Oct. 17, 2023
RESPONSE TO PROPOSAL FROM THE IRS Proposal name: Gross Proceeds and Basis Reporting by Brokers and Determination of Amount Realized and Basis for Digital Asset Transactions Posted by: The Securities and Exchange Commission on 08/30/2023 Webpage: https://www.federalregister.gov/documents/2023/08/30/2023-18667/safeguarding-advisory-client-assets-reopening-of-comment-period Document Citation: 88 FR 59818 Comment Due Date: Oct 30, 2023 Release number: IA-6384 File Number: S7-04-23 RIN: 3235-AM32 Document Number: 2023-18667 CFR: 17 CFR 275, 17 CFR 279 I oppose the above proposed rule for a number of important reasons. 1) The proposal exceeds the SEC’s regulatory authority by imposing private contractual terms and other obligations on third-party QCs over whom the SEC does not have jurisdiction, expanding the scope of custody to include discretionary trading authority, expanding the definition of assets to include all assets (not just funds and securities), intruding on non-U.S. laws governing foreign custodians, and failing to perform a proper cost-benefit analysis of the Proposal’s cumulative or interactive effects. 2) The proposed rule would impose additional costs and compliance burdens on smaller investment advisers and accounting firms that would be difficult for them to bear and would inhibit their ability to compete with larger firms, which may harm their ability to compete with larger firms. This could be seen as anti-competitive regulatory capture creating disproportionate impact on smaller advisory firms. 3) The proposed rule imposes additional requirements on both the investment adviser and the accountant without clear evidence that such requirements are necessary to protect client assets. For example: The proposal includes additional limited exceptions from the surprise examination requirement for client accounts where the investment adviser has custody solely (i) pursuant to a standing letter of authorization (SLOA); or (ii) because it has discretionary authority with respect to client assets if the assets are maintained with a qualified custodian and discretionary authority for the account is limited to instructing the qualified custodian to transact in assets that settle exclusively on a delivery versus payment (DVP) basis. This could be seen as being overly burdensome and complex, as it would require investment advisers to navigate a range of additional requirements and exceptions. The proposal would define the term "qualified custodian" to mean a bank or savings association, registered broker-dealer, registered futures commission merchant (“FCM”), or certain type of foreign financial institution (“FFI”) that meets the specified conditions and requirements. This could be seen as being overly restrictive, as it would limit the range of potential custodians that investment advisers could use, and could therefore increase costs and reduce flexibility. The proposal would require that the written agreement between the investment adviser and the accountant require the accountant to submit Form ADV-E to the SEC within four business days of its resignation, dismissal, or other termination of the engagement, or upon removing itself or being removed from consideration for being reappointed, in each case accompanied by a statement explaining any problems relating to the examination, scope, or procedure that contributed to the event. This could be seen as being overly burdensome, as it would impose additional requirements on both the investment adviser and the accountant, and could potentially lead to a reduction in the number of accountants who are willing to undertake such work. The proposal would require investment advisers to obtain reasonable assurances in writing and maintain an ongoing reasonable belief that the qualified custodian (i) will exercise due care and implement appropriate measures to safeguard client assets; (ii) will indemnify the client (and will have insurance arrangements in place that will adequately protect the client) against the risk of loss in the event of the custodian’s own negligence, recklessness, or willful misconduct; (iii) will not be excused from any obligations to the client in connection with any sub-custodial arrangement; (iv) will clearly identify the client’s assets as such and segregate them from the custodian’s own assets and liabilities; and (v) will not subject client assets to any right, charge, security interest, lien, or claim in favor of the custodian. This could be seen as being overly burdensome, as it would impose additional requirements on investment advisers, and could potentially lead to a reduction in the number of investment advisers who are willing to undertake such work. 4) The proposal would require advisers to disclose information about their clients to independent public accountants, which may raise privacy concerns. 5) The proposal would result in onerous reporting requirements, such as requiring advisers to obtain certain reports from qualified custodians, which may be difficult to obtain or may result in additional costs. This could be seen as overly burdensome and costly. 6) The proposal does not take into consideration the fact that it may be difficult to actually demonstrate exclusive possession or control of crypto assets due to their specific characteristics. 7) The expanded scope of assets subject to the proposed rule could create costs for those advisers (and their clients) with custody of crypto assets that are not funds or securities. This could be seen as a hindrance for these businesses. 8) The requirement for advisers to maintain a fidelity bond policy would be costly and burdensome, and could ultimately be passed on to clients in the form of increased fees. It may also be difficult for advisers to maintain appropriate coverage efficiently and effectively as they buy and sell various investments on behalf of their clients or as those investments increase and decrease in value. 9) The proposed rule would impose significant costs on advisers with custody of crypto assets that are not funds or securities, as they would need to find alternative arrangements for storing these assets. This could create a burden on these advisers, and this could give an advantage to larger firms that have the resources to comply with the rule. 10) The proposed rule would require advisers to obtain certain reports from qualified custodians, which may be difficult to obtain or may result in additional costs. The costs would depend on factors such as the types of assets the adviser has custody of and the heterogeneity in these asset types. For example, an adviser that has custody of client assets that are relatively homogenous may only have to monitor a single market for custodial services, whereas an adviser with custody of many different types of assets would likely incur higher costs in monitoring and determining whether custodial services are available in multiple markets. 11) The proposed rule would also require advisers to segregate client assets from the adviser's assets and its related person's assets in circumstances where the adviser has custody. This would result in additional costs for advisers. 12) The proposed rule would impose additional requirements on advisers that custody digital assets, which may harm the development of the digital asset market. 13) The proposed rule would create a disadvantage for U.S. advisers competing with foreign advisers that are not subject to similar requirements and, thus, drive business overseas. 14) The proposal could be considered to impose additional requirements on both investment advisers and accountants without clear evidence that these requirements are necessary to protect client assets in the case where an adviser uses a qualified custodian that is not a bank. If the qualified custodian is not a bank, the adviser must enter into a written agreement with the qualified custodian that the adviser reasonably believes is capable of, and intends to, comply with the agreement and the obligations the qualified custodian is responsible for under the surprise examination requirement. The proposal would require the adviser to also enter into a written agreement with the accountant that the adviser reasonably believes is capable of, and intends to, comply with the agreement and the obligations the accountant is responsible for under the surprise examination requirement. This additional requirement for a written agreement with the accountant could be seen as imposing additional requirements on both the adviser and the accountant without clear evidence that such requirements are necessary to protect client assets. 15) The proposed rule would result in high and unnecessary aggregate ongoing annual costs. The SEC itself estimates that the proposed rule would lead to $21 million to $322 million direct costs for advisers, which are certainly low estimates and do not take into account much larger secondary costs for little or no benefit and all the aforementioned harms. In summary, it is important to consider the potential impacts of the proposed rule and whether it is necessary to protect client assets. I argue that it clearly does not.