Critics object to SEC rule requiring crypto safeguarding

The US Securities and Exchange Commission (SEC) has proposed a new rule that demands investment firms safeguard all of their clients' assets, including cryptocurrencies, with approved custodians. However, the proposal has drawn criticism from an array of critics not often in alignment.

The SEC's proposal requires registered investment advisers to keep customer assets with "qualified custodians," which generally means a chartered bank or trust company, a broker-dealer registered with the SEC, or a futures commission merchant registered with the Commodity Futures Trading Commission. The regulator explicitly folded in cryptocurrency but also included other assets.

As the two-month public comment period expired, the Small Business Administration argued the SEC "drastically underestimates potential impacts" from its proposal. Senior SBA lawyers said the "sweeping changes" could threaten smaller investment advisers and force them to merge with others or get out of the business.

SEC Chair Gary Gensler, who said the rule "would help ensure that advisers don't inappropriately use, lose, or abuse investors' assets," pointed out that the crypto platforms that maintain custody of investors' assets don't fit in. "Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians," Gensler said, suggesting the rule would sever the investment firms from the crypto industry.

Executives at JPMorgan accused the SEC of taking an "overly broad approach" that "would disrupt a significant portion of the operations in the financial markets which have been well-functioning for many years." The US securities industry's chief lobbying group, the Securities Industry and Financial Markets Association, called it "jurisdictional overreach, resulting in indirect and inappropriate regulation."

From the crypto sector, investment firm a16z said, "We believe this proposed prohibition to be illegal, infeasible, and dangerous." The letter signed by several executives suggested investment advisers would find the rule almost impossible to comply with because it "largely failed to consider the logistics of how custody works for many crypto assets, the economics underpinning crypto asset markets, and even the basic statistics and other data that should inform a considered regulatory approach."

After the SEC first proposed the rule, statements from crypto platforms such as Anchorage Digital Bank and state-chartered trusts including Coinbase's Custody Trust Co. and BitGo insisted they would qualify as proper custodians. The state-chartered trust companies in the crypto sector are still eager to find out whether they can get on the list as qualified custodians.

The New York Department of Financial Services (NYDFS) also weighed in, pointing out that in the absence of similar federal oversight, its system for regulating trust companies that specialize in crypto is the best way to ensure they'll be safe custodians. "Preserving this structure would be in the best interest of consumers, allowing them to maintain existing relationships and current holdings with best-in-class custody providers, who in turn are subject to the industry-leading prudential regulation and supervision of DFS," wrote the regulator's general counsel, Peter Dean.

The proposed rule cannot be finalized until after the SEC has reviewed all of the outside comments.