Oct. 30, 2023
To Whom It May Concern: I write with the following concerns regarding the proposed regulation: 1. THE PROPOSED RULE LIMITS ACCESS TO INFORMATION NECESSARY TO SUPPORTING SMALL CRYPTO INVESTMENTS. The SEC’s proposed amendments to Rule 206(4)-2 and adoption of Rule 233-1 aim to enhance investor protections relating to the custody of crypto assets. However, the proposed rules’ stringent requirements and limited guidance around qualifying crypto custodians significantly restrict the ability of registered investment advisers (RIAs) to support investments in small and nascent crypto assets. This inhibits access to critical market information needed for effective investor protection and capital formation. The proposed rules would require RIAs to hold all “client assets,” including crypto assets, with “qualified custodians.” However, many small crypto assets lack custody support from qualified custodians. Without guidance on how RIAs can comply when investing in these unsupported assets, the proposed rules effectively bar investments in small cryptos. This reduces price discovery and stifles innovation around new blockchain technologies and crypto asset projects. As the SEC has recognized, such loss of information hinders its mission because it will drive trading offshore and reduce the amount of information available. The SEC should provide guidance on permissible custody models for unsupported crypto assets or exempt small investments from the qualified custodian requirement. This would enable continued access to market data on new crypto projects necessary for effective oversight. Strict custody requirements should apply only above a reasonable threshold based on crypto asset characteristics. 2. THE PROPOSED RULE’S APPLICABILITY IS DIFFICULT TO UNDERSTAND. The SEC's proposed amendments significantly expand the scope of assets subject to custody requirements without providing sufficient clarity on how the new requirements apply in practice. As drafted, the proposed rule does not clearly delineate which specific assets fall under the expanded definition of "custody." There is ambiguity around whether certain digital assets like cryptocurrencies and non-fungible tokens are intended to be covered. The lack of bright-line guidance creates compliance uncertainty. Advisers could take on unnecessary costs and burdens to over-comply or conversely under-comply and fail to meet expectations. Either outcome undermines the rule's effectiveness. Before finalizing the amendments, the SEC should provide more concrete examples of covered assets and excluded assets to resolve interpretation doubts. The proposing release broadly states that "custody" includes holding "any asset." But without itemizing specific assets in scope, it is challenging for advisers to accurately assess if the enhanced requirements apply. Assets differ greatly in their attributes, risks, and need for third-party safekeeping. Clarification is needed on the rule's reach. The SEC should also address seeming inconsistencies on whether certain assets mandatorily require a qualified custodian. The proposing release suggests expanded coverage of assets like cryptocurrencies. However, past SEC statements indicate some crypto assets fall outside SEC jurisdiction and definitions of "securities." There are open questions around reconciling the new custody provisions with previous crypto guidance. Before imposing sweeping new custody burdens, the SEC must provide precise direction on which assets are implicated. The current broadly written amendments create compliance confusion. Advisers should not have to guess whether their assets fall under the rule. The SEC can ease uncertainty through detailed applicability examples covering assets like cryptocurrencies, stablecoins, and non-fungible tokens. Clearer contours on the scope will allow advisers to implement appropriate controls and procedures. 3. THE RULE FAILS TO ADEQUATELY CONSIDER ITS POTENTIAL NEGATIVE SOCIAL IMPACTS. The proposal fails to adequately consider the potential negative social impacts. Specifically, the proposed changes to limit the privately offered securities exception could restrict access to capital for startups and small businesses. Many early-stage companies rely on private capital raises to fund growth and innovation. By requiring that ownership of such securities be recorded and maintained by a qualified custodian, and adding extensive verification requirements, the amendments would impose significant additional costs on issuers of private securities. This could discourage private investment and starve promising young companies of critical early funding. In addition, the proposed requirement that qualified custodians demonstrate "possession or control" and participate in transactions could greatly increase custody costs, especially for digital assets. These heightened costs may price out certain investors and prevent wider adoption of novel asset classes like cryptocurrencies. Broader participation by a diverse range of investors facilitates capital formation and financial inclusion. Furthermore, mandating prescriptive contractual provisions between advisers and custodians could restrict market innovation. The dynamism and rapid evolution of the financial sector depends on the freedom to develop new services, asset types, and custodial models. Overly rigid requirements risk stifling product development and diversity of choice for investors. While the SEC aims to enhance investor protections, the proposed amendments sweep too broadly and ignore potential damage to capital formation, innovation, and financial inclusion. I urge the SEC to take into account these unintended consequences and reconsider the privately offered securities exception, qualified custodian requirements, and mandatory contract terms in the final rule. With balanced reforms that safeguard investors while supporting broader access and innovation, the Custody Rule can be modernized responsibly. 4. THE PROPOSED RULE LIMITS ACCESS TO RELEVANT POLICY FRAMEWORKS. The Securities and Exchange Commission's proposed amendments regarding the custody of digital assets by registered investment advisers fail to provide meaningful guidance on whether state-chartered trusts can serve as qualified custodians. This ambiguity severely limits investment advisers' access to policy frameworks relevant to developing compliant crypto custody solutions. The proposed rules do not categorically prohibit state-chartered trusts from serving as qualified custodians but imply significant barriers without detailing what those barriers are. The SEC stresses the importance of custodians demonstrating "exclusive possession or control" over crypto assets but does not explain what models could satisfy this standard. Rather than delineate requirements for obtaining qualified custodian status, the proposal vaguely cautions that "we must be mindful of the extent to which many of these new entrants to the custodial marketplace offer, and are regulated to provide, the types of protections we believe a qualified custodian should provide." This ambiguity regarding state-chartered trusts contradicts the SEC's stated intent to provide meaningful guidance to registered investment advisers on compliant crypto custody practices. As the Supreme Court has noted, a central purpose of administrative rulemaking is to provide regulated parties advance notice of the agency's intentions, not to keep them in the dark. By intimating significant hurdles without specifying what they are, the proposal frustrates investment advisers' ability to adapt their practices to comply with the SEC's expectations. The SEC should clarify what models could enable state-chartered trusts to provide sufficient custodial protections. For example, under the Uniform Commercial Code, segregation and traceability protections may sufficiently secure client assets (See U.C.C. § 8-503(b)). Clarifying acceptable frameworks would allow investment advisers to make informed decisions when selecting qualified crypto custodians. This transparency is vital given the proposal's suggestion that existing crypto custody arrangements likely violate the Advisers Act. 5. INADEQUATE COST-BENEFIT ANALYSIS. The SEC's proposed amendments to the custody rule, Rule 206(4)-2, fail to adequately consider the costs and benefits of applying the expanded definition of "assets" to include all crypto assets. While the goal of enhanced investor protection is laudable, the SEC underestimates the burden imposed by requiring advisers to hold all crypto assets with qualified custodians. The SEC claims that the benefits to investors justify any increased costs, but its analysis is speculative and conclusory. The proposing release suggests that the risk of loss from inadequate custody of crypto assets is high, but provides no empirical data on losses associated with current market practices. The SEC does not quantify the reduced risk of loss or other benefits that would result from the proposal. Conversely, the SEC neglects to fully consider the costs to advisers and markets. The custody requirements may preclude advisers from holding certain crypto assets, reducing investment opportunities. New infrastructure would be needed to custody the wide variety and volume of crypto assets. These direct costs are ignored. Further, the SEC fails to analyze how driving crypto asset trading to a limited number of venues would impact liquidity, trading costs, and fairness and efficiency of markets. There is no consideration of the proposal's effects on competition. The SEC violated its obligation under the Administrative Procedure Act to assess the need for regulation and weigh the consequences. See, e.g., Chamber of Commerce v. SEC, 412 F.3d 133 (D.C. Cir. 2005). By glossing over the costs, the SEC put a thumb on the scale in violation of settled principles of reasoned decisionmaking. The SEC must conduct a rigorous and objective analysis before imposing requirements that will substantially affect markets. The current proposal falls short of that standard. 6. THERE IS INSUFFICIENT PUBLIC AWARENESS OF THE PROPOSED RULEMAKING TO EXISTING AND POTENTIAL AFFECTING MARKET PARTICIPANTS. The proposed amendments to Rule 206(4)-2 lack sufficient public awareness to existing and potential affected market participants. The comment period has not allowed adequate time for key stakeholders that would be impacted by the proposed rule to fully analyze its complex implications and provide thoughtful feedback. This compressed timeline is inconsistent with the Administrative Procedure Act, which calls for agencies to provide "interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments" (5 U.S.C. § 553(c)). While the crypto asset market has grown substantially in recent years, it remains an emerging industry with many new entrants and innovators. The SEC's proposal would significantly alter custody requirements and qualified custodian eligibility for crypto assets. However, two months is an insufficient window for many affected participants to properly assess the rule's consequences, including state-chartered trust companies, decentralized finance platforms, crypto asset exchanges, investors, and other stakeholders. This lack of public awareness undermines the SEC's ability to gather comprehensive data to inform a balanced, effective final rule. The Administrative Conference of the United States recommends comment periods last at least 60 days, but calls for longer timeframes for complex rulemakings or those raising significant issues (Recommendation 2011-2, Rulemaking Comments). Courts have invalidated rules for inadequate comment periods under the APA, including where novel requirements warranted more time for public input. The SEC should extend the comment deadline and take additional steps to raise awareness of the proposal among affected participants. Adequate public input will strengthen the final rule and facilitate compliance. 7. LIMITED ACCESS TO RELEVANT INFORMATION REGARDING THE SEC’S PROPOSED CRYPTO SAFEGUARDING RULE. The SEC's proposed amendments related to the safeguarding of digital assets held by SEC-registered investment advisers lack sufficient clarity and fail to provide the public with enough relevant details to fully evaluate the proposal. There are several key aspects where more information is needed: First, the proposal does not provide enough technical details on how the "possession or control" requirement would work for digital asset qualified custodians. The SEC acknowledges that demonstrating exclusive control of cryptoassets presents challenges, but does not provide sufficient guidance on compliant approaches. More details are needed on acceptable cryptoasset custody models, especially those involving multisig and multiparty computation. Without this, commenters cannot properly assess the feasibility and costs of complying. Second, the SEC does not provide economic analysis of the costs and benefits from its proposed changes related to digital assets. The proposal would significantly expand the types of assets subject to the custody rule and impose new requirements on qualified custodians. However, there is no data on the number of advisers impacted, the costs of transitioning to compliant custody solutions, or the expected benefits to investors. An economic analysis is essential for the public to evaluate the merits of the proposal. Third, the proposal lacks clarity around executing and settling digital asset transactions. The SEC indicates that moving assets to exchanges may violate the custody rule, but does not provide guidance on compliant workflows. This hinders the ability to analyze the proposal's effects on trading digital assets for clients. More details are needed on permissible transaction settlement methods. In summary, while the goal of better safeguarding digital assets is sound, the public lacks access to several categories of relevant technical, economic, and operational details needed to fully comment on the SEC's proposal. The SEC should endeavor to provide more information in these areas so stakeholders can provide informed feedback on crafting a digital asset custody framework that enhances investor protections while allowing responsible innovation in this developing area. 8. THE RULE EMPLOYS INEFFECTIVE EVALUATION METHODS REGARDING CUSTODY. The SEC's proposed amendments to the custody rule fail to adequately consider the unique attributes of digital assets and decentralized financial services. By narrowly focusing evaluation methods on traditional notions of custody, the proposal overlooks innovative technologies that provide secure custody solutions tailored to digital assets. The proposed requirements for "exclusive possession and control" do not account for decentralized consensus mechanisms like multisig wallets that provide equal or greater protections than traditional custodial models. For example, a 2-of-3 multisig wallet arrangement prevents unilateral control over assets while still allowing flexibility for asset management. Other decentralized protocols also enable novel custodial solutions not contemplated by the SEC. These alternative custody arrangements adhere to the spirit and purpose of safeguarding client assets. However, the SEC's proposed methods fail to properly evaluate their effectiveness. The custody rule should expand its evaluative approaches to encompass the latest cryptographic and decentralized innovations for securing digital assets. Otherwise, the rule risks stifling further technological growth in this area. 9. THE RULE MAY RESULT IN INCREASED RISK OF LOSS FOR DIGITAL ASSET INVESTORS. The SEC’s proposed amendments to the custody rule, while well-intentioned, may have the unintended consequence of increasing risks for market participants investing in digital assets. By imposing stringent requirements on qualified custodians, the proposed rule risks excluding digital asset-native companies currently providing custody services. This could force investors to rely on custodians less familiar with the unique attributes of digital assets, thereby increasing vulnerabilities. Digital assets have novel technological features that distinguish them from traditional asset classes. Unlike securities which exist on a centralized ledger maintained by an intermediary, digital assets like cryptocurrencies exist on public blockchains. To access and transact digital assets, users require a private cryptographic key. While this architecture provides transparency and eliminates reliance on a single entity, it also creates risks if keys are mishandled. Existing digital asset custodians have developed specialized expertise and technology like multiparty computation to securely safeguard private keys while still allowing assets to be traded. However, by requiring “exclusive control” of private keys and limiting acceptable custodial models, the proposed amendments risk disqualifying these experienced providers. Investors would be forced to rely on custodians less familiar with digital asset technology. Without requisite technical knowledge and security protocols, these custodians may expose assets to loss through hacking, theft, or simple operational errors. There could also be significant opportunity costs from forgoing innovative digital asset strategies reliant on smart contracts, staking, decentralized finance protocols, and other features incompatible with the proposed rule’s stringent possession and control mandates. Rather than impose a uniform custody framework across all asset classes, regulators should account for the unique attributes of digital assets and emerging custodial models. With thoughtful calibration, enhanced investor protections can be achieved while still allowing qualified digital asset custodians to service this market. Outright exclusion risks pushing activity offshore or underground, depriving investors of safeguards altogether. The goal should be encouraging custodial best practices tailored to this nascent technology’s intricacies. 10. THE PROPOSED RULE WILL RESULT IN DIFFICULTY ENSURING FAIRNESS IN ENFORCEMENT COORDINATION EFFORTS. The proposed amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 significantly expand the assets that registered investment advisers (RIAs) must maintain at qualified custodians to include crypto assets. While the proposed rule aims to enhance investor protections, the interpretation of "exclusive possession or control" over crypto assets and the qualifications to serve as a custodian raise concerns regarding the ability to ensure fairness in enforcement coordination efforts across multiple regulators. The proposed rule requires advisors to obtain "exclusive possession or control" over crypto assets to comply with custody requirements. However, the characteristics of crypto assets, including the ability for private keys to be transferred, may make it difficult to demonstrate exclusive control in practice. Unlike traditional securities, the immutability of blockchain transactions means that loss or theft of private keys can lead to irreversible and potentially catastrophic consequences for investors. While the Commission aims to hold advisors accountable for safeguarding assets, advisors may argue that true "exclusive control" over crypto assets is functionally impossible. Judgments regarding exclusive control must account for the novel technological aspects of crypto assets. Moreover, the proposed rule casts doubt on whether state-chartered trusts can serve as qualified custodians for crypto assets, despite meeting the definition of "bank" under the Advisers Act (15 U.S.C. §80b–2(a)(2)). The Commission stresses that custodians must provide specified safeguards, but outright prohibiting regulated state entities from qualifying could contradict principles of cooperative federalism. State regulators have an interest in developing frameworks appropriate for local institutions. Denying state trusts the ability to become qualified custodians based on rigid interpretations of "control" risks creating an unlevel playing field. Excluding state regulated entities also concentrates crypto custody into a few federally regulated banks, reducing competition. While the Commission aims to protect investors from loss, interpretation and implementation details significantly impact whether the requirements can be fairly enforced. Accounting for the novel aspects of crypto assets and enabling compliant state institutions to qualify as custodians will help ensure advisors can reasonably comply with custody rules and coordinate with diverse regulators. Clear, flexible guidance grounded in the regulatory expertise of federal and state authorities will facilitate consistent, equitable enforcement. 11. THE COMMISSION SHOULD NOT IMPOSE GREATER CUSTODY REQUIREMENTS ON CRYPTO ASSETS TO PREVENT REGULATORY ARBITRAGE. The SEC's proposed amendments requiring advisers to hold all client "assets," including crypto assets, with a qualified custodian goes too far and risks regulatory arbitrage by pushing activity offshore or onto less regulated venues. The SEC should narrowly tailor any amendments to address legitimate risks without imposing undue burdens that inadvertently undermine investor protections. The SEC's authority to regulate custody under the Advisers Act derives from Section 206(4). The Supreme Court has made clear that Section 206(4) gives the SEC flexibility to regulate adviser conduct but does not empower the Commission to do whatever it deems necessary or appropriate to promote investment adviser accountability generally. Goldstein v. SEC, 451 F.3d 873, 883 (D.C. Cir. 2006). Rather, SEC rules under Section 206(4) must be reasonably related to preventing fraud. Id. at 877. Requiring advisers to hold all crypto assets with a qualified custodian, including assets the SEC has stated are not securities, exceeds the SEC's authority because (i) it does not directly target adviser fraud, and (ii) is not reasonably calibrated to preventing fraud. At most, the SEC could mandate custody of crypto assets that qualify as securities without pushing activity offshore or onto less regulated venues, undermining the SEC's investor protection mandate. Subjecting non-security crypto assets to custody requirements may have the unintended effect of regulatory arbitrage by moving activity to offshore exchanges or decentralized exchanges. This raises risks to investors who would lose SEC protections. The SEC should tailor any rule to balance meeting legitimate custody concerns applicable to crypto that are securities without spurring regulatory arbitrage. 12. THERE WILL BE SIGNIFICANT DIFFICULTY COMPLYING WITH THE PROPOSED CRYPTO CUSTODY RULE. The proposed crypto custody rule would impose significant, and likely insurmountable, operational challenges for registered investment advisers seeking to custody crypto assets, contrary to congressional intent in the Dodd-Frank Act. The Securities and Exchange Commission's proposed amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 significantly expand the scope of the custody rule by requiring registered investment advisers (RIAs) to hold all "client assets" with a qualified custodian, including crypto assets even where they are not funds or securities. However, operationalizing custody of crypto assets under the proposed rule would impose undue burdens on RIAs that Congress did not intend. When enacting the Dodd-Frank Act, Congress authorized the SEC to require RIAs to custody "client funds and securities" to afford meaningful investor protections without imposing unnecessary burdens on advisers. 15 U.S.C. 80b-4. By expanding the custody rule to reach all client "assets," including crypto assets that are not funds or securities, the proposed rule exceeds the SEC's authority under Dodd-Frank. Nothing in the legislative history suggests Congress intended to authorize the SEC to regulate the custody of other property like crypto assets. Moreover, crypto assets have unique properties that make demonstrating "exclusive possession or control" substantially more difficult, if not impossible in some cases, as compared to traditional securities. The proposing release even questions whether exclusive possession or control of crypto assets can be demonstrated at all. Imposing rigid custody requirements designed for securities on such novel assets stretches the custody rule beyond what is workable for industry participants and was envisioned by Congress. The proposed rule also risks driving advisers toward less regulated and more risky options for crypto custody and trading, which is directly counter to the SEC’s mission of protecting investors. Rather than imposing a one-size-fits-all regime, the SEC should consider more tailored alternatives that enable advisers to utilize responsible emerging crypto custodial models while ensuring client assets are adequately safeguarded. 13. THE SEC’S OUTDATED REGULATIONS LIMIT CRYPTO INNOVATION. The SEC's proposed amendments to the custody rule reflect an outdated regulatory approach that will stifle crypto asset innovation and limit investor choice. The SEC focuses on speculation-driven risks without considering the investor protection benefits of crypto asset custody models involving qualified state-chartered trusts. The proposed amendments conflict with existing federal law recognizing state-chartered trust companies as qualified custodians. The SEC should re-propose the amendments to align with the existing statutory definition of "qualified custodian" and establish a flexible framework that accommodates responsible crypto asset custody innovation. The SEC's proposed interpretation of "qualified custodian" ignores federal law specifying that state-chartered trust companies satisfying enumerated criteria are qualified custodians. The SEC proposes to functionally exclude state-chartered trusts providing crypto custody, conflicting with the Investment Advisers Act's broad definition of "bank" as a qualified custodian. The Act includes trusts substantially exercising fiduciary powers under state laws. 15 U.S.C. §80b-2(a)(2). Congress codified this inclusive definition of qualified custodian to provide advisers flexibility in selecting responsible custodians based on client needs. The proposed amendments improperly exceed the SEC's authority by functionally excluding state-chartered crypto custodians that squarely satisfy the statutory requirements. By ignoring the Act's plain language, the proposal reflects outdated assumptions that innovation by novel market entrants inherently risks harming investors. The SEC should re-propose more flexible amendments permitting state-chartered trusts satisfying the Act's definition of qualified custodian to custody crypto assets. This approach would enable continued responsible innovation in crypto custody models involving rigorous security protocols and controls. State regulators are instituting rigorous oversight frameworks specifically tailored to crypto custodians within their jurisdictions. With appropriate controls, state trust companies can execute novel custody arrangements like multiparty signing protocols that responsibly leverage cryptocurrencies' distinctive technical attributes to strengthen investor protections. The SEC should establish custodian requirements flexible enough to accommodate such beneficial innovations. Outdated regulations assuming custody risks can only be addressed through centralized control conflict with crypto assets' core technical characteristics. By adopting a more flexible framework, the SEC can balance innovation with rigorous security standards to both enable crypto progress and protect investors. 14. THE PROPOSED RULE LACKS CONSISTENCY IN THE APPLICATION OF THE PENALTY. The proposed SEC safeguarding rule aims to enhance protections for advisory clients' assets, including digital assets. While this goal is laudable, certain provisions in the rule may lead to inconsistent and disproportionate penalties that undermine fairness. Specifically, the proposed rule's prescriptive requirements around written agreements and contractual provisions between advisers and qualified custodians could result in inconsistent penalties. Minor contractual discrepancies could trigger enforcement even when the custodial relationship adequately safeguards assets. This strict liability approach risks penalizing mere technical violations that do not harm clients. Moreover, the proposed rule's expansion of "custody" to include discretionary trading authority may disproportionately impact digital asset advisers. These advisers routinely direct trades to platforms that are not qualified custodians per SEC guidance. Under the proposed rule, such activity may automatically trigger custody status and penalties for advisers, even if assets were subsequently returned to qualified custodian accounts. This could lead to unduly harsh sanctions disconnected from any actual client harm. The SEC should reconsider aspects of the proposed rule that may lead to inconsistently applied punishments not aligned with policy objectives. To ensure fairness, penalties should correlate to actual risks and losses to clients, not mere technical violations. And discretionary trading that returns assets to qualified custodians should not automatically trigger full-scale custody violations. With targeted adjustments, the rule can achieve the SEC's laudable investor-protection goals while also ensuring consistency and proportionality in enforcement. 15. THE PROPOSED SEC RULE IMPOSES DETRIMENTAL REGULATORY BURDENS ON GLOBAL ECONOMIES BY STIFLING INNOVATION, INCREASING OPERATIONAL COSTS, AND CREATING BARRIERS TO ENTRY FOR DIGITAL ASSET AND PRIVATE FUND MARKETS. The proposed rules present significant regulatory burdens that could adversely affect the global economies. These burdens manifest in several ways, including stifling innovation, increasing operational costs, and creating barriers to entry which are discussed below: Stifling Innovation: The expanding definition of "assets" to cover all "positions held in a client’s account" and the inclusion of digital assets within this definition, irrespective of whether such assets are classified as "funds" or "securities," demonstrates a lack of understanding and flexibility towards novel or innovative asset types. This rigid categorization can hinder the growth and innovation in the rapidly evolving digital assets sector. Increasing Operational Costs: The extensive requirements proposed, such as the annual audit requirement for each private fund, preparation and distribution of detailed fund-level information in quarterly statements, and the requirement for qualified custodians to demonstrate "possession or control" of client assets among others, are likely to result in significant operational and compliance costs. These increased costs may deter new entrants and could potentially lead to a consolidation of the market, favoring large established players with the resources to comply, thus reducing competition and choice for consumers. Creating Barriers to Entry: The proposed rule may create barriers to entry for both US and Non-US Fund Managers, including many entities previously exempt from SEC regulation, thereby limiting the market's accessibility to new and smaller players. This is particularly concerning as it could lead to a monopolistic or oligopolistic market structure, further exacerbated by the increased operational costs imposed by the new rules. Global Repercussions: The broad-reaching effects of these rules extend beyond the United States, impacting Non-US Fund Managers and the global digital asset market. The global nature of digital assets and private funds means that overly stringent regulations in a significant market like the US can have ripple effects across the globe, potentially stifling innovation and market growth internationally.