McHenry, Hill, Subcommittee Chairs Demand SEC Rescind Its Disastrous Custody Proposal, Slam Proposed Rule's Impact on Digital Assets

Press Release

"We write to express our strong concerns with the Securities and Exchange Commission (SEC)'s proposed rule, "Safeguarding Advisory Client Assets' (Proposed Rule). The rule deviates significantly from traditional custody practices and would dramatically increase the cost of offering custodial services. Additionally, the SEC is using its authority to regulate registered investment advisors (RIAs) as a backdoor to regulate entities outside of its jurisdiction.

"Even more concerning is the Proposed Rule's lack of a comprehensive economic analysis. The SEC's explanation that it "is unable to quantify certain economic effects because it lacks the information necessary to provide estimates or ranges of costs" is unacceptable and indicates a reckless approach to rulemaking. We urge the SEC to withdraw the Proposed Rule and reconsider its approach to regulating entities outside of its jurisdiction.

"Like many of the agency's other rulemakings, the Proposed Rule far exceeds the SEC's statutory mandate. The Dodd-Frank Act expanded the SEC's authority to require RIAs to safeguard client assets. However, this expansion was only intended to apply to assets within the SEC's jurisdiction. The Proposed Rule, in contrast, extends to all assets, including art, cash, commodities, and nontraditional assets. By disregarding jurisdictional lines, the SEC is attempting to establish standards in areas that it has no authority to regulate. Finally, the Proposed Rule impedes the jurisdiction of other regulators by imposing custody rules on entities that already have their custody practices regulated by another regulator.

"The Proposed Rule would fundamentally reshape traditional custody practices for market participants. This even though the SEC acknowledges that custodians have a long history of "innovating and modernizing their practices' and "developing different procedures for safeguarding a variety of assets.' For example, the Proposed Rule would lower the negligence standard required for indemnification from gross negligence to simple negligence. This is a significant departure from traditional custody practice and would impose significant new costs on qualified custodians. The rule would also require a qualified custodian to have "insurance arrangements in place' to "adequately protect the client' in the event of custodial negligence. As negligence could be extended to cover the loss of a client's assets outside of the qualified custodian's control, this insurance would be exorbitantly expensive and difficult to find.

"The Proposed Rule would have an outsized impact on digital asset market participants, as entrepreneurs and companies within the ecosystem already struggle to find banks willing to custody their assets. Recent joint statements from the federal banking regulators have discouraged federally chartered banks from holding digital assets or even holding the deposits of digital asset firms. As a result, many digital asset companies have opted to custody their assets with state-chartered banks and trusts. Thus, the question in the proposal regarding whether qualified custodians should be limited to federally chartered entities is highly concerning, especially as it applies to digital assets. More broadly, restricting state-chartered banks and trusts from acting as qualified custodians would only serve to further entrench incumbents and prevent necessary competition in our banking sector.

"The SEC also fails to consider how the Proposed Rule would interact with Staff Accounting Bulletin (SAB) 121. Under the combined rules, banks that serve as qualified custodians would not only have to fully indemnify digital assets from loss, but they would also have to hold the digital assets on their balance sheets and capitalize against them. This is not only overly onerous but extremely costly, potentially preventing larger, established qualified custodians in the form of public company banks from providing custody services to digital assets.

"In conclusion, the Proposed Rule follows the SEC's pattern of promulgating rules that go beyond the SEC's authority and fail to provide a sufficient, statutorily-mandated economic analysis. Moreover, the Proposed Rule fails to consider the interconnectedness of the proposal with other SEC rulemaking, discouraging firms from serving as qualified custodians for RIAs and imposing major consequences for market participants. Additionally, the Proposed Rule would have particularly harmful impacts to the digital asset ecosystem. We urge the SEC to withdraw the Proposed Rule and remain committed to holding the SEC accountable for seeking to continue to expand its jurisdiction."

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