By Eric Gronroos, Baker Tilly
Just as cryptocurrencies like Bitcoin are starting to make news again and exciting investors, custodial broker-dealers continue to seek clarity on the ability to maintain custody of the digital assets under Rule 15c3-3. On Dec. 23, 2020, the Securities and Exchange Commission (SEC) issued a statement and request for comment regarding the custody of these assets by broker-dealers.
The statement provides the expected measures that broker-dealers must take when acting as a custodian over digital securities. The SEC is allowing for a period of five years in which a broker-dealers will not be subject to an enforcement action. This is only “…on the basis that the broker-dealer deems itself to have obtained and maintained physical possession or control of customer fully paid and excess margin digital asset securities for the purposes of paragraph (b)(1) of SEC Rule 15c3-3.”
The new guidance can be seen as a step forward in comparison to the joint staff statement issued by the SEC and Financial Industry Regulatory Authority (FINRA) on July 8, 2019. The original joint statement made comments to the difficulties broker-dealers may face protecting customers’ digital assets under the Customer Protection Rule due to the risks of cyber-related theft and fraud. Furthermore, it expressed that it would be a challenge for broker-dealers to determine who has the custody of the digital asset, and the transfer of such assets are susceptible to such risks.
In the most recent statement, the SEC provides initial steps on how this can be accomplished by the broker-dealers and noted that the SEC “envisions broker-dealers performing the full set of broker-dealer functions with respect to digital asset securities – including maintaining custody of these assets – in a manner that addresses the unique attributes of digital asset securities and minimizes risk to investors and other market participants.”
The statement gives guidance on certain safeguards and procedures to reasonably mitigate risk, and recommends disclosures be made to customers – most notably that the broker-dealer limits business to digital asset securities. Reasonably designed implementation procedures within these areas are to ensure the broker-dealer complies with Customer Protection Rule. The SEC provides seven steps that that a broker-dealer should consider to establish, maintain and enforce in order to comply with Rule 15c3-3 to mitigate risks.