Following the collapse of FTX and other high-profile crypto frauds, the Securities and Exchange Commission has proposed changes to custody rules to better protect clients of registered investment advisors as well as hedge funds and mutual funds. But some experts are concerned the changes could inhibit the broader adoption of crypto by financial advisors.
Jason Gottlieb, partner and chair of the white-collar regulator enforcement practice group at Morrison Cohen, and Brian Forman, partner and chair of the investment funds and advisors practice at the law firm, believe the proposal will inhibit investors from seeking advice and cited the one commissioner who dissented. In an email, the partners said, “The new rule could potentially prevent advisors from trading products that they want to trade that they believe are in the best interest for the clients to have exposure to. In Hester Peirce’s dissent, she stated that this could have the effect of encouraging investors to pursue these assets on their own instead of investing through professional asset managers, which would be contrary to their interests.”
In a vote this week, four out of five SEC commissioners supported the proposed changes. Chair Gary Gensler said investors’ crypto assets have not been properly segregated. “When these platforms go bankrupt — something we’ve seen time and again recently — investors’ assets often have become property of the failed company, leaving investors in line at the bankruptcy court,” he said in a statement.
If adopted, the proposal would broaden the custody rule beyond funds and securities to include any assets, including digital currency, that the advisor manages or oversees. It would also require for the first time that investment advisors enter into written agreements with ‘qualified custodians,’ such as banks or broker-dealers.
Although the definition of a qualified custodian is well established, Stacy Sizemore, chief compliance officer at tru Independence in Portland, Oregon, said the inclusion of crypto creates ambiguity for custodians of digital assets.
“It’s unclear to me how the revised rule will affect who can be a digital assets custodian. The SEC’s current actions in other areas of digital assets suggest that their new rules on who can qualify as a custodian for digital assets may be too difficult to practically meet. But we just don’t know yet,” Gottlieb said in his email.
As Peirce wrote in her dissent, “We run the risk, in the words of the proposing release, of “caus[ing] investors to remove their assets from an entity that has developed innovative safeguarding procedures for those assets, possibly putting those assets at a greater risk of loss.”
Gottlieb and Forman want the SEC to provide more clarification. “Safeguarding customer assets is, of course, a good idea, but, as far as digital assets go, we have to see whether the SEC will allow custodians to be qualified,” they wrote. “If the SEC says ‘all digital assets held at an RIA must have a qualified custodian,’ but then they don’t allow anyone to be a qualified custodian for cryptocurrency, that’s not helpful for advisors or investors.”