SEC proposes custody framework for advisers and funds

The SEC proposed new rules on Oct. 1 for how registered investment advisers and regulated funds may custody certain crypto assets, setting out options that include adviser custody when no permitted custodian is available. The agency said the proposal would also allow state trust companies to act as custodians. The SEC’s announcement says the changes would apply under the Investment Advisers Act and Investment Company Act.

The proposal covers crypto assets that are funds or securities under the Advisers Act, and securities or similar investments under the Investment Company Act. It is a proposal, not a rule in effect: the SEC will accept public comments for 60 days after the release appears in the Federal Register.

When could an adviser hold a client’s crypto keys?

An adviser could hold crypto for a client or regulated fund only if the proposed conditions are met. The SEC’s proposed rule defines this form of “self-custody” as the adviser possessing some or all of the private keys needed to access and transact in the asset. It does not mean the investor personally controls the keys.

First, the adviser would have to determine in writing that no permitted custodian is available for that asset. It would have to make that determination before taking custody and repeat it quarterly. The adviser would also need documented expertise in safeguarding the asset, systems to protect against loss, theft, misuse and misappropriation, and annual reviews of those systems and its cybersecurity controls.

Transactions would require joint authorisation by at least two people, like a safe that needs two keys. The proposal also calls for client assets to be kept in addresses corresponding only to that client’s crypto, internal control reports, and account statements at least quarterly. For a regulated fund using adviser custody, the fund’s board would oversee the arrangement.

What changes for state trust companies?

The proposal would add state trust companies to the permitted custody options for client and regulated-fund crypto assets. Before engaging one, and annually afterward, an adviser or fund would need to make a written determination after due inquiry that the company is authorised by the relevant state banking authority to provide crypto custody.

That review would also cover whether the company has and implements written safeguards against theft, loss, misuse and misappropriation. At a minimum, those procedures would address private-key management and cybersecurity. The proposal further requires advisers and funds to receive and review the trust company’s latest audited annual financial statements.

The SEC says the expanded options are intended to address limits in the current custody framework while adding safeguards. What changed on Oct. 1 is that the agency put those options and conditions out for public review. The next step is the Federal Register publication, which starts the 60-day comment period; the SEC has not yet adopted a final rule.