Oct. 30, 2023
To whom it may concern: Please see the comments listed below reflecting numerous concerns with the Commission’s proposed rule. 1. THE PROPOSED RULE FAILS TO ADEQUATELY CONSIDER THE UNIQUE NEEDS OF FAITH-BASED ORGANIZATIONS TO ACCESS AND SECURELY HOLD DIGITAL ASSETS FOR RELIGIOUS PURPOSES. The proposed SEC rule regarding the safeguarding of client assets raises concerns about its potential negative impact on faith-based organizations. While the goal of enhanced investor protections is laudable, the rule as drafted does not give adequate consideration to the unique needs and circumstances of faith-based organizations. Faith-based organizations may rely on digital assets and cryptocurrencies to further their religious missions, or may do so in the future. These assets allow global transactions and avoid third party intermediaries that could conflict with religious tenets. However, the proposed rule's stringent requirements around "possession and control" of digital assets and the designation of "qualified custodians" do not take into account how these provisions may restrict faith-based organizations from accessing and securely holding digital assets in a manner consistent with their beliefs. The limited exceptions also do not carve out allowances for good faith religious reasons. The proposed rule should be modified to provide a broader exemption for faith-based organizations to hold certain digital assets without being subject to the qualified custodian requirements. The rule should permit faith-based organizations to develop reasonable alternative means of custody that serve the principle of safeguarding assets while enabling religious liberty. While the SEC may still require faith-based organizations to implement robust controls and provide reporting, the outright prohibition on self-custody of digital assets conflicts with organizations' abilities to advance their religious missions through these technologies. With appropriate modifications to accommodate religious liberty, the SEC can achieve its investor protection goals without hindering the legitimate interests of faith-based organizations. 2. THE PROPOSED RULE CREATES SIGNIFICANT AND UNNECESSARY REGULATORY COMPLEXITY FOR INVESTMENT ADVISERS. The proposed amendments to the SEC's custody rule under the Investment Advisers Act would create significant and unnecessary regulatory complexity for investment advisers. While the goal of enhancing protections for client assets is laudable, the prescriptive and complex requirements in the proposal go too far. The proposed requirements for detailed written agreements between advisers and qualified custodians impose rigid contractual mandates that fail to account for the wide variety of custodial relationships and asset types. The proposed contractual requirements such as specific indemnities, insurance provisions, and limitations on liens create thorny legal and operational issues for advisers and custodians without providing materially greater protection for clients. These mandatory terms undermine the ability of advisers and custodians to negotiate tailored agreements based on their particular facts and circumstances. In addition, the proposed requirements create uncertainty for advisers utilizing novel asset types such as digital assets. The complex "possession and control" concept lacks clarity about how advisers can comply when transacting through platforms that are not qualified custodians. The SEC should provide more flexibility for advisers to demonstrate controls rather than mandating rigid terms. Taken together, the proposed amendments impose overly rigid requirements that ignore the diversity of advisory services, asset types, and custodial relationships. A more principles-based approach would focus on advisers demonstrating and documenting compliance rather than mandating strict contractual terms. The sheer complexity of the proposal creates unnecessary burdens and legal risks for advisers trying to serve clients. I urge the SEC to take a more flexible and principles-based approach focused on effective controls rather than rigid mandates. Regulatory complexity rarely enhances investor protection and often creates unintended consequences. 3. THERE ARE INSUFFICIENT JUSTIFICATIONS TO DISQUALITY STATE-CHARTERED TRUST COMPANIES AS QUALIFIED CUSTODIANS OF CRYPTO ASSETS. The SEC's proposed amendments to Rule 206(4)-2 lack sufficient justification to categorically disqualify state-chartered trust companies from serving as qualified custodians of crypto assets. The proposed rules go beyond the SEC's statutory authority and are arbitrary and capricious under the Administrative Procedure Act. First, the proposed rules conflict with the plain language of the Advisers Act. The Act's definition of "qualified custodian" includes any "bank" that meets certain requirements. The Act defines "bank" to include any "State-chartered trust company" that satisfies the listed characteristics, without excluding those that custody crypto assets. Nothing in the Act provides the SEC authority to exclude state-chartered trust companies from the qualified custodian definition. The proposed categorical exclusion thus exceeds the SEC's rulemaking authority. See Utility Air Regulatory Group v. EPA, 573 U.S. 302, 324 (2014) (agency cannot “rewrite clear statutory terms to suit its own sense of how the statute should operate”). Second, the SEC failed to justify its proposed exclusion of state-chartered crypto custodians as qualified custodians. The SEC speculated about risks of crypto custody but identified no record evidence substantiating heightened risks from state-chartered trust companies specifically. See Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983) (agency must examine relevant data and articulate satisfactory explanation for its action). Nor did the SEC explain why expanded regulations and assurances applicable to all qualified custodians under the proposal would not sufficiently address any heightened risks. This lack of reasoned decisionmaking renders the proposed exclusion arbitrary and capricious. Id. at 52 (agency action arbitrary and capricious where agency fails to consider important aspect of problem). In sum, the SEC lacks statutory authority to categorically exclude state-chartered trust companies from the qualified custodian definition, and failed to provide reasoned justification for such exclusion. The SEC should abandon this unjustified aspect of its proposal. 4. THE PROPOSED RULE SUFFERS FROM A LACK OF FLEXIBILITY FOR STATE CHARTERED TRUST COMPANIES. The SEC's proposed amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 impose rigid and inflexible requirements on state chartered trust companies that provide crypto custody services, which will severely limit their ability to innovate and develop solutions tailored to digital assets. This lack of flexibility threatens to stifle competition and consumer choice in the crypto custody market. Under the proposed rule, the SEC takes an overly restrictive view of "possession or control" that would preclude commonly used custodial arrangements like key sharding and multisig, despite no evidence these arrangements actually put client assets at risk. The SEC also sets an impossible standard for demonstrating "exclusive" control of crypto assets that even federally regulated, OCC-approved crypto custodians likely can't satisfy. By mandating such inflexible requirements, the proposed rule ignores state trust law statutes that provide flexibility in structuring custodial arrangements based on client need while still maintaining strong investor protections. It also disregards the ability of state regulators to regulate emerging crypto custodians appropriately. This lack of flexibility threatens to chill further innovation in the crypto custody market and risks driving activity offshore. The SEC should adopt a principles-based approach that gives state regulators flexibility to authorize custodial arrangements tailored to different crypto assets while still protecting investors. 5. THE RULE LACKS CLEAR GUIDELINES FOR ENFORCEMENT TRAINING PROGRAMS. The proposed SEC rule regarding the safeguarding of advisory client assets raises significant concerns due to the lack of clear guidelines for enforcement training programs. While the rule aims to enhance investor protections, the prescriptive requirements around contractual provisions, account statements, and internal controls place a substantial burden on advisers and custodians without providing sufficient clarity on enforcement. Specifically, the rule does not outline clear expectations or requirements regarding the training programs that SEC examiners and enforcement staff will undergo to ensure proper oversight and equitable enforcement. The success of any new regulation depends heavily on regulators having a nuanced understanding of practical implementation challenges and trade-offs. This is especially true for a complex issue like digital asset custody involving evolving technologies. However, the 217-page proposing release does not discuss examiner training or provide any indication of the SEC's plans to develop specialized expertise. There is a high likelihood of inconsistent or unfair enforcement in the absence of rigorous, ongoing training programs for SEC staff tailored to the rule. The SEC should issue detailed guidance on the structure, content, and frequency of enforcement training programs prior to finalizing this sweeping rule change. At a minimum, examiner training should encompass the following topics: Technology fundamentals of cryptocurrency custody models involving keys, wallets, multi-party computation, etc. Nuances in assessing "possession and control" for different digital asset custodians and advisers Real-world digital asset trading workflows and reconciling with qualified custodian requirements Costs and benefits of prescriptive contractual provisions across different types of advisers and qualified custodians Appropriate methods for evaluating due care and reasonableness standards based on facts and circumstances Implementing a major rule change without providing regulators the tools to enforce it properly risks creating significant confusion and inconsistency for the industry. The SEC should address the lack of detail around enforcement training programs before finalizing the safeguarding rule. Doing so will improve consistency in examinations and provide greater regulatory clarity for advisers navigating digital asset custody. 6. THE PROPOSED SEC RULE ON CRYPTO CUSTODY WOULD STIFLE INNOVATION IN THE FINANCIAL SECTOR. The SEC's proposed amendments to the custody rule, which would significantly expand the scope of the rule to cover digital assets such as crypto, do not adequately consider the potential unintended consequences of stifling innovation in the financial sector. While protecting investors is undoubtedly important, the SEC must be mindful that overly prescriptive regulation risks limiting progress and improvements in financial services. Crypto assets represent a technological leap forward for finance, providing greater transparency, efficiency, and security compared to traditional systems reliant on intermediaries. However, aspects of the proposed rule, such as the strict "exclusive control" requirement, seem incompatible with the unique nature of crypto and would impose barriers to crypto-native companies developing better custody solutions. This could prevent further innovation and freeze crypto custody at its current state. Rather than take a technology-neutral approach, the proposal specifically targets crypto's distinct features like transferability of assets as problems to be regulated, instead of considering how those features could enable better investor protections. The proposed indemnification and insurance requirements also seem tailored to discourage crypto-native companies from participating as qualified custodians. While traditional custodians like banks may readily provide such indemnification, these requirements present a huge obstacle for crypto companies. The result would be reduced choice for investors and less competition among custodians to improve security practices. The SEC should reconsider imposing a one-size-fits-all custody framework designed for traditional assets onto emerging crypto technology. Doing so risks closing the door on future innovation that could meaningfully improve safekeeping and empower investors. The SEC must find a balanced solution that accomplishes its investor protection goals without blocking further progress and beneficial developments in crypto custody systems. Stifling crypto's distinct abilities rather than encouraging the industry to develop better protective tools would be a tremendous loss for American leadership in financial technology. 7. THE PROPOSED RULE NEGLECTS UNDERFUNDING OF REGULATORY BODIES. The Proposed Rule assumes regulators are equipped to properly oversee crypto-assets when there is ample evidence to the contrary. The SEC is underequipped to monitor crypto innovations that often outpace its resources and expertise. The resulting information asymmetry compounds issues outlined in the Proposed Rule and undermines its efficacy. Without properly funding the infrastructure to regulate crypto, rules risk being ineffective or harmfully overbroad. Upton Sinclair’s famous quote, “It is difficult to get a man to understand something when his salary depends upon his not understanding it,” should give pause. Regulators’ salaries do not depend on misunderstanding crypto, but their capacity to understand depends on sufficient funding. Unfortunately, funding has not kept pace with crypto’s rapid evolution. In 2018, SEC Chairman Clayton conceded budgets had not matched crypto’s growth, hampering enforcement efforts and investor education initiatives. Since then, the information asymmetry has grown. Regulatory technology and human capital have not kept pace with private sector crypto innovation. Under the Securities Exchange Act of 1934, the SEC is empowered to regulate crypto-assets as securities. 15 U.S.C. § 78c(a)(10). However, courts evaluate the exercise of that power against arbitrariness and capriciousness standards. See Motor Vehicle Mfrs. Ass’n of U.S. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983). Rules predicated on inadequate determinations may be invalidated for deficiencies in fact finding. Here, neglected funding has stymied the fact-finding necessary to craft crypto policy attuned to rapid innovation. The Proposed Rule relies on overbroad assumptions and outdated information about the nature of crypto-assets and platforms. Its attempted oversight of custody and transaction irreversibility is premature absent funding to accurately identify risks and craft narrow rules. Congress has been derelict in its responsibility to adequately fund the SEC to regulate 21st century financial technologies. See Sarbanes-Oxley Act of 2002 § 601, 15 U.S.C. 78kk (requiring “that all fees collected . . . be expended only for the purposes of . . . oversight of securities markets and the related activities”). Neglect has left regulators without the resources to properly understand crypto-asset risks. The Proposed Rule’s approach ignores this reality to the detriment of regulated entities, investors, and the SEC itself. The solution is not to abandon efforts to regulate crypto-assets and platforms, which innovation necessitates. However, rules grounded in assumptions rather than facts flout standards of reasoned decision-making. See State Farm, 463 U.S. at 43. The SEC cannot adequately regulate that which it does not adequately understand. Thus, the Proposed Rule puts the cart before the horse in seeking to regulate crypto custody before securing resources to properly understand crypto-assets. The prudent path is to ensure adequate funding of the SEC and deferred rulemaking pending necessary research and investigation. 8. THE PROPOSED RULE IS VOID FOR VAGUENESS. The proposed amendments to the SEC's custody rule create ambiguity and fail to provide fair notice as required by the void for vagueness doctrine. The proposed rule does not clearly define what constitutes "exclusive possession or control" over crypto assets, making it unclear how crypto custodians can comply. The void for vagueness doctrine requires rules to define prohibited conduct with sufficient clarity so that ordinary people can understand what is prohibited. See Connally v. General Constr. Co., 269 U.S. 385, 391 (1926) (finding that a statute is unconstitutionally vague if persons "of common intelligence must necessarily guess at its meaning and differ as to its application"). A fundamental principle in our legal system is that laws must give people fair notice of the conduct a rule prohibits or requires. See FCC v. Fox Television Stations, Inc., 567 U.S. 239, 253 (2012). Here, the proposed rule fails to clearly define "exclusive possession or control" over crypto assets. The SEC expresses doubt about whether proving exclusive control is even possible due to the nature of crypto assets being transferrable if one has the private key. See Proposed Rule Release at 60-61. However, the SEC does not provide guidance on if or how crypto custodians can demonstrate the requisite control. This ambiguity does not give fair notice to crypto custodians, who are left guessing at what is required for compliance. Moreover, the SEC concludes that failure to maintain "exclusive possession or control" means the custodian does not "maintain" the assets under the rule. See id. at 40. However, the SEC does not explain what constitutes sufficient possession or control. This ambiguity renders the custody obligation indeterminate and leaves crypto custodians in the dark. The void for vagueness doctrine exists precisely to avoid this situation – to prevent arbitrary and discriminatory enforcement where regulated parties lack notice of what is required. See Gentile v. State Bar of Nevada, 501 U.S. 1030, 1051 (1991). The SEC should clarify how crypto custodians can comply with the "exclusive possession or control" standard to give fair notice and ensure the rule is not void for vagueness. 9. THE PROPOSED CRYPTO CUSTODY RULE SHOULD ACCOUNT FOR PRACTICAL IMPEDIMENTS TO INFORMATION GATHERING. The SEC's proposed amendments to the custody rule, while well-intentioned, fail to appreciate the significant informational challenges advisers face in complying with the rule's new mandates. As the crypto ecosystem continues evolving at a breakneck pace, advisers often lack ready access to the data essential for strict compliance. The SEC must acknowledge these practical difficulties and refine the rule accordingly. Specifically, the proposed rule would require advisers to obtain reasonable assurances that qualified custodians will safeguard crypto assets as stringently as traditional securities. But the opacity of the crypto sector hinders advisers' ability to conduct proper due diligence. Unlike custodian banks, fledgling crypto platforms rarely provide transparency into their operational controls, security protocols, or financial safeguards. And the limited track records of these startups offer little insight into their stability. The proposed rule also demands advisers demonstrate "exclusive control" over crypto assets. Yet the breadth of existing crypto projects, combined with the permissionless nature of blockchain networks, makes continuously monitoring exclusive control rights exceedingly difficult. Advisers may not even know who else holds keys providing access to client assets, let alone prevent their use. Simply put, advisers lack the infrastructure to readily access the information essential for strict compliance. The SEC must recalibrate its expectations accordingly. It should phase-in requirements as the crypto industry matures, provide safe harbors for good faith efforts to obtain assurances from custodians, and avoid rigid mandates that assume unfettered transparency. With thoughtful adjustments, the rule can balance investor protection with practical realities. The SEC should meet advisers halfway, not leave them out to sea without a compass. 10. EXCESSIVE PAPERWORK BURDENS ARE LIKELY IF THE EXPANDED CUSTODY RULE IS ADOPTED. The SEC's proposed amendments to the custody rule, Rule 206(4)-2, should not be adopted because they would impose excessive paperwork burdens on registered investment advisers (RIAs) without providing meaningful additional protections for clients. The current custody rule already requires RIAs to maintain client funds and securities with qualified custodians, provide notices to clients, and obtain annual surprise exams. Expanding the custody rule to cover "all crypto assets" as proposed would force RIAs to overhaul compliance policies and procedures and overhaul operations to safeguard crypto assets in accordance with stringent new qualified custodian requirements. This imposes excessive paperwork burdens without commensurate benefit. The administrative burdens associated with the proposed rule changes would be disproportionate to any incremental protection afforded to clients. Paperwork burdens disproportionate to any end they are to serve may run afoul of the Paperwork Reduction Act. Here, crypto assets introduce novel risks, but novel risks alone do not justify imposing significant new paperwork burdens under the custody rule. Less burdensome means exist to address novel crypto risks, including issuing SEC guidance to highlight risks and specifying reasonable policies and procedures RIAs should adopt. Congress has also made clear that regulations must balance meaningful protections against excessive paperwork burdens. For example, the Regulatory Flexibility Act requires agencies to carefully consider less burdensome alternatives before adopting regulations that would have significant economic impact on small businesses. 5 U.S.C. § 601 et seq. Imposing sweeping new qualified custodian mandates and compliance burdens on RIAs under the custody rule amendments runs counter to this carefully calibrated regulatory framework. In sum, while the SEC's motivations are understandable, the solution proposed sweeps too broadly and imposes excessive paperwork burdens not justified by the risks presented or benefits gained. Less burdensome alternatives exist to address novel crypto risks that would not overwhelm RIAs with unnecessary paperwork. The SEC should pursue those targeted alternatives instead of adopting the proposed custody rule amendments. 11. THE PROPOSED RULE INADEQUATELY CONSIDERS THE NEEDS OF UNDERSERVED POPULATIONS. The SEC's proposed amendments to the custody rule fail to adequately consider the needs of underserved populations who rely on cryptocurrencies as a critical financial lifeline. The proposed restrictions on "qualified custodians" would severely limit access to cryptocurrency services for millions of unbanked and underbanked individuals across the globe. This violates the SEC's mandate to consider the public interest and protect investors. Underserved populations have embraced cryptocurrencies as an alternative to traditional banking services that they cannot access. There are 1.7 billion unbanked adults worldwide, predominantly located in Africa, Asia, Latin America, and the Middle East. These individuals have no bank accounts due to poverty, lack of proper identification, mistrust of banks, and other barriers. Cryptocurrencies enable them to store and transfer value, often at lower cost than traditional remittances. The proposed rule threatens to cut off their access. The SEC has a duty under the securities laws to consider whether its rules will promote efficiency, capital formation, and competition. The proposal fails on all three counts. It would stifle innovation in cryptocurrency custody solutions tailored to serve unbanked populations. It would also reduce access to capital in developing regions that benefit economically from remittance inflows. Finally, it would hinder competition from cryptocurrency startups aiming to expand financial inclusion. The SEC must also consider the protection of investors when engaging in rulemaking. However, the proposal goes too far in restricting investor choice. It essentially forces unbanked investors to rely on custodians that are inaccessible to them instead of custody solutions built for their needs. This violates the SEC's mandate to protect investors. Rather than take a sledgehammer approach, the SEC should craft a more nuanced rule that balances innovation and inclusion. For instance, it could create a separate category of "qualified crypto custodians" with tailored requirements appropriate for underserved populations. Or it could exempt from certain requirements crypto custodians that serve users below a certain income threshold. The SEC should meet its statutory obligations by considering more flexible approaches. 12. THE RULE MAY CAUSE UNFAIR TREATMENT DUE TO ITS COMPLEXITY. The proposed amendments to Rule 206(4)-2 (the "Proposed Rule") would impose overly complex and prescriptive requirements on advisers and custodians that are unfairly burdensome for digital assets compared to traditional assets. While the goal of enhanced investor protections is laudable, the Proposed Rule goes too far by mandating detailed contractual provisions, assurance requirements, and strict possession/control mandates that do not account for the novel technological complexities of digital asset custody solutions. This results in disparate treatment of digital assets that is fundamentally unfair. The Proposed Rule's stringent possession/control requirement does not accommodate the emerging technological methods that allow shared control over digital assets in a secure manner. For example, multisignature arrangements, where multiple parties hold separate shards of a private key, allow "possession" to be distributed across entities while still preventing unauthorized transfers. The Proposed Rule should recognize these complex technical solutions and provide more flexibility for demonstrating control than the rigid exclusive possession standard. A custodian's required participation should be sufficient, even if it does not have unilateral ability to effect transfers. Otherwise, adhering to the Proposed Rule would constrain innovation in digital asset custody. Further, the detailed contractual provisions mandated by the Proposed Rule create complexity that is manageable for traditional custodians but extremely burdensome for new digital asset companies. Unlike established banks and brokerages, digital asset firms lack the legacy documentation, resources and insurance/indemnification frameworks to cost-effectively comply with the prescriptive assurance requirements in the time frame required. These examples demonstrate how the well-intended Proposed Rule results in disparate impact and unfair treatment for digital asset advisers and custodians. The Commission should reconsider the Proposed Rule's stringent requirements through the lens of regulatory complexity and aim for technological neutrality across asset classes. Doing so would further the goal of enhanced investor protection while still allowing responsible innovation in digital asset custody solutions. 13. THERE IS A LACK OF CLEAR GUIDANCE IN THE DEFINITIONS AROUND KEY REQUIREMENTS OF THE RULES. The proposed amendments to the SEC's custody rule lack clear guidance and definitions around key requirements, which will create significant uncertainty and impose undue burdens on investment advisers. Specifically: The requirement for a qualified custodian to demonstrate "possession or control" of digital assets is vague. The SEC acknowledges the difficulty in proving exclusive control of digital assets, but does not provide clear criteria for when a custodian has sufficient control. This ambiguity leaves advisers unsure of how to comply. The rule should delineate specific technological and procedural standards for establishing control of digital assets. The definition of “custody” to include discretionary trading authority is overly broad. Advisers often execute trades on clients' behalf without taking custody of assets. The SEC should clarify this definition and provide exceptions for common legitimate trading activities that do not constitute custody. The required contractual protections between advisers and custodians lack specificity. Terms like “reasonable care” and “reasonable commercial standards” are undefined, creating uncertainty around adviser and custodian duties. The requirements should be clarified and tailored to different asset types. The limitations on the private securities exception are vague, especially the need for an adviser to “reasonably determine” when ownership cannot be recorded by a custodian. The SEC should delineate specific criteria for when this exception applies. Without clearer standards and definitions around these key provisions, the proposed amendments will impose undue burdens on advisers struggling to comply amidst substantial uncertainty. The SEC should clarify ambiguities in the rule and provide more precise guidelines tailored to different assets and activities. This will allow for proper safeguarding of client assets while avoiding unnecessary confusion and costs.