The U.S. Securities and Exchange Commission announced a proposed crypto-custody framework on October 1 that would cover registered investment advisers and regulated funds, including registered investment companies and business development companies. Addressing custody under the Investment Advisers Act and the Investment Company Act, the proposal would also establish conditions for using state trust companies to safeguard crypto assets.

The SEC’s proposal could expand the range of investments available through a manager. At the same time, it would make custody arrangements more important for clients to understand, particularly when the firm selecting an investment also holds the assets.

When an asset reaches the market before a custodian

Crypto custody involves protecting the credentials that authorize transactions and controlling who can use them. For an investment firm, deciding to purchase an asset is only part of its responsibility. It must also have a lawful arrangement to protect the client’s holdings.

That requirement can create an obstacle when an asset reaches the market before a 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.” Until that support arrives, an adviser can lack a compliant way to hold the asset for clients.

The proposed self-custody option is intended to address that gap. An adviser could hold an eligible client asset while no qualified custodian is available, provided that it meets the proposed safeguards. Atkins described the proposal as offering “a compliant pathway where none existed before.”

Two custody routes with different responsibilities

The proposal would add two routes: one for qualifying outside providers and another that would allow an adviser to take custody in specified circumstances. The adviser amendments would cover crypto assets that are funds or securities, while the regulated-fund provisions would cover securities or similar investments.

The state trust company route would require due diligence, reviews of audited financial statements and control reports, and the separation of client assets from the provider’s own holdings. The SEC’s proposed rule and full proposing release set out the proposed requirements.

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

Self-custody would require an ongoing search for alternatives

The proposing release makes the availability of a qualified custodian a continuing consideration. An adviser would have to document its determination initially and at least quarterly. If a qualified custodian became available, the adviser would have to transfer the assets as soon as reasonably practicable.

In the meantime, transfers would require joint authorization from at least two designated people. Separate client addresses, cybersecurity measures, reviews and reports on safeguarding controls would provide additional checks on the adviser’s handling of the assets.

Those controls are significant because the firm would combine investment decision-making with custody. Commissioner Mark Uyeda said 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 clients would need to understand

an 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 satisfying the conditions. The client’s exposure would depend on both the investment and the firm’s ability to protect access to it.

Before accepting such an arrangement, a client would need answers to several practical questions:

• Transfer authority: Who can approve transactions, and who provides the second authorization?
• Verification: What statements and control reports would allow the client to check the holdings and custody arrangements?
• Future custody: How would the adviser transfer the assets if an outside qualified custodian became available?

These questions concern risks that a price chart cannot show. A token could increase in value while poor key management put access to it at risk. Conversely, effective custody would not prevent losses if the asset’s market price declined.

Proposal enters public consultation

The custody framework forms part of the SEC’s broader work on crypto offerings, tokenization and trading. Earlier coverage of the SEC and CFTC proceeding under existing authority 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, identified by file number S7-2026-35. 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 custody routes could take effect.

The consultation gives advisers, custodians and investors an opportunity to assess whether the controls are practical to implement. Responses could 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 rulemaking. Source: Coindoo.