Amendments to SEC Custody Rule Would Expand Scope to More Asset Classes

The comment period for a Securities and Exchange Commission proposal to expand the type of investments subject to custodial oversight by advisers to things like physical commodities, digital assets and artwork is set to expire on Monday, May 8, though multiple industry associations are asking for a 60-day extension.

The SEC first proposed an amendment to the “custody rule” regarding adviser-led investing on February 15, citing the many advancements in technology, advisory services and custodial practices since the rule was last amended in 2009. The SEC’s proposal also changes the title of the “custody rule,” originally included in the Investment Advisers Act of 1940, to the “safeguarding rule.”

The new rule, as proposed, would expand its application beyond just securities and funds to all assets in a custodian’s custody. Physical commodities, real estate, artwork, short positions and digital assets would all be subject to the new rule. The SEC has explained that this understanding of the term asset is supposed to be “evergreen” so that the protections of the rule do not “depend on which type of assets the client entrusts to the adviser.”

With the amendment, advisers would be required to obtain certain written assurances from their custodians of investment items. These assurances would include confirmation: that the client’s assets are segregated so that they are protected in the case of bankruptcy; that the custodian will provide records to the SEC at their request; of the adviser’s authority to effect transactions; and that the custodian will have insurance to indemnify the client against losses due to the custodian’s recklessness.

The rule would also clarify explicitly that if an adviser has the authority to trade a client’s assets on a discretionary basis, then that adviser is subject to the rule.

A joint comment letter signed by industry actors, including the ABA Securities Council, the American Bankers Association, the Investment Adviser Association, the Investment Company Institute and the Securities Industry and Financial Markets Association, requested an extension of the comment period for an additional 60 days from its initial February 15 filing. The organizations explained that in order to comment in a thorough manner, they must coordinate among various types of market constituents to understand the rule’s true effect.

The letter also argues that the overall pace of the SEC’s rulemaking justifies a longer comment period, which is a common complaint levied against the SEC under Chairman Gary Gensler.

The Office of the Attorney General for Massachusetts, under Andrea Joy Campbell, wrote in support of the proposal. She expressed concern about investors in digital assets, one of the primary motivations for the proposal, and approval for the rule’s ability to protect them. She explained that her office has seen a “sharp increase in consumer complaints related to cryptocurrency investments” in recent years. She elaborated that “consumers misperceived centralized exchanges such as FTX as stable custodians. This misconception cost Massachusetts consumers millions of dollars.”