SEC proposes crypto custody framework for advisers and regulated funds

The Securities and Exchange Commission proposed rules and amendments on Oct. 1 that would create a custody framework for crypto assets at registered investment advisers and regulated funds, addressing where client crypto is held, which institutions may hold it, and what financial statement audits an adviser has to produce. The proposal runs under the Investment Advisers Act of 1940 and the Investment Company Act of 1940, and its fund-side population is named precisely in the release as registered investment companies and business development companies, two wrapper types the proposal would open to a wider range of crypto asset-related strategies. The proposal's self-custody provision arrives with its conditions unwritten: crypto assets would be permitted to be held that way under certain circumstances, and the release does not describe them.

The Commission presents the proposal as a modernization that would remove regulatory barriers inhibiting an adviser's ability to provide crypto-related investment advice and as a way to expand investor choice, while Chairman Paul S. Atkins, in a statement accompanying the release, described a market that had grown since Bitcoin's advent in 2008 from a niche curiosity into a multi-trillion-dollar asset class investors actively seek and rules that had not kept pace with it. The proposal, he said, would give advisers and funds a route to compliance that had been absent and replace the uncertainty left by custody rules written for an earlier market.

The release then lists what would change among other items, and the list is short enough to read in full.

Of the four items, self-custody is the one with a blank in it: crypto assets would be permitted to be held that way under certain circumstances, and the release does not describe those circumstances. That gap is where the provision's usefulness to a practice gets decided, because conditions drawn tightly would leave most client crypto with an outside custodian, while conditions drawn loosely would put key management, its controls and its documentation inside the advisory firm. Both readings are inferences from an undefined term, and the definition arrives through the comment process rather than in the proposal text.

The custodian line is the more concrete of the two: state trust companies would be permitted to serve as custodians for client and for regulated fund crypto assets, which widens the set of institutions an adviser can vet and name in a client agreement. The release treats the change as one of several updates to industry practice, attaching no capital, insurance or operational standards to those trust companies and not saying how many of them are positioned to take the business.

For funds, the promise is breadth: registered investment companies and business development companies would be able to offer a wider range of crypto asset-related strategies than they can now. The release does not name the strategies or the assets that would qualify, so the value of the framework to a model portfolio will be set by what survives into a final rule rather than by the existence of the framework.

The cost side shows up in the audit item: the proposal would update a number of requirements relating to, among other things, financial statement audits for registered investment advisers and broker-dealer custodial services for regulated funds, which makes the two listed items examples rather than an exhaustive account of what the amendments would touch. The release labels them as updates and stops there, so the annual bill for keeping crypto inside an adviser's custody framework cannot be read off the text.

Timing is fixed only in part: comments remain open for 60 days following publication of the proposing release in the Federal Register, and the release does not give a date for that publication. A proposal does not alter the rules in force, so existing custody arrangements remain the ones an adviser operates under until the Commission acts.

This publication has argued that custody stopped being neutral plumbing some time ago, with shelf, sweep and referral economics now competing for the client relationship, and the custody proposal pushes on the same question from the other end: if state trust companies and, conditionally, advisers themselves can hold crypto assets, the list of parties standing between an investor and an asset grows, and the adviser's selection among them becomes a term a client can ask about. That reading is an inference; the release is a framework proposal, not a competitive analysis, and it says nothing about how the custodian market would respond.

What the 60-day comment file will test first is the self-custody clause. Whether those circumstances arrive as bright-line conditions or as a standard an adviser applies in judgment decides which practices can use the pathway and which keep paying a third party to hold the keys. The Federal Register publication, undated in the release, starts that clock.