US SEC seeks to expand the scope of custody rules in the crypto sector

Updated: 16 February 2023

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The US SEC recently saw a five-member panel vote on a new proposal that is supposed to build upon the 2009 Custody Rules and, essentially, make it more difficult for crypto firms to serve as custodians. The vote resulted in 4 out of 5 members voting in favor or if.

The regulator has yet to officially approve the amendments to the 2009 rules, but if it happens, it will apply to custodians of all assets, which includes cryptocurrencies. This was confirmed in a statement by SEC Chair Gary Gensler himself, who added that, currently, there are numerous crypto platforms that offer custody services without being qualified custodians.

US SEC believes that crypto custodians are not qualified

The SEC believes that a qualified custodian can only be a state or federal-charted bank, trust company, savings association, registered broker-dealer, futures commission merchant, or an international financial institution. Having any company become a custodian and manage people’s money is unsafe in the eyes of the regulator.

The new rules will allow firms to become qualified custodians, but in order to do so, both domestic and offshore companies would have to ensure that all assets under custody are properly segregated. The would-be custodians would also be obligated to comply with yearly audits conducted by public accountants and agree to additional transparency measures.

Gensler said that the amendments would expand the scope to all asset classes and not just cryptocurrencies. However, he did specifically focus on crypto. “Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets. […] Further, though some crypto trading and lending platforms may claim custody of investors’ crypto, that does not mean they are qualified custodians. Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto,” he said.

We @SECGov just proposed to expand & enhance the role of qualified custodians when registered investment advisers custody assets on behalf of investors.

Thru our rule, investors would get the time-tested protections—and qualified custodians—they deserve.

What does this mean? ⬇️ pic.twitter.com/RerUGnpArI

— Gary Gensler (@GaryGensler) February 15, 2023

He highlighted that many crypto businesses have gone bankrupt, which results in the investors’ assets becoming the property of a failed firm. As for the investors themselves, all they can do is turn to the bankruptcy court in an attempt to try and get something back through lengthy court processes.

He added that the crypto industry’s track record in this regard is not great, and very few of them are reliable enough to be custodians.

Not everyone supports the proposal

However, it appears that not all members of the SEC are supportive of the proposal. Commissioner Hester Peirce stated that the latest statement published by the regulator seems designed for immediate effect, even though the proposal is not “regulation by enforcement. According to her, the SEC’s new move is an attempt to take down the crypto industry.

My statement on today's custody proposal. Looking forward to comments from the public. This one affects crypto, among many other issues: https://t.co/1eWT6P45Ya

— Hester Peirce (@HesterPeirce) February 15, 2023

Peirce added that the proposal is likely to do more harm than good, as it represents strong measures that will lead investors to remove their funds from custodians that have put advanced measures in place to safeguard the assets. The move will leave investors in crypto assets more vulnerable to fraud and theft, and not less, according to Peirce.

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