptocurrencies on behalf of their clients.

A Wednesday proposal, voted 4-1 by regulators, would expand the types of assets fund managers are required to hold by using qualified custodians, which include state-certified banks and brokerages.

That could make it more difficult for asset managers, including hedge funds and pension funds, to hold crypto without violating certain compliance measures.

Custodian rules are designed to safeguard the client’s assets in the event of bankruptcy or other types of insolvency.

In a statement alongside the proposal, SEC Chairman Gary Gensler said: “Through this expanded custody rule, investors who work with advisers will get the time-tested protection they deserve for all their assets, including crypto assets, consistent with what Congress envisioned.”

The SEC argued that since the last amendment to the Dodd-Frank Act in 2009, developments in technology have allowed investors to risk losses from new sources, in a likely nod to crypto.

Increased scrutiny of crypto in recent years has encouraged firms like Coinbase to set themselves up as qualified custodians, through the Coinbase Custody Trust Co. Coinbase earned $68.4 million from custody services in the first nine months of 2022, down from $86.6 million a year earlier.

This brooding may have implications for its own custody provision.

In a tweet Wednesday in response to the announcement, Coinbase’s legal director Paul Grewal said “Coinbase Custody Trust Co. is a qualified custodian today and will be a qualified custodian tomorrow.”

“While we commend the SEC for following proper public rulemaking procedures, today’s proposal is just that — a proposal,” Grewal said.

For now, the rule change may also be part of Gensler’s deeper battle with the industry to determine whether most crypto tokens and offerings are securities, and thus subject to registration rules.

Several crypto companies, including Gemini, Genesis and Paxos, are facing lawsuits from the SEC over the offering of these alleged “unregistered securities”.