The US Securities and Exchange Commission on October 1 announced a proposed custody framework for crypto assets that covers registered investment advisers and regulated funds, including registered investment companies and business development companies. The proposal would also establish the conditions under which state trust companies could be used to safeguard crypto assets.

For clients, the changes could broaden the range of investments available through a manager. They would also make a manager's custody arrangements something clients need to understand — particularly when the same firm that selects an investment also holds the assets itself.

Custody and the Gap Between Launch and Safekeeping

Crypto custody involves safeguarding the credentials that authorize transactions and controlling who can use them. For an investment firm, deciding to buy an asset is only part of the job; the firm also needs a lawful arrangement for protecting the client's holdings. The qualified custodian requirement at the center of the proposal stems from the SEC's custody rule under the Investment Advisers Act of 1940, which generally directs advisers to maintain client funds and securities with qualifying institutions such as banks and broker-dealers.

That can become an obstacle when an asset reaches the market before any permitted custodian supports it. SEC Chairman Paul Atkins said in his October 1 statement that “custodial capabilities may lag an asset's deployment by many months.” In that interval, an adviser has lacked a compliant route for holding the asset on a client's behalf.

The proposed self-custody route is designed to address that interval. It would allow an adviser to hold an eligible client asset while no qualified custodian is available, provided the firm can meet the proposed safeguards.

Two Custody Routes, Different Responsibilities

Atkins described the proposal as creating “a compliant pathway where none existed before.” Its two additions would accommodate qualifying outside providers and permit an adviser to take custody in specified circumstances.

The adviser amendments would cover crypto assets that are funds or securities, while the provisions for regulated funds would cover securities or similar investments.

Under the state trust company route, an adviser would have to conduct due diligence, review audited financial statements and control reports, and keep client assets separated from the provider's own holdings.

Under self-custody, the adviser itself would hold the private-key material needed to access client assets. The client would still be relying on a firm to safeguard the investment. For regulated funds, the arrangement would operate through the fund's adviser with board oversight.

An Ongoing Obligation to Look for Alternatives

According to the full proposing release, custodian availability would be a continuing condition. An adviser would have to document its determination when first using self-custody and at least quarterly thereafter. If a qualified custodian became available, the adviser would have to move the assets as soon as reasonably practicable.

Transfers would require joint authorization by at least two designated people. Separate client addresses, cybersecurity measures, and reviews and reports on safeguarding controls would add further checks on how the adviser handles the assets.

Those checks matter because the firm would be combining investment decisions with custody. Commissioner Mark Uyeda acknowledged in his accompanying statement that “self-custody creates an inherent conflict of interest,” while emphasizing that an adviser's fiduciary duty would continue to apply.

What a Client Would Need to Understand

Consider a hypothetical adviser seeking to add a newly issued crypto security to a client's portfolio. If no qualified custodian would maintain the asset, the proposed framework could allow the adviser to hold it directly after meeting the conditions. The client's exposure would then depend both on the investment itself and on the firm's ability to safeguard access to it.

Before accepting such an arrangement, a client would need to weigh several practical questions — who holds the key material, how asset transfers are authorized, and what the firm's reviews of its safeguarding controls would show.

These questions address risks that a price chart cannot show. A token could rise in value while poor key management puts access to it at risk. Equally, effective custody would not prevent losses if its market price fell.

Public Consultation Ahead

The custody framework advances the SEC's broader work on crypto offerings, tokenization and trading. Earlier coverage of the SEC and CFTC proceeding under existing authority had identified custody as an initiative still awaiting a complete proposal; the October 1 release now sets out the proposed operating conditions.

The framework remains a proposal. The public-comment period will run for 60 days after publication in the Federal Register, and the Commission would need to adopt final rules before the new routes take effect.

The consultation gives advisers, custodians and investors an opportunity to examine whether the controls are practical to implement. Their responses can also test whether client statements and reviews would provide enough information to scrutinize a firm that both manages an investment and safeguards it.

This article is for informational purposes only and does not constitute legal or investment advice. The SEC proposal may change during the rulemaking process.

Source: CryptoNewsNet