Oct. 30, 2023
I respectfully submit the following comments regarding the proposed rule. Thank you for your consideration. 1. ENFORCEMENT PROGRAM FLEXIBILITY NEEDED FOR EVOLVING TECHNOLOGIES The SEC should provide clear guidelines for adapting its enforcement program to evolving technologies. Rigid rules risk stifling innovation and limiting access to new technologies that benefit investors. The SEC should retain flexibility in its rulemaking approach that protects investors without prematurely judging new technologies. The SEC's enforcement powers are broad and discretionary under the securities laws. The SEC has authority to conduct investigations and bring enforcement actions for violations of the securities laws. See 15 U.S.C. § 78u. This enforcement authority is essential but also raises concerns when applied to new technologies like crypto assets. Rigid rules could have a chilling effect on development of innovative technologies still in their infancy. The SEC should instead retain flexibility to balance its mandate to protect investors with room for new technologies to develop. Imposing rigid enforcement rules now on nascent crypto technologies would be premature. Crypto innovations like decentralized finance hold great promise but are still developing. Flexible oversight allows appropriate development within the SEC's investor protection mandate. The SEC should thus avoid rigid enforcement requirements and maintain discretion to apply established liability standards to fast-changing technologies. The SEC is to be commended for seeking comment on its evolving enforcement program for new technologies. But preserving flexibility in enforcement will best serve investor protection goals while still encouraging further responsible crypto innovation. A rigid, prescriptive enforcement framework risks prematurely chilling development of technologies still in their adolescence. As to crypto assets, the SEC should stick to high-level principles and avoid codifying particular requirements not clearly mandated by existing law. The securities laws already contain ample standards of liability that the SEC can apply case-by-case. Rulemaking should focus on providing flexible guidance to an evolving market, not adopting dubious new enforcement mandates. With an eye to the future, the SEC should stay the enforcement course and keep nurturing responsible crypto innovation. 2. INADEQUATE ANALYSIS OF RISKS TO INVESTORS The SEC's proposed amendments to the custody rule (Rule 206(4)-2) do not adequately analyze the risks posed to investors by the SEC's prescriptive approach to regulating custody of crypto assets. The proposed amendments go too far by effectively requiring that all crypto assets be held by SEC-registered broker-dealers, futures commission merchants, or banks, without properly weighing the benefits to investors. This exceeds the SEC's statutory authority under the Investment Advisers Act and is arbitrary and capricious under the Administrative Procedure Act. Section 206(4) of the Advisers Act authorizes the SEC to adopt rules that are "necessary or appropriate" to prevent fraudulent or manipulative practices by advisers. However, the SEC has not demonstrated that the existing custody rule is inadequate to protect against adviser misappropriation of crypto assets or that the prescriptive approach in proposed Rule 206(4)-2 is necessary to protect investors. The SEC has provided no evidence quantifying incidents of misappropriation of crypto assets by SEC-registered advisers or establishing that such incidents pose systemic risks to investors. Absent such evidence, the SEC has not justified abandoning principles-based regulation or imposing overly prescriptive requirements on how advisers must hold crypto assets. The SEC's failure to adequately analyze the costs and benefits of the proposed rule also renders it arbitrary and capricious under the APA. The SEC does not quantify the costs to investors and advisers of limiting qualified custodians largely to SEC-registered entities. These costs could be significant given the limited crypto services currently offered by banks and broker-dealers. The SEC also fails to analyze reasonable alternatives to a prescriptive approach, such as enhancing existing requirements for audits of self-custodied assets. By not properly weighing the proposal's costs and benefits, the SEC has likely exceeded its statutory authority and acted arbitrarily. 3. THE PROPOSED RULE AMENDMENTS CREATE UNFAIR TREATMENT AND REGULATORY CONFUSION ACROSS INTERNATIONAL BOUNDARIES FOR CRYPTO CUSTODIANS AND INVESTORS The proposed amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 seek to expand the definition of "qualified custodian" and impose significant new requirements on entities that hold crypto assets on behalf of investment advisory clients. While enhanced investor protections are a laudable goal, several aspects of the proposal will lead to unfair treatment and regulatory confusion for crypto custodians operating across international borders. First, the proposed "exclusive possession or control" standard creates an uneven playing field between federally regulated banks that custody crypto assets and state-chartered trust companies seeking to enter this market. Although the proposal does not technically preclude state-chartered trusts from qualifying, statements by SEC leadership strongly imply these "new entrants" will face a nearly insurmountable hurdle to demonstrate the requisite level of control over crypto assets. This restrictive approach unfairly disadvantages state-chartered trusts vis-à-vis national banks for no justifiable policy reason. Both types of entities can develop secure custody protocols that fully segregate client assets and implement robust controls to prevent fraud and theft. The Commission should revise the "exclusive possession or control" test to focus on substantive custodial protections rather than bright-line exclusivity. See Investment Company Institute v. Conover, 790 F.2d 925, 929 (D.C. Cir. 1986) (agency must provide reasoned explanation for treating similar entities differently). Second, the proposal's stringent requirements could lead to conflicts with regulations in other jurisdictions, especially relating to crypto asset storage and transfer. For example, laws in Country A may require custodians to adopt certain private key backup procedures prohibited under the SEC's "exclusive control" test. Without clarification, custodians operating across borders would find it difficult or impossible to comply with both regulatory regimes. The Commission should coordinate with foreign regulators to harmonize custody requirements for crypto assets to the greatest extent possible. Finally, the proposal's suggestion that advisers are already violating custody rules by using non-qualified crypto custodians relies on a presumption that all crypto assets are securities. This presumption ignores the complexity of determining whether a particular digital asset qualifies as a security under the Howey test. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Rather than take a one-size-fits-all approach, the Commission should clarify that the custody requirements apply only to crypto assets definitively classified as securities to avoid ensnaring advisers who reasonably determined certain assets, like Bitcoin, fall outside the definition. The Commission's goals of protecting investors and ensuring proper custody of crypto assets are commendable. But the proposal goes too far in several respects that could lead to inappropriate exclusions of certain custodians, create conflicts across borders, and punish advisers operating in good faith. The Commission should revise the proposal to provide greater clarity and flexibility for crypto custodians operating globally while still upholding rigorous security standards. 4. DIFFICULTY VERIFYING COMPLIANCE WITH PROPOSED CUSTODY RULE FOR CRYPTO ASSETS The SEC's proposed custody rule amendments raise significant questions about how investment advisers can comply with the rule's requirement that they maintain "exclusive possession or control" over crypto assets. The SEC acknowledges that "proving exclusive control of a crypto asset may be more challenging than for assets such as stocks and bonds." Yet the rule provides no clear guidance on how advisers can satisfy the exclusive possession or control standard given the unique characteristics of crypto assets. This lack of clarity will make it extremely difficult for advisers to verify compliance. The proposed rule should provide more specific guidance on acceptable methods for demonstrating exclusive possession or control over crypto assets. For example, the rule should clarify whether sharding arrangements where the adviser holds one key and a custodian holds two keys would satisfy the possession or control standard. The rule should also confirm whether staking arrangements where the adviser delegates staking rights but retains control over the assets themselves would comply. Without detailed guidance, advisers will struggle to implement compliant custody arrangements. 5. THE PROPOSED RULE VIOLATES RIGHTS TO ANONYMITY AND ASSOCIATION The proposed amendments to the investment adviser custody rule undermine the constitutional rights to anonymity and association. The Supreme Court has long recognized that the First Amendment protects the right to speak anonymously. See McIntyre v. Ohio Elections Comm'n, 514 U.S. 334, 342 (1995) ("An author's decision to remain anonymous, like other decisions concerning omissions or additions to the content of a publication, is an aspect of the freedom of speech protected by the First Amendment."). This right encompasses financial transactions. By requiring advisers to disclose details of crypto transactions, including identification of crypto assets held in custody, the proposed rule forces advisers to reveal client identities and associations that clients may wish to keep private. There is no compelling interest to justify this intrusion. The purported interest in preventing fraud and theft has little application when advisers use qualified crypto custodians that maintain exclusive possession and control over private keys. Moreover, less intrusive alternatives exist, like requiring disclosure of aggregate crypto assets without details of specific assets and transactions. Federal statutes also recognize privacy in financial transactions. Right to Financial Privacy Act prohibits banks from disclosing individual account records without consent. The proposed rule should similarly protect anonymity of crypto transactions. In summary, the proposed custody rule amendments violate the First Amendment by compelling disclosure of details related to crypto transactions and ownership without sufficient justification. The SEC should modify the proposal to allow aggregated disclosure of crypto assets in custody without revealing specific assets and transactions in order to protect clients' constitutional rights to anonymity and freedom of association. 6. DIFFICULTY IMPLEMENTING THE PROPOSED SEC CUSTODY RULE FOR CRYPTO ASSETS The SEC's proposed custody rule creates significant hurdles for crypto custody that are practically impossible to overcome. The SEC's proposed amendments to Rule 206(4)-2 raise serious concerns about the feasibility of implementing crypto custody in a manner that complies with the rule. Specifically, the requirement for "exclusive possession or control" creates an impractical standard that qualified custodians will struggle to satisfy. Both the plain language of the rule and the SEC's discussion in the proposing release suggest an incredibly high bar for demonstrating exclusive possession or control over crypto assets. The SEC emphasizes the "transferability" of crypto assets by virtue of private keys as somehow uniquely problematic, despite the analogous ability for traditional securities to be transferred on a book-entry basis by qualified custodians and broker-dealers. Imposing an "exclusive possession or control" standard that qualified custodians cannot reasonably meet would undermine the goal of investor protection. As the SEC itself acknowledges, requiring advisers to self-custody crypto assets raises significant risks of loss, theft or misappropriation. The SEC should reconsider whether its proposed standard for custody is realistic and reconsider more flexible approaches to crypto asset custody. There are alternative models of custody that could provide meaningful protections without requiring unattainable exclusivity. For instance, key sharding and multisig arrangements requiring custodian authorization or participation to effect transfers would offer significant safeguards against theft and loss. The SEC should consider whether its "exclusive possession or control" language in the final rule could be reasonably interpreted to encompass joint control models. The SEC's stringent view of custody may ultimately leave advisers unable to use any qualified custodian to hold crypto assets on behalf of clients. This result would contradict the SEC's clearly stated policy rationale for amending the custody rule in the first place. 7. REGULATORY AMBIGUITY UNDERMINES THE PROPOSED SEC SAFEGUARDING RULE The proposed SEC safeguarding rule amending the custody requirements for investment advisers creates ambiguity that will undermine effective regulation. By mandating prescriptive requirements while failing to provide clear guidance on critical issues, the rule establishes rigid mandates that will be difficult or impossible for firms to implement in certain cases. This ambiguity related to digital asset custody in particular creates regulatory uncertainty that will challenge firms seeking to comply in good faith. The following examples illustrate key areas where the SEC should provide flexibility and additional clarity rather than impose ambiguity through rigid requirements. First, the proposed rule does not sufficiently address how advisers can fulfill trade execution and settlement obligations when digital asset trading platforms that facilitate transactions are not qualified custodians. Absent further guidance, advisers may face conflicting pressures of maintaining "possession and control" through qualified custodians while also meeting best execution obligations. The SEC should clarify that temporary custody by non-qualified custodian trading platforms for execution purposes remains permissible. Second, while the rule expands the definition of qualified custodians to encompass certain foreign financial institutions, the proposed conditions create ambiguity. Terms such as "requisite financial strength" and "exercise of due care" are undefined, leaving firms guessing at whether their custodians meet the standard. The SEC should provide clear, objective criteria rather than subjective judgments on topics like financial strength. Finally, requirements related to insurance pose ambiguity as coverage options remain limited in the digital asset space. The SEC should clarify the scope of "reasonably available" coverage rather than impose undefined mandates. In sum, ambiguity in the proposed rule will foster confusion and make compliance difficult, undermining the SEC's objectives. The Commission should provide flexibility and clarity to support the rule's effectiveness. Rigid mandates and ambiguity threaten to stifle progress in the digital asset custody space absent thoughtful revision. 8. REGULATORY VACUUM The SEC's proposed amendments to the custody rule, Rule 206(4)-2, relating to digital assets create a dangerous regulatory vacuum. By expanding the definition of "custody" to include digital assets without providing sufficient clarity on how entities may comply as qualified custodians of such assets, the amendments would significantly restrict access to digital asset markets and deprive investors of opportunities in this innovative sector. At the same time, the amendments fail to provide alternative mechanisms for investor protection. This overbroad regulation risks pushing activity into actually less regulated spaces, contrary to legislative intent. The SEC should refrain from adopting amendments expanding the custody rule to digital assets until it can provide clear guidance on compliant custody models. Imposing a heightened regulatory standard without providing a feasible path to compliance conflicts with the SEC’s mandate to facilitate capital formation and stifles responsible innovation. Instead, the SEC should pursue a measured approach that tailors regulation to the unique attributes of digital assets. The proposed amendments acknowledge “it is possible for a custodian to implement processes that seek to create exclusive possession or control of crypto assets,” yet simultaneously express doubt that “exclusive possession or control” can be demonstrated. This contradictory position leaves market participants without guidance on compliant custody arrangements, effectively prohibiting activity the SEC’s release admits is possible. Such regulatory uncertainty is at odds with Congress’s directive that the SEC “regulate...the promotion of efficiency, competition and capital formation” and foster responsible innovation. See 15 U.S.C. § 77b(b); 15 U.S.C. § 80a-2(c). By acknowledging but not clarifying feasible compliance models, the amendments hinder efficiency, competition and capital formation. Rather than impose a disproportionate compliance burden without commensurate guidance, the SEC should pursue a tailored approach attuned to the unique properties of digital assets. This measured regulatory approach would further Congress’s stated goals, while appropriately balancing investor protection. The SEC should not adopt amendments expanding the custody rule to digital assets absent sufficient guidance for compliance. 9. THE PROPOSED RULE INADEQUATELY CONSIDERS THE NEEDS OF DIVERSE POPULATIONS The SEC's proposed amendments to the investment adviser custody rule fail to adequately consider the needs of diverse populations. The proposed rule would impose strict standards on qualified custodians that many smaller, niche custodians may be unable to meet. This could severely limit investment options for minority groups and other diverse populations. The proposed rule seems to target "new entrants" to crypto custody, such as state-chartered trusts. While the rule does not technically exclude these custodians, the enhanced qualifications create prohibitive barriers. These new entrants often cater to niche demographics and diverse populations underserved by traditional banks. For example, some focus on providing crypto custody services for women, minorities, or other groups without restricting the range of assets held. Limiting these custodians could disproportionately impact diverse investors. Furthermore, the proposed requirements for "exclusive possession and control" of crypto assets could preclude specialized custodians from qualifying (See Article 1). However, reasonable alternative models exist that still prevent commingling of assets and theft, while providing investors more options. The SEC should explore these models rather than setting impractical standards that could harm diversity. Overall, the proposed rule does not adequately consider its potential disparate impact on diverse populations as required by Section 342 of the Dodd-Frank Act. Section 342 mandates that federal agencies assess how their regulations affect minority and underserved communities (12 USC 5452). While protecting investors is important, there are less restrictive ways to achieve this that do not hamper inclusion. Moreover, Section 342 intends for agencies to improve diversity in the financial sector, but the proposed rule could accomplish the opposite. By limiting specialized crypto custodians, it constrains options for diverse investors. And by creating barriers to entry and growth, it stifles diversity and inclusion efforts by smaller firms. This violates the spirit of Section 342 and fails to consider the needs of America's diverse population. The SEC should reconsider the proposed custody rule in light of its obligations under Section 342. Achieving fair investor protection need not come at the expense of diversity, especially given more moderate alternatives. With some refinement, the rule could strike a better balance between safety and inclusion. America's diversity is its strength, not an obstacle, and the SEC should craft regulations that embrace this principle. 10. UNFAIR TREATMENT OF STATE-CHARTERED CRYPTO CUSTODIANS The SEC's proposed custody rule amendments unfairly disadvantage state-chartered crypto custodians by imposing stricter standards on them compared to federally regulated banks and trust companies. The proposed amendments to Rule 206(4)-2 would expand the definition of "qualified custodian" to include certain state-chartered trust companies that provide crypto custody services. However, the SEC has made clear that it intends to hold these state-chartered custodians to a higher standard than federally regulated banks and trust companies that also custody crypto assets. This unequal treatment is unfair and discriminatory. The SEC's position violates the Federal Deposit Insurance Act, which prohibits federal banking regulators from discriminating against state banks. "It is not the purpose of this chapter to discriminate in any manner against State nonmember banks or State savings associations and in favor of national or member banks or Federal savings associations, respectively. It is the purpose of this chapter to provide all banks and savings associations with the same opportunity to obtain and enjoy the benefits of this chapter". 12 U.S. Code § 1830 – Nondiscrimination. Further, as the Supreme Court held in Lewis v. BT Investment Managers (1980), the federal regulators are generally restricted from unequal burdens on state banks and trust companies. By subjecting state-chartered crypto custodians to stricter standards than federally regulated custodians, the SEC is contravening the purpose of this statute. In addition, the SEC's stance contradicts its own prior guidance stating that state-chartered trust companies should be regulated in a consistent manner as national banks providing the same services. Singling out state-chartered custodians for heightened regulation compared to federally regulated competitors violates principles of competitive equality and fairness. The SEC should reconsider its position and hold all qualified crypto custodians, whether state or federally chartered, to uniform standards. Unequal treatment of state-chartered custodians is unfair, discriminatory, and contrary to the SEC's own guidance as well as federal banking law. The custody rule amendments should create a level playing field, not tilt it against state-chartered institutions. 11. LACK OF INTERAGENCY COORDINATION UNDERMINES THE PROPOSED SEC CUSTODY RULE The SEC's proposed amendments to the custody rule lack sufficient coordination with other financial regulators, undermining the rule's effectiveness. The custody and management of cryptoassets involves complex technical considerations outside the SEC's core expertise. By failing to adequately consult and coordinate with more expert agencies like the CFTC and OCC, the SEC risks enacting a rule that is technically unworkable or introduces unnecessary inconsistencies into the broader regulatory framework. The SEC should have engaged in more robust interagency discussions before proposing amendments that would directly impact cryptoasset custody frameworks established under OCC or CFTC oversight. This lack of coordination risks cementing flaws or ambiguities into the rule that could have been avoided. It also means the SEC may be working at cross-purposes with its peer regulators. Section 712(a)(2) of Dodd-Frank specifically calls for heightened consultation between the SEC and CFTC to "promote effective and consistent global regulation of swaps and security-based swaps." Rulemaking under the Advisers Act impacting cryptoassets may implicate swap regulation, so coordination was required. The SEC's failure to adequately discharge its consultation obligations undermines this rulemaking. 12. LACK OF ENFORCEMENT The SEC’s proposed amendments seek to address perceived deficiencies in the existing custody rule by imposing significant new requirements on RIAs and qualified custodians. However, the SEC has failed to meaningfully enforce the existing rule against RIAs that self-custody crypto assets. Expanding the scope of the custody rule is unnecessary where the SEC has not exhausted its enforcement authority under the current rule. The SEC should first bring enforcement actions under the existing custody rule before amending it to address perceived non-compliance. Section 206(4) of the Advisers Act prohibits fraudulent conduct by RIAs. Through its implementing regulations, the SEC has the authority to bring enforcement actions against RIAs that engage in conduct that operates as a fraud or deceit on clients. Section 206(4) has been interpreted to cover a wide range of conduct, including failure to disclose material information and breaches of fiduciary duty. The existing custody rule, Rule 206(4)-2, was adopted pursuant to this authority and failure to comply with the rule has consistently been found to violate Section 206(4). Prior to expending significant SEC resources to overhaul the custody rule, enforcement actions should be pursued against RIAs that are custodying crypto assets outside of the existing rule. Expanding the custody rule to expressly include crypto assets is unnecessary when failure to comply already violates Section 206(4). The SEC has simply failed to enforce the current rule. 13. LACK OF CLARIFICATION REGARDING CRYPTO ASSET CUSTODY LEAVES TOO MANY OPEN QUESTIONS The SEC's proposed amendments to the custody rule create significant ambiguities regarding the custody of crypto assets that must be addressed. The SEC should provide additional clarification on what constitutes "possession or control" and "exclusive control" of crypto assets to enable RIAs to comply with the rule in a reasonable manner. The proposing release leaves open questions about whether crypto assets can be held in compliance at all. The SEC states that "proving exclusive control of a crypto asset may be more challenging" but does not elaborate on what specific models or procedures could satisfy the custody rule (Proposing Release, at 64). While the SEC notes concerns around private keys, it does not directly address other possible ways to demonstrate control, like sharding arrangements. More guidance is needed here. There are also open questions around whether state-chartered trusts could serve as qualified custodians for crypto assets. While the rule does not explicitly prohibit this, statements by Chairman Gensler suggest skepticism of crypto platforms as qualified custodians. Again, further clarification would enable industry participants to conform their operations to the SEC's expectations. Finally, the proposing release suggests that RIAs who self-custody crypto assets are likely violating the existing rule. However, application of the custody rule to crypto assets depends on their status as securities. The SEC should clarify its views on which specific crypto assets it considers securities subject to the existing custody rule. Greater transparency around the SEC's interpretations would allow RIAs to implement appropriate policies, procedures, and technology to comply with the rule. The proposing release leaves too many critical issues ambiguous, making it difficult for industry participants to conform to the SEC's expectations. We urge the SEC to provide additional clarification on these topics.