Industry trade groups including the Investment Adviser Association (IAA) and Securities Industry and Financial Markets Association (SIFMA) are asking the Securities and Exchange Commission to make substantial changes to its proposal to expand the custody rule—which the agency says is necessary to safeguard investor assets.
The rule, which was introduced by the SEC in February, requires all advisors to significantly ramp up due diligence of the custodians they select. It also requires, for the first time, that even advisors with discretionary authority use “qualified custodians.”
Advisors must also agree to warn clients in each statement to crosscheck their accounts statements with those sent by custodians. Moreover, each advisory firm must agree to submit to annual surprise exams by public accountants who will contact some or all of each firm’s clients, according to the SEC.
“Make no mistake, based on how crypto trading and lending platforms generally operate, investment advisers cannot rely on them today as qualified custodians,” SEC Chairman Gary Gensler said at the SEC’s March Investor Advisory Committee meeting.
“Just because a crypto trading platform claims to be a qualified custodian doesn’t mean that it is. When these platforms fail—something that we’ve seen time and again—investors’ assets often have become property of the failed company, leaving investors in line at the bankruptcy court,” Gensler added.
But IAA General Counsel Gail Bernstein said in a comment letter that the proposal goes well beyond protecting client assets from misappropriation. Particularly troubling, she said, is “the dramatic expansion of the concept of custody to include discretionary authority and the virtually boundless scope of assets transacted in myriad different markets that the proposed rule seeks to cover."
Bernstein said the agency “has not demonstrated any meaningful analysis that an investment advisor’s discretionary trading authority presents risks that are in any way proportionate to the vast new burdens that the proposed rule would impose on investment advisers,” Bernstein said.
She also cited the agency’s “unrealistic requirements to enter into written agreements with custodians with specific terms that custodians likely wouldn’t agree to, and the attempt to use the Investment Advisers Act to indirectly regulate custodians, which are already subject to their own regulatory regimes, and many of which the SEC has no authority to regulate directly.”
Bernstein called the proposal “backdoor regulation” that would compel advisors “to police commercial terms between custodians and their customers on matters unrelated to the investment advice provided by the adviser, including custodians not regulated by the SEC.”
SIFMA and SIFMA Asset Management Group (SIFMA AMG) asked the SEC to withdraw the proposal entirely until the agency “has fully considered and can explicitly address the critical legal, regulatory, policy and practical concerns raised in this letter,” SIFMA Deputy General Counsel Kevin Carroll said in a comment letter Monday.
“The written agreement requirement is unworkable. As a result, advisers and custodians would likely reduce services and pass along higher costs to clients,” Carroll said.
As problematic, advisors “would likely decline discretionary authority for certain assets. In turn, clients would be forced to self-direct in these assets and thus would be deprived of their adviser’s advice, guidance, and management services,” he added.
SIFMA also used the letter to lobby for the SEC to amend the proposal to allow qualified custodians to provide digital asset safekeeping services to their clients—something the SEC does not currently allow.