Oct. 14, 2023
Hello. I am writing to comment on the proposed rulemaking on safeguarding advisory client assets, which was published in the Federal Register on August 30, 2023 (86 FR 51076). I strongly oppose the proposed rulemaking, as I believe it is an outreach of the SEC outside its jurisdiction, as it attempts to regulate digital assets that are not securities under federal law. I also believe it infringes on freedom of speech in the form of publishing on public blockchain, as it imposes restrictions and burdens on advisory clients and advisers who use blockchain technology to create, distribute, or exchange digital assets. I further believe it is unactionable, as it creates impractical and impossible requirements for advisory clients and advisers who use blockchain technology to create, distribute, or exchange digital assets. The proposed rulemaking is an outreach of the SEC outside its jurisdiction, as it attempts to regulate digital assets that are not securities under federal law. The SEC has applied the Howey Test, a four-part test that determines whether an investment contract is a security subject to federal regulation. The test asks whether there is (1) an investment of money (2) in a common enterprise (3) with an expectation of profits (4) solely from the efforts of others. The SEC has applied this test to digital assets, arguing that they are securities because they involve an investment of money in a common enterprise with an expectation of profits from the efforts of third parties, such as developers, miners, or promoters. However, this interpretation is flawed and inconsistent with the SEC's own guidance and statements, which recognize that digital assets can have multiple functions and use cases, and that not all digital assets are securities. Digital assets are not homogeneous or standardized, but rather vary widely in their characteristics, features, and use cases. Some are designed to be used as currencies, others as platforms, others as utilities, and others as tokens of membership or access. The SEC's approach fails to account for these differences and nuances, and instead treats all digital assets as securities without providing clear and consistent criteria or guidance. This creates uncertainty and confusion for advisory clients and advisers who use blockchain technology to create, distribute, or exchange digital assets. The proposed rulemaking infringes on freedom of speech in the form of publishing on public blockchain, as it imposes restrictions and burdens on advisory clients and advisers who use blockchain technology to create, distribute, or exchange digital assets. Blockchain technology is a system of distributed ledger that records transactions in a secure and transparent way without relying on intermediaries or central authorities. Blockchain technology can enable users to create and share content on a decentralized web, where information is stored and verified on a network of nodes rather than on centralized servers. This can enhance users' autonomy, privacy, and sovereignty over their data and content. Blockchain technology can also facilitate capital formation and innovation by enabling users to create and exchange digital assets that represent value or rights. For example, users can create cryptocurrencies, which are digital tokens that function as mediums of exchange; smart contracts, which are self-executing agreements encoded on a blockchain; DAOs, which are organizations that operate autonomously according to predefined rules; and NFTs, which are unique digital representations of art, music, or other forms of expression. These digital assets can offer new opportunities and benefits for consumers, businesses, and society. However, the proposed rulemaking could limit or undermine the potential of blockchain technology for enhancing freedom of speech and facilitating capital formation. The rulemaking could impose excessive and disproportionate costs and burdens on advisory clients and advisers who use blockchain technology to create, distribute, or exchange digital assets. For example, the rulemaking could require advisory clients and advisers to: - Provide additional information in their Form ADV filings, which could expose sensitive or proprietary information to competitors or hackers. - Obtain a written internal control report from the custodian that holds the digital assets, which could be costly, time-consuming, and impractical, as most custodians do not have the expertise or experience to audit blockchain networks or digital assets. - Undergo an annual surprise examination by an independent public accountant, which could be disruptive, intrusive, and unnecessary, as blockchain transactions and balances are already transparent and verifiable on the ledger. - Comply with the expanded definition of custody, which could limit their ability to use innovative and user-friendly features of blockchain technology, such as allowing users to create or access digital assets directly from their wallets or to delegate their rights or responsibilities to others. - Return or forward any digital assets that they inadvertently receive within a short time frame, which could be impractical or impossible, as blockchain transactions are irreversible and immutable. These requirements could discourage users from participating in blockchain-based platforms and services, which offer environmental, social, and governance benefits, such as reducing energy consumption, enhancing network security, and promoting decentralization and democracy. The rulemaking could also stifle innovation and competition in the securities industry, as it could create a competitive advantage for traditional intermediaries over blockchain-based platforms and services. The rulemaking could also harm US competitiveness and leadership in the global securities market, as other jurisdictions have adopted more favorable and flexible regulatory frameworks for blockchain technology and digital assets. The proposed rulemaking is unactionable, as it creates impractical and impossible requirements for advisory clients and advisers who use blockchain technology to create, distribute, or exchange digital assets. The rulemaking assumes that advisory clients and advisers have custody of digital assets in the same way that they have custody of traditional securities, such as stocks or bonds. However, this assumption is false and misleading, as digital assets are fundamentally different from traditional securities in terms of their nature, function, and purpose. Digital assets are not physical objects or legal documents that can be stored or transferred by custodians or intermediaries. Rather, they are pieces of information that can be accessed or spent by users who have the corresponding private keys. Private keys are not something that users have, but something that users know. They are not stored or transferred by custodians or intermediaries, but generated or derived by users themselves. Therefore, advisory clients and advisers do not have custody of digital assets in the same way that they have custody of traditional securities. The rulemaking also assumes that advisory clients and advisers can comply with the Custody Rule's requirements for digital assets in the same way that they comply with them for traditional securities. However, this assumption is also false and misleading, as digital assets pose new challenges and opportunities for compliance that are not addressed by the Custody Rule's requirements. For example: - Providing additional information in Form ADV filings may not be feasible or meaningful for digital assets, as they may not have a clear or consistent name, location, number, or amount. Digital assets may also have multiple functions and use cases that may not fit into the existing categories or definitions of the Form ADV. - Obtaining a written internal control report from the custodian may not be possible or reliable for digital assets, as most custodians do not have the expertise or experience to audit blockchain networks or digital assets. Moreover, the custodian's controls may not be relevant or effective for ensuring the security or integrity of digital assets, as they may depend on factors outside the custodian's control, such as network consensus rules, user behavior, or external events. - Undergoing an annual surprise examination by an independent public accountant may not be necessary or useful for digital assets, as blockchain transactions and balances are already transparent and verifiable on the ledger. Furthermore, the accountant may not have the expertise or experience to audit blockchain networks or digital assets, nor the authority or access to verify the ownership or control of private keys. - Complying with the expanded definition of custody may not be appropriate or desirable for digital assets, as it may limit the ability of advisory clients and advisers to use innovative and user-friendly features of blockchain technology, such as allowing users to create or access digital assets directly from their wallets or to delegate their rights or responsibilities to others. It may also create conflicts or inconsistencies with other laws or regulations that apply to digital assets, such as tax laws, privacy laws, or anti-money laundering laws. - Returning or forwarding any digital assets that they inadvertently receive within a short time frame may not be practical or possible for digital assets, as blockchain transactions are irreversible and immutable. Moreover, the source or destination of the digital assets may not be identifiable or reachable, as blockchain transactions are pseudonymous and decentralized. These requirements could create impractical and impossible situations for advisory clients and advisers who use blockchain technology to create, distribute, or exchange digital assets. They could also create legal risks and liabilities for advisory clients and advisers who may not be able to comply with the Custody Rule's requirements for digital assets. Therefore, I urge the SEC to reconsider its proposed rulemaking and adopt a more flexible and nuanced approach that recognizes the diversity and complexity of the crypto industry, and that applies a case-by-case analysis of digital assets based on their facts and circumstances. I also urge the SEC to engage in meaningful consultation and collaboration with the crypto industry and other stakeholders, such as Congress, other regulators, academia, and civil society, to develop a balanced and harmonized regulatory framework for blockchain technology and digital assets that fosters innovation, competition, and consumer protection. Best regards, John Witlesbey