SEC wants improved protections on crypto, other advisor-managed investments
The Securities and Exchange Commission on Wednesday proposed rule changes to improve the protection of client funds managed by registered investment advisers, including cryptocurrency investments.
The amendments seek to amend the so-called “custodian rule” under the Investment Advisers Act of 1940 to protect against what the SEC identifies as a “general reduction in the level of protection offered by custodians,” according to the proposed rule. The SEC also cited “significant developments” in the trading of cryptoassets through blockchain technology that, while efficient, create regulatory risks for investors.
“Unlike mechanisms used to trade in more traditional assets, this technology generally requires the use of public and private cryptographic key pairings, resulting in the inability to restore or restore many cryptoassets in the event that the keys are lost, forgotten, misused or destroyed,” the SEC filing said. “These specific features may leave advisory clients without meaningful use to reverse erroneous or fraudulent transactions.”
Although the 434-page document does not name the failed cryptocurrency exchange FTX by name, regulators such as the SEC and the Commodity Futures Trading Commission have called for regulatory action to protect investors and markets from another multibillion-dollar collapse.
“The proposed changes are intended to help ensure that qualified custodians provide certain standard custodial protections when maintaining an advisory client’s assets,” the SEC proposal said. “These protections are designed, among other things, to ensure that the client’s assets are properly segregated and held in accounts to protect the assets in the event of a qualified custodian’s bankruptcy or other insolvency.”
Alternative investments
Before the FTX collapse that led to a Chapter 11 bankruptcy filing in November 2022, pension industry record holders Fidelity Investments and ForUsAll had begun offering retirement savers access to cryptocurrency investments in their defined benefit plans. Fidelity offers investment in bitcoin through its core pension program. ForUsAll offers access through the self-managed brokerage window to an exchange called Coinbase Institutional.
According to the proposal, cryptocurrency and other RIA-led investments will have to be managed by qualified custodians such as banks or savings associations, registered brokers/dealers or foreign financial institutions. Coinbase, which operates Coinbase Institutional, announced that the SEC has recognized Coinbase Custody Trust Co. as a qualified custodian and that the proposed rulemaking will not change this designation.
“We wholeheartedly agree that investors deserve to feel confident that their assets are safe — a reminder that our customers’ assets are segregated and secured,” Paul Grewal, Coinbase’s CEO, said in a statement. “We support the Commission’s efforts to provide all investors with the protections already available to CCTC customers.”
ForUsAll did not immediately respond to a request for comment.
Early response
Investment Advisers Association General Counsel Gail Bernstein says her organization is still delving into the proposal. Bernstein’s initial response was that the rule would be a “major departure from how the rule” discretionary advice is currently treated from advisers and would include all authorized adviser trading on behalf of a client.
The IAA, which represents investment advisers, noted that safeguarding client assets is paramount and in need of modernisation, but Bernstein said care must be taken in how to get there.
“The proposal expands the reach of the rule far beyond what it is today,” Bernstein writes via email. “It will expand from covering a client’s funds and securities to include all assets in a client’s portfolio with an advisor, such as crypto, derivatives, real estate and more.”
The SEC’s comment period on the proposal will remain open for 60 days after publication of the proposal in the Federal Register.