SEC Seeks Input on Impact of Digital Assets and Distributed Ledger Technology (DLT) on Compliance with Custody Rules for Investment Advisers | Practical Law

SEC Seeks Input on Impact of Digital Assets and Distributed Ledger Technology (DLT) on Compliance with Custody Rules for Investment Advisers | Practical Law

The SEC issued a notice seeking input on the impact of digital assets and the use of distributed ledger technology (DLT) on compliance with the custody rule for investment advisors (IAs), as well as on non-DVP practices for IAs, under the Investment Advisers Act of 1940.

SEC Seeks Input on Impact of Digital Assets and Distributed Ledger Technology (DLT) on Compliance with Custody Rules for Investment Advisers

by Practical Law Finance
Published on 20 Mar 2019 • USA (National/Federal)
The SEC issued a notice seeking input on the impact of digital assets and the use of distributed ledger technology (DLT) on compliance with the custody rule for investment advisors (IAs), as well as on non-DVP practices for IAs, under the Investment Advisers Act of 1940.
On March 12, 2019, the SEC issued a notice seeking public input on certain questions related to the custody rule for investment advisers (IAs), rule 206(4)-2, under the Investment Advisers Act of 1940 (17 CFR § 275.206(4)-2). Specifically, the SEC is seeking input on:
  • The application of the custody rule to custodial trading practices that are not processed or settled on a delivery versus payment (DVP) basis, known as non-DVP practices.
  • The impact of digital assets and the use of distributed ledger technology (DLT) on compliance with the custody rule.
The custody rule states it is a fraudulent, deceptive, or manipulative act for a registered IAs to have custody of client funds or securities unless certain requirements are met. Following SEC guidance on inadvertent custody issued in February 2017, IAs and market participants have raised questions regarding the application of the custody rule to non-DVP practices.
In addition, SEC staff, together with the Strategic Hub for Innovation and Financial Technology (FinHub), have discussed whether characteristics of digital assets affect compliance with the custody rule.
The SEC is gathering information on whether revisions to the custody rule would be helpful in addressing non-DVP practices as well as questions regarding the custody of digital assets.
The SEC has identified specific questions for both of these topics. Some of the questions concerning custody of digital assets include:
  • To what extent are IAs construing digital assets as "funds," "securities," or neither, for purposes of the custody rule?
  • To what extent are IAs including digital assets in calculating regulatory assets under management for purposes of the thresholds for registering with the SEC?
  • To what extent do IAs use state chartered trust companies or foreign financial institutions to custody digital assets?
  • How should concerns about misappropriation of digital assets be addressed?
  • What is the settlement process of peer-to-peer digital asset transactions? What risks does this process present?
  • Can DLT be useful for custody and recordkeeping purposes for other types of assets, and not just digital asset securities?
  • What concerns are there about the use of DLT with respect to custody and recordkeeping?
Comments should be directed to [email protected] with either “Custody Rule and Non-DVP Trading” or “Custody Rule and Digital Assets” in the subject line.