SEC invites feedback on application of Custody Rule to digital assets

On November 9, 2020, the Staff of the Securities and Exchange Commission’s Division of Investment Management published a statement inviting feedback from investment advisers, custodians, and other market participants on application of the SEC Custody Rule to digital assets – specifically, whether non-depository firms such as state-chartered trust companies can act as qualified custodians for digital assets. 

The statement follows an October 23, 2020 no-action letter issued by the Wyoming Division of Banking (DOB), which determined that a Wyoming-chartered public trust company is permitted under Wyoming law to provide custodial services for digital assets, including virtual currency and tokenized securities, and stated that such entity may serve as a “qualified custodian” under the Investment Advisers Act of 1940 and the SEC Custody Rule. The DOB’s opinion was based on its analysis that the particular state-chartered trust company being evaluated, Two Ocean Trust, provides discretion-based fiduciary services similar to national banks.

The SEC’s statement was issued to encourage dialogue directly with the Staff regarding the application of the Custody Rule to digital assets.  State regulators typically interpret state law, not federal law, and the DOB no-action letter concedes that it should not be interpreted as representing the SEC’s views regarding the Custody Rule.  The Staff statement noted that the Commission is not bound by statements or views expressed by state regulators generally, or this particular letter, when considering the Custody Rule’s requirements.  It also noted that the analysis comparing a state-charted trust company to a bank would require consultation with the Office of the Comptroller of the Currency. 

Due to the critical role qualified custodians play, the SEC has historically limited the types of financial institutions that may act as qualified custodians to those that possess key characteristics, including being subject to extensive regulation and oversight.  Nevertheless, the statement also acknowledges that the determination of who qualifies as a qualified custodian is complicated and based on facts and circumstances.  To that end, the SEC is soliciting feedback on issues related to the development of Staff recommendations to amend the Custody Rule and, in particular, seeks feedback on the following questions:

• Do state-chartered trust companies possess characteristics similar to those of the types of financial institutions the Commission identified as qualified custodians?  If yes, to what extent?
• In what ways are custodial services that are provided by state-chartered trust companies equivalent to those provided by banks, broker-dealers, and futures commission merchants?  In what ways do they differ?  Would there be any gaps in – or enhancements to – protection of advisory client assets as a result of a state-chartered trust company serving as qualified custodian of digital assets or other types of client assets?
• How do investment advisers assess whether an entity offering custodial services satisfies the definition of qualified custodian in the Custody Rule?  What qualities does an adviser seek when entrusting a client’s assets to a particular custodian?  Do the qualities vary by asset class?  That is, are there qualities that would be important for safeguarding digital assets that might not be important for safeguarding other types of assets?  If so, what qualities and why?  Should the rule prescribe different qualities based on asset class, or should the rule take a more principals-based approach and allow advisers to exercise care in selecting a custodian?
• Are there entities that currently satisfy the definition of qualified custodian under the Custody Rule that should not be included within that definition because they do not meet the policy goals of the rule?  If so, which ones and why?  Conversely, are there entities that currently do not satisfy the definition of qualified custodian but should?  If so, which ones and why?

Submissions should be emailed to IMOCC@sec.gov with “Custody Rule and Digital Assets” in the subject line.