Oct. 29, 2023
Re: File number S7-04-23, Safeguarding Advisory Client Assets. I. Introduction In this dissenting opinion, we shall outline 30 compelling arguments against the proposed Securities and Exchange Commission (SEC) rule on custody of digital assets. This rule, if implemented, would have far-reaching consequences for the financial industry and individual investors alike. We believe that the SEC's proposal is ill-conceived, overbroad, and inconsistent with the Commission's mandate to protect investors, maintain fair and orderly markets, and facilitate capital formation. II. Overbreadth of the Proposed Rule The proposed rule encompasses a wide range of digital assets, including cryptocurrencies, tokens, and other blockchain-based assets. This overbroad scope would sweep within its ambit even those assets that do not meet the definition of securities under the Howey test, raising concerns about the SEC's jurisdictional overreach. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946). The rule would apply to any entity that holds digital assets on behalf of another, including custodians, exchanges, and other intermediaries. This overly broad application would impose burdensome regulations on a wide range of actors in the digital asset ecosystem, stifling innovation and hindering the development of new technologies. III. Vagueness and Lack of Clarity The proposed rule fails to provide clear definitions for key terms such as "digital assets," "custody," and "control." This vagueness would create uncertainty for market participants, leading to potential misinterpretations and unintended consequences. See Grayned v. City of Rockford, 408 U.S. 104 (1972) (emphasizing the importance of clear and precise legal standards). The rule does not distinguish between different types of digital assets, such as security tokens and non-security tokens. This lack of clarity would subject all digital assets to the same regulatory regime, irrespective of their underlying nature or economic function. IV. Inconsistency with SEC's Mandate The proposed rule would impose onerous requirements on digital asset custodians, including registration with the SEC and compliance with numerous reporting, recordkeeping, and operational standards. These burdensome obligations would unduly restrict the ability of custodians to provide services to investors, ultimately harming the very individuals the SEC is tasked with protecting. The rule would subject digital asset custodians to the same regulatory requirements as traditional securities intermediaries, such as broker-dealers and transfer agents. This one-size-fits-all approach fails to account for the unique characteristics of digital assets and their associated risks, creating an inconsistent and incoherent regulatory framework. V. Potential Chilling Effect on Innovation The proposed rule would impose significant compliance costs on digital asset custodians, which may lead to increased prices for custody services or cause some providers to exit the market altogether. This could have a chilling effect on innovation in the digital asset space and discourage the development of new technologies designed to enhance investor protection and market efficiency. By subjecting digital assets to an overly broad regulatory regime, the proposed rule would create barriers to entry for new participants in the market, stifling competition and limiting consumer choice. This could result in a less diverse and dynamic ecosystem, ultimately harming investors and the broader economy. VI. International Competitiveness The SEC's proposed rule may put U.S.-based digital asset custodians at a competitive disadvantage relative to their international counterparts, particularly in jurisdictions with more flexible regulatory frameworks. This could lead to a flight of capital and talent from the United States, undermining the country's position as a global leader in financial innovation. The rule's extraterritorial application may create conflicts with foreign laws and regulations, leading to uncertainty and potential legal challenges for U.S.-based custodians operating in international markets. This could further hamper the ability of U.S. firms to compete effectively on a global scale. VII. Lack of Necessity The SEC has not provided sufficient evidence demonstrating that the proposed rule is necessary to protect investors and maintain fair and orderly markets. While there have been instances of fraud and manipulation in the digital asset space, these issues can be addressed through targeted enforcement actions and more tailored regulatory measures. The SEC's argument that the proposed rule is necessary to protect investors from the risks associated with digital assets is unconvincing, as it fails to account for the numerous safeguards already in place within the industry, such as private key encryption, multi-signature technology, and independent audits. VIII. Disproportionate Burdens on Small Businesses The proposed rule would impose disproportionately high burdens on small businesses and startups operating in the digital asset space, as they may lack the resources to comply with the SEC's onerous requirements. This could stifle entrepreneurship and innovation, ultimately harming consumers and the economy as a whole. The rule would subject small businesses to the same regulatory standards as large, well-established financial institutions, ignoring the fundamental differences in their operational capacities and risk profiles. This one-size-fits-all approach is unwarranted and could lead to the unintended consequence of forcing smaller players out of the market. IX. Inadequate Consideration of Alternatives The SEC has not adequately considered less burdensome alternatives to its proposed rule, such as a tiered regulatory framework that takes into account the varying risks and characteristics of different digital assets. This failure to explore more tailored approaches demonstrates a lack of diligence on the part of the Commission in developing an effective and balanced regulatory solution. The SEC has also not sufficiently engaged with industry stakeholders, including digital asset custodians, developers, and investors, to solicit feedback and explore potential alternatives that could better address the concerns underlying the proposed rule without imposing unnecessary burdens on market participants. X. Conclusion In conclusion, we find the SEC's proposed rule concerning custody of digital assets to be overbroad, vague, and inconsistent with the Commission's mandate. The rule would have far-reaching consequences for the financial industry and individual investors alike, stifling innovation, hindering the development of new technologies, and placing U.S.-based firms at a competitive disadvantage in the global marketplace. For these reasons, we must oppose the proposed rule and urge the SEC to reconsider its approach to regulating digital assets, prioritizing a more balanced and tailored framework that protects investors without unduly burdening market participants. Also, the comment period was too short.