In an open letter (Mar 12) to Karen Barr, President and CEO of the Investment Adviser Association, the US Securities and Exchange Commission (SEC) has formally asked for comments and views from all stakeholders regarding its review of existing custody rules, as well as how such rules that could apply to digital assets.

Currently, the Custody Rule (Rule 206(4)-2) of the Investment Advisers Act of 1940 protects investors who utilize custodian services for their assets. The rule essentially only allows custodians to act on moving funds or securities for their clients on a delivery versus payment (DVP) basis.

DVP is a form of the cash-on-delivery or payment-upon-receipt concept, which protects investors from scenarios where custodians may misappropriate their clients’ assets under the pretext of trading their funds or securities on their behalf. With DVP trading, it is therefore usually not possible, for example, for a custodian to take a client’s funds to pay for security in advance before the security is delivered to the client’s account.

SEC is now in the midst of reviewing and seeking feedback on its existing Custody Rule with specific regard to instances of non-DVP trading – such as which instruments trade on a non-DVP basis and how, but also what associated misappropriation risks these may carry.

In a related vein, SEC is thus considering how the Custody Rule might apply to digital assets, and what sort of instruments these might be classified as if they are not seen as securities. It is interested in knowing how investment advisers themselves have been viewing digital assets to be, and the challenges they face in complying with the Custody Rule when handling these.

Katherine Wu, business development director for crypto research firm Messari in New York, observed, “What’s interesting to me is that the SEC does not seem to be jumping the gun in subjecting all non-DVP trades as under the custody rule, but rather is posing this as an opportunity for them to assess the underlying custody risks.”  

Around the same time as SEC’s letter, its chairman Jay Clayton reiterated the regulator’s concerns about maintaining investor protection should it approve products like crypto exchange-traded funds (ETFs).

Speaking with FOX Business on March 14, Clayton was quoted saying, “What I’m concerned about at the moment is if it can be reasonably demonstrated that the underlying trading is generally not manipulated, it’s happening on reliable venues with good rules and that custody is something we can feel comfortable about.”