SEC proposes narrower custody rules, limited crypto self-custody

The Securities and Exchange Commission on Thursday released a 760-page proposal to narrow when registered investment advisers are treated as having custody of client assets and to update how digital assets are held for safekeeping.

Under the draft rule, advisers with discretionary authority to trade or move assets would not automatically be treated as custodians if they meet specified conditions. Those conditions require advisers to place assets only into client accounts and prohibit transfers into accounts owned by the adviser or related parties. Transfers into non-client accounts would be allowed only with specific client direction.

The SEC cited industry data showing discretionary accounts represent the bulk of assets managed by advisers, reporting about $117.57 trillion of $128.96 trillion overseen by advisers last year were in discretionary accounts.

The proposal would codify a long-standing staff interpretation on standing letters of authorization. If a client signs a written, named instruction to pay a mortgage or other recurring bill and does not authorize the adviser to change the payee or payment terms, the adviser would be exempt from surprise examinations by outside accountants. The change formalizes guidance that has been informal since a 2017 SEC staff letter.

On digital assets, the draft would let advisers act as their own custodians for crypto only when no outside qualified custodian is available or willing to hold the assets. Advisers choosing self-custody must implement protections and cybersecurity controls to prevent theft or tampering, test those controls at least annually, obtain annual independent-accountant reports on internal controls, and deliver account statements to clients at least quarterly. The proposal would also permit advisers to use state trust companies as custodians after reviewing those firms’ audited internal controls and financial statements.

Industry groups and advisers offered preliminary reactions. The Investment Adviser Association described the proposal as “an important and welcome step toward a more modern, workable custody framework.” Aaron Kaplan, founder and CEO of Prometheum Inc., called the proposal “a net positive for both the regulated financial services industry, the investors they serve and the qualified custodians like Prometheum Capital that make it possible to hold crypto assets with the same protections investors already expect from their brokerage accounts.” Richard Chen, founder of Brightstar Law Group, characterized the expected effect as generally positive but noted advisers must understand the conditions that qualify for relief.

The SEC will publish the proposal in the Federal Register and accept public comment for 60 days. The agency can then decide whether to adopt, modify or withdraw the rule based on feedback. The draft responds to industry concerns that a 2023 custody proposal would have required large-scale contract changes and surprise audits; that earlier proposal was abandoned after significant pushback.