Key Takeaways
- • The SEC's Custody Proposal would create new pathways for crypto custody, allowing advisers to self-custody crypto assets when they have a reasonable basis for believing no qualified custodian is available, and allowing certain state trust companies to serve as qualified custodians for crypto assets and related cash.
- • Crypto self-custody would carry ongoing obligations, including documented safeguarding expertise, private-key management and joint authorization systems, client-by-client segregation, cybersecurity controls, an independent internal control report, annual reviews, quarterly client disclosures, and generally the annual surprise examination.
- • The proposal offers compliance relief on discretionary trading authority (proposed rule 223-1(b)(9)), inadvertent custody (rule 223-1(b)(10)), and standing letters of authorization (rule 223-1(b)(8)), which could simplify recurring custody issues for advisers.
- • The Advisers Act custody rule would move from rule 206(4)-2 to rule 223-1, replacing its anti-fraud framing with an express safeguarding obligation under Section 223 of the Advisers Act.
- • Native digital commodities such as bitcoin and ether would generally remain outside the Advisers Act custody rule for clients other than registered funds and BDCs, while payment stablecoins and tokenized deposits would be treated as client funds.
Summary
The U.S. Securities and Exchange Commission has proposed broad changes to custody requirements for registered investment advisers, registered investment companies, and business development companies, according to a report by Morgan Lewis. Crypto custody is the headline element, but the Custody Proposal also modernizes longstanding custody practices that would apply across traditional assets.
On crypto, the proposal would allow advisers to self-custody crypto assets, subject to significant conditions, when they have a reasonable basis for believing no qualified custodian is available to maintain them. Registered funds and BDCs could hold crypto assets through their advisers on the same basis, subject to board oversight. The proposal would also treat certain state trust companies as qualified custodians for crypto assets and related cash. Self-custody would require advisers to document appropriate safeguarding expertise, maintain systems addressing private-key management, joint authorization, and client-by-client segregation, implement cybersecurity controls, obtain an independent internal control report, conduct annual reviews, and provide specified information to clients at least quarterly. Unless an exception applies, advisers would also continue to obtain the annual surprise examination.
The proposal includes several areas of potential relief. Proposed rule 223-1(b)(9) would exclude funds and securities over which an adviser has custody solely due to its discretionary trading authority, provided the adviser trades only in designated accounts in the client's name and cannot move assets to itself, a related person, or any nonclient account, other than at the client's direction in connection with trading. Proposed rule 223-1(b)(10) would exclude custody arising solely from a client's custodial agreement, but only if the adviser did not recommend, request, or require the custodian and either lacks knowledge of the authority or promptly repudiates it in writing. Proposed rule 223-1(b)(8) would codify surprise-examination relief for standing letters of authorization, except where the custodian is the adviser or a related person.
The SEC would also redesignate the Advisers Act custody rule from rule 206(4)-2 to rule 223-1, consistent with the 2023 Safeguarding Rule proposal. Morgan Lewis notes that, although the change may appear technical, it could affect investor reporting, representations, and due diligence questionnaires, and that the SEC's ability to pursue safeguarding failures under the Advisers Act's antifraud provisions is not expressly stated in the current proposal. The release also seeks to codify positions developed through staff no-action letters, FAQs, and interpretive guidance, which would supersede inconsistent staff views if adopted.
The crypto provisions are narrower than the SEC's withdrawn 2023 Safeguarding Rule proposal. The Advisers Act framework continues to apply to client "funds and securities," so native digital commodities such as bitcoin and ether generally remain outside the rule for clients other than registered funds and BDCs, while payment stablecoins and tokenized deposits would be treated as client funds. The SEC is seeking comment on qualified custodian availability, self-custody conditions, safeguarding and cybersecurity requirements, state trust company custody, and modernization of existing regimes.
On crypto, the proposal would allow advisers to self-custody crypto assets, subject to significant conditions, when they have a reasonable basis for believing no qualified custodian is available to maintain them. Registered funds and BDCs could hold crypto assets through their advisers on the same basis, subject to board oversight. The proposal would also treat certain state trust companies as qualified custodians for crypto assets and related cash. Self-custody would require advisers to document appropriate safeguarding expertise, maintain systems addressing private-key management, joint authorization, and client-by-client segregation, implement cybersecurity controls, obtain an independent internal control report, conduct annual reviews, and provide specified information to clients at least quarterly. Unless an exception applies, advisers would also continue to obtain the annual surprise examination.
The proposal includes several areas of potential relief. Proposed rule 223-1(b)(9) would exclude funds and securities over which an adviser has custody solely due to its discretionary trading authority, provided the adviser trades only in designated accounts in the client's name and cannot move assets to itself, a related person, or any nonclient account, other than at the client's direction in connection with trading. Proposed rule 223-1(b)(10) would exclude custody arising solely from a client's custodial agreement, but only if the adviser did not recommend, request, or require the custodian and either lacks knowledge of the authority or promptly repudiates it in writing. Proposed rule 223-1(b)(8) would codify surprise-examination relief for standing letters of authorization, except where the custodian is the adviser or a related person.
The SEC would also redesignate the Advisers Act custody rule from rule 206(4)-2 to rule 223-1, consistent with the 2023 Safeguarding Rule proposal. Morgan Lewis notes that, although the change may appear technical, it could affect investor reporting, representations, and due diligence questionnaires, and that the SEC's ability to pursue safeguarding failures under the Advisers Act's antifraud provisions is not expressly stated in the current proposal. The release also seeks to codify positions developed through staff no-action letters, FAQs, and interpretive guidance, which would supersede inconsistent staff views if adopted.
The crypto provisions are narrower than the SEC's withdrawn 2023 Safeguarding Rule proposal. The Advisers Act framework continues to apply to client "funds and securities," so native digital commodities such as bitcoin and ether generally remain outside the rule for clients other than registered funds and BDCs, while payment stablecoins and tokenized deposits would be treated as client funds. The SEC is seeking comment on qualified custodian availability, self-custody conditions, safeguarding and cybersecurity requirements, state trust company custody, and modernization of existing regimes.
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