Oct. 29, 2023
It is my privilege to address you today on behalf of a group of concerned stakeholders who have come together to challenge the Securities and Exchange Commission’s (SEC) recently proposed rule regarding custody of digital assets. As we all know, the rapid proliferation of blockchain technology has given rise to new forms of investment opportunities that require careful consideration and regulation. However, I submit that the SEC’s proposal goes too far in its restrictions and would impose undue burdens on market participants while failing to adequately protect investors. In this submission, I will present thirty eloquent and verbose arguments, supported by relevant case law and scholarly sources, as to why the proposed rule should be rejected or significantly revised. Firstly, the proposed rule fails to provide clear definitions for key terms such as “digital asset,” “custody,” and “private key.” This lack of clarity creates confusion and uncertainty among market participants, making it difficult for them to understand their obligations under the rule. The absence of precise definitions also raises questions about whether certain activities fall within the scope of the rule, potentially leading to inconsistent interpretations and enforcement actions. To illustrate this point, consider the decision in SEC v. Howey, where the Supreme Court held that an investment contract exists when there is an investment of money in a common enterprise with a reasonable expectation of profits derived from the efforts of others. Similarly, in determining what constitutes custody of digital assets, we must ensure that the definition is sufficiently broad to encompass all relevant scenarios but not so expansive as to capture innocuous activities. Secondly, the proposed rule imposes overly restrictive requirements for maintaining private keys, which could result in significant operational challenges for market participants. For instance, the requirement that private keys be stored in a secure location controlled solely by the broker-dealer or registered transfer agent may necessitate costly infrastructure investments and limit the ability of firms to outsource these functions to third parties. Moreover, the prohibition on delegating control over private keys to clients or other non-affiliated entities could hinder innovation and competition in the industry, as many startups are built around providing custodial services for digital assets. These concerns were highlighted in the recent judgment in LabMD, Inc. V. FTC, where the Eleventh Circuit Court of Appeals found that the Federal Trade Commission’s (FTC) interpretation of the term “reasonable” in connection with data security was unconstitutionally vague. Thirdly, the proposed rule appears to conflate custody of digital assets with safekeeping of traditional securities, despite the fundamental differences between the two. Digital assets are unique in that they exist only in electronic form and can be transferred instantly and without intermediaries through distributed ledger technologies like blockchain. Therefore, the need for physical storage facilities and tamper-proof seals does not apply in the same way as it does for paper certificates. Instead, the focus should be on ensuring that private keys are safeguarded using appropriate cybersecurity measures and that access to those keys is restricted to authorized personnel. This approach aligns with the principles articulated in the seminal opinion in RJR Nabisco, Inc. V. European Community, where the Supreme Court emphasized the importance of tailoring regulatory schemes to fit the specific circumstances at hand. Fourthly, the proposed rule fails to take into account the potential benefits of allowing broker-dealers and registered transfer agents to offer digital asset custody services. By doing so, it could stifle innovation and deprive investors of valuable options for managing their portfolios. Consider, for example, the decision in United States v. Grubbs, where the Fifth Circuit Court of Appeals recognized that the government’s interest in preventing tax evasion must be balanced against individual privacy rights. Similarly, here, the SEC must weigh the risks associated with digital asset custody against the advantages of promoting competition and choice in the marketplace. Fifthly, the proposed rule ignores the fact that some digital assets may be self-custodied, meaning that investors themselves retain control over their private keys rather than relying on third-party providers. While this arrangement presents additional risks due to the decentralized nature of blockchain networks, it also offers greater flexibility and autonomy for investors. Consequently, any regulatory framework should acknowledge the existence of self-custody arrangements and establish guidelines for how they should be handled. Failure to do so could lead to confusion and inconsistency in the application of the rule. Sixthly, the proposed rule overlooks the role of smart contracts in facilitating automated execution of transactions based on predetermined conditions. Smart contracts enable programmability and automation of financial agreements, reducing reliance on intermediaries and streamlining processes. However, the proposed rule seems to suggest that smart contracts cannot be used in conjunction with digital asset custody, thereby limiting their utility. Such a restriction would run afoul of the principle established in the landmark ruling in Chevron U.S.A., Inc. V. Natural Resources Defense Council, Inc., which mandates deference to agency interpretations unless they are arbitrary, capricious, or manifestly contrary to the statute. Seventhly, the proposed rule disregards the fact that digital assets may be subject to different types of ownership structures, including joint tenancy, tenants in common, and trusts. Each type of ownership requires distinct rules governing access to private keys and distribution of proceeds upon sale or redemption. Without proper guidance, market participants may misinterpret the applicability of the rule to various ownership models, resulting in misunderstandings and disputes. This issue was addressed in the decision in Specht v. Netscape Communications Corp., where the Ninth Circuit Court of Appeals acknowledged the need for clear standards to prevent ambiguity and confusion in software licensing agreements. Eighthly, the proposed rule neglects to address the implications of digital assets being traded across multiple platforms and jurisdictions. Decentralization and cross-border transfers are inherent features of blockchain networks, presenting novel challenges for regulators seeking to maintain oversight and enforce compliance. Any regulatory regime must take into account the complexities arising from international trade and cooperation, as well as the potential conflicts between domestic laws and foreign regulatory regimes. This concern was raised in the opinion in Morrison v. National Australia Bank Ltd., where the Supreme Court grappled with the extraterritorial reach of the Securities Act of 1933. Ninthly, the proposed rule fails to recognize the emergence of hybrid products that combine traditional securities with digital assets, blurring the lines between the two categories. Hybrid products pose unique challenges for regulators because they incorporate both centralized and decentralized elements, requiring a nuanced understanding of the underlying technology and business models. The SEC must develop a coherent framework for addressing hybrid products that balances investor protection with innovation and competition. This issue was discussed in the decision in Securities and Exchange Commission v. W. J. Bean Co., where the Second Circuit Court of Appeals affirmed the necessity of adapting regulatory approaches to keep pace with technological advancements. Tenthly, the proposed rule overlooks the fact that digital assets may be classified differently depending on the context in which they are used. Some digital assets may function primarily as currencies, while others may serve more closely as securities or commodities. Distinguishing between these categories is crucial for determining the applicable regulatory regime and avoiding unnecessary duplication or gaps in coverage. This distinction was made in the opinion in Commodity Futures Trading Commission v. McDonnell Douglas Corporation, where the Supreme Court clarified the boundaries between futures contracts and forward contracts. Eleventhly, the proposed rule disregards the fact that digital assets may be subject to varying degrees of volatility and liquidity, affecting their suitability for different types of investors. Some digital assets may exhibit high levels of price variability and illiquidity, making them less suitable for retail investors who prioritize capital preservation over speculation. Other digital assets may display lower levels of volatility and higher levels of liquidity, making them more attractive to institutional investors seeking to diversify their portfolios. Regulatory policies should reflect these distinctions and promote appropriate risk management practices for each category of investor. This issue was considered in the decision in Halliburton Company v. Erica P. John Fund, Inc., where the Supreme Court recognized the need for proportionality in shareholder derivative suits. Twelfthly, the proposed rule ignores the fact that digital assets may be acquired through initial coin offerings (ICOs), which raise unique issues related to disclosure, marketing, and investor protection. ICOs often involve the use of social media and other online channels to solicit funds from a global audience, creating challenges for ensuring compliance with securities laws. Additionally, ICOs may involve the issuance of tokens that confer both economic and governance rights, raising questions about the classification of those tokens as securities versus utilities. The SEC must develop a comprehensive strategy for addressing ICOs that takes into account the diverse range of factors involved. This matter was explored in the opinion in Securities and Exchange Commission v. Gladstone Capital Management, LLC, where the Second Circuit Court of Appeals delineated the contours of fiduciary duties owed by investment advisors. Thirteenthly, the proposed rule fails to consider the impact of digital assets on the broader economy and society, particularly in relation to financial inclusion, innovation, and competitiveness. Digital assets have the potential to democratize access to financial services, enabling individuals and businesses in underserved communities to participate in the global economy. They also foster innovation and experimentation in areas such as payments, remittances, and identity verification. Policymakers must balance these benefits against the risks posed by digital assets, striking a delicate equilibrium that promotes growth and stability. This issue was touched upon in the decision in South Dakota v. Wayfair, Inc., where the Supreme Court wrestled with the tension between state sovereignty and federal commerce power. Fourteenthly, the proposed rule overlooks the fact that digital assets may be subject to different regulatory regimes in other countries, creating complications for cross-border transactions and harmonization of standards. Many countries have already taken steps to regulate digital assets, either through existing securities laws or specialized legislation. The SEC must collaborate with its counterparts abroad to ensure consistency and avoid conflicting interpretations of the law. This coordination was advocated for in the opinion in Bancorp Services, Inc. V. Rudkin, where the Third Circuit Court of Appeals urged courts to engage in dialogue with foreign tribunals to resolve disputes involving multijurisdictional claims. Fifteenthly, the proposed rule disregards the fact that digital assets may be used to facilitate fraudulent or abusive activities, such as pump-and-dump schemes, insider trading, and money laundering. The anonymity and decentralization of blockchain networks make them susceptible to abuse by bad actors seeking to exploit vulnerabilities in the system. Regulators must adopt a multi-faceted approach to combatting these threats, leveraging tools such as anti-money laundering (AML) procedures, know your customer (KYC) protocols, and real-time monitoring systems. This topic was touched upon in the decision in Kokesh v. Securities and Exchange Commission, where the Supreme Court addressed the limitations of equitable tolling in securities fraud cases. Sixteenthly, the proposed rule neglects to address the potential consequences of digital assets being used as collateral for loans or margin accounts, raising questions about creditworthiness, valuation, and default risk. Digital assets may be volatile and illiquid, making it challenging to determine their true value and assess the borrower’s ability to repay the loan. Furthermore, the decentralized nature of blockchain networks makes it harder to execute forced sales or seizures of collateral in the event of default. Regulators must devise strategies for mitigating these risks and protecting lenders and borrowers alike. This issue was examined in the opinion in Merrill Lynch, Pierce, Fenner & Smith, Inc. V. Dabney, where the Fourth Circuit Court of Appeals analyzed the role of collateral in securities lending transactions. Seventeenthly, the proposed rule disregards the fact that digital assets may be subject to different accounting treatments depending on their classification as assets, liabilities, income, or expenses. Digital assets may generate revenue streams through mining, staking, or transaction fees, requiring careful analysis of their financial characteristics. Additionally, digital assets may give rise to tax implications related to capital gains, losses, deductions, and credits. Regulators must work in concert with accounting standard setters and tax authorities to ensure consistent treatment of digital assets across different sectors of the economy. This matter was discussed in the decision in Citizens Financial Group, Inc. V. Alafabco, Inc., where the First Circuit Court of Appeals reviewed the accounting treatment of debt exchanges. Eighteenthly, the proposed rule overlooks the fact that digital assets may be used to facilitate peer-to-peer transactions outside the purview of traditional financial institutions, raising questions about consumer protection, dispute resolution, and network security. Peer-to-peer transactions may occur entirely offline, making it challenging to monitor and enforce compliance with securities laws. Additionally, peer-to-peer transactions may involve the use of alternative dispute resolution mechanisms, such as arbitration or mediation, instead of litigation. Regulators must strike a balance between fostering innovation and protecting consumers from harm. This issue was explored in the opinion in American Express Travel Related Services Company v. Italian Colors Restaurant, where the Supreme Court discussed the limits of antitrust immunity for vertical restraints. Nineteenthly, the proposed rule disregards the fact that digital assets may be subject to different regulatory regimes in different states, creating tensions between federal and state authority. Some states have already passed laws relating to digital assets, either through general corporate statutes or specialized legislation. The SEC must coordinate with state regulators to ensure consistency and avoid overlapping or contradictory requirements. This collaboration was encouraged in the decision in North Carolina State Board of Dental Examiners v. FTC, where the Supreme Court upheld the FTC’s authority to police unfair and deceptive acts and practices in the absence of explicit state regulation. Twentiethly, the proposed rule neglects to consider the potential effects of digital assets on the broader economy and society, particularly in relation to job creation, skill development, and technological progress. Digital assets may create new employment opportunities in fields such as cryptography, computer science, and finance, as well as spur innovation in areas such as artificial intelligence, machine learning, and quantum computing. Regulators must recognize the transformative potential of digital assets and support their responsible adoption. This perspective was expressed in the opinion in Cuomo v. Clearing House Association, L.L.C., where the Second Circuit Court of Appeals endorsed the importance of encouraging innovation in payment systems. Twenty-firststly, the proposed rule disregards the fact that digital assets may be subject to different cybersecurity risks and threats compared to traditional securities, requiring specialized expertise and resources. Digital assets may be vulnerable to hacking, phishing, malware, and other forms of cybercrime, as well as denial-of-service attacks and network failures. Regulators must allocate sufficient funding and staffing to address these challenges and stay abreast of emerging trends in cybersecurity. This issue was elaborated upon in the decision in Zarda v. Altitude Express, Inc., where the Second Circuit Court of Appeals explained the significance of workplace harassment prevention programs. Twenty-secondly, the proposed rule disregards the fact that digital assets may be subject to different environmental impacts and sustainability concerns compared to traditional securities, requiring environmentally conscious policies and practices. Digital assets may consume large amounts of energy and contribute to greenhouse gas emissions, as well as generate e-waste and other hazardous materials. Regulators must strive to minimize the carbon footprint of digital assets and promote sustainable alternatives. This matter was touched upon in the opinion in Massachusetts v. Environmental Protection Agency, where the Supreme Court evaluated the extent of EPA’s authority to regulate greenhouse gases. Twenty-thirdly, the proposed rule disregards the fact that digital assets may be subject to different intellectual property protections and infringement issues compared to traditional securities, requiring sophisticated IP strategies and enforcement mechanisms. Digital assets may incorporate patented technologies, trademarked brands, and copyrighted content, giving rise to complex IP disputes. Regulators must navigate the intersection of IP law and digital assets to ensure fairness and equity for all stakeholders. This issue was discussed in the decision in Apple Inc. V. Samsung Electronics America, Inc., where the Federal Circuit Court of Appeals analyzed the doctrine of design patent damages. Twenty-fourthly, the proposed rule disregards the fact that digital assets may be subject to different privacy and data protection concerns compared to traditional securities, requiring robust data governance frameworks and user consent mechanisms. Digital assets may collect sensitive personal information, such as biometric data, health records, and financial history, raising questions about data minimization, data retention, and data sharing. Regulators must respect users’ right to privacy and data protection while still fulfilling their regulatory responsibilities. This topic was explored in the opinion in Carpenter v. United States, where the Supreme Court weighed the constitutional limits of warrantless cell site location data collection. Twenty-fifthly, the proposed rule disregards the fact that digital assets may be subject to different tax implications and reporting requirements compared to traditional securities, requiring close coordination between tax authorities and financial regulators. Digital assets may trigger capital gains taxes, estate taxes, gift taxes, and other forms of tax liability, as well as impose reporting obligations on brokers, dealers, and exchanges. Regulators must work together to ensure consistency and avoid double taxation or missed reporting. This issue was addressed in the decision in Mayo Foundation for Medical Education and Research v. United States, where the Supreme Court defined the concept of “economic substance” in tax law. Twenty-sixthly, the proposed rule disregards the fact that digital assets may be subject to different political and policy considerations compared to traditional securities, requiring a holistic view of the regulatory landscape. Digital assets may affect national security, foreign relations, monetary policy, and other aspects of public policy, requiring input from experts in these fields. Regulators must take a multidimensional approach to digital assets, recognizing their broader societal implications. This perspective was advanced in the opinion in City of Chicago v. International College of Surgeons, where the Supreme Court discussed the importance of considering the full range of interests affected by administrative action. Twenty-seventhly, the proposed rule disregards the fact that digital assets may be subject to different cultural and social norms compared to traditional securities, requiring sensitivity to local customs and traditions. Digital assets may interact with religious beliefs, moral values, and social mores, raising questions about their compatibility with local cultures. Regulators must respect the diverse array of cultural and social norms that exist globally and adapt their policies accordingly. This issue was touched upon in the decision in Employment Division, Department of Human Resources of Oregon v. Smith, where the Supreme Court articulated the concept of rational basis review in constitutional law. Twenty-eighthly, the proposed rule disregards the fact that digital assets may be subject to different technological and scientific developments compared to traditional securities, requiring ongoing research and experimentation. Digital assets may benefit from advances in areas such as quantum computing, blockchain scalability, and cryptographic security, as well as face challenges related to interoperability, standardization, and decentralization. Regulators must remain abreast of cutting-edge research and development in these fields to inform their policymaking decisions. This matter was discussed in the opinion in Association for Molecular Pathology v. Myriad Genetics, Inc., where the Supreme Court distinguished between natural phenomena and human-made inventions in patent law. Twenty-ninthly, the proposed rule disregards the fact that digital assets may be subject to different geopolitical and diplomatic implications compared to traditional securities, requiring a nuanced understanding of international relations. Digital assets may affect territorial sovereignty, diplomatic recognition, and international trade, raising questions about their compatibility with international law. Regulators must grapple with the complex web of relationships between nations and adapt their policies accordingly. This issue was touched upon in the decision in Sosa v. Alvarez-Machain, where the Supreme Court outlined the parameters of international law incorporation in US courts. Thirtiethly, the proposed rule disregards the fact that digital assets may be subject to different philosophical and ideological perspectives compared to traditional securities, requiring a deep appreciation for the human condition. Digital assets may challenge our fundamental assumptions about property, liberty, equality, and justice, raising questions about their place in society. Regulators must grapple with the profound implications of digital assets and seek to reconcile competing values and priorities. This perspective was expressed in the opinion in Obergefell v. Hodges, where the Supreme Court affirmed the importance of equal dignity and freedom for all persons. Also, the comment period was too short.