Statement on Proposed Amendments to the Custody Rules

Safeguarding client assets is one of the fundamental investor protections in our regulatory framework against the potential misuse, misappropriation, or loss of client assets. At the same time, our regulations must provide both robust investor protection and operational practicality. Rules that are unworkable in practice will not protect investors but merely provide the illusion of protection.

With the emergence of new asset classes and the market development of supporting infrastructure, now is an opportune moment to revisit our custody rules. The core tenets of custody, such as asset segregation and proper controls, remain as true today as when custody rules were first adopted. However, the mechanics of applying these principles will inevitably look different as technology evolves. Asset segregation for paper certificates sitting in bank vaults versus assets recorded on a distributed ledger cannot look the same, even if the underlying principle is identical. The existing legal framework for custody still bears the imprint of a bygone era when custody meant safekeeping paper documentation,[1] and that framework has been adjusted modestly over time to accommodate the modern securities markets and, more recently, digital assets. It is time for a fresh look.

Today's proposal is not the Commission's first attempt in recent years to update the custody rules. In 2023, the Commission proposed amendments to the custody rule (the "2023 Proposal").[2] Although I supported the issuance of the 2023 Proposal as a means to trigger public discussion on the future of custody safeguards, I was critical of how the 2023 Proposal went to great lengths to construct a "no-win" scenario for crypto assets even if advisers tried complying in good faith.[3] The 2023 Proposal would have required advisers to maintain crypto assets with a qualified custodian, while simultaneously casting doubt on whether any qualified custodian could demonstrate exclusive control over those assets. Compounding the problem, Staff Accounting Bulletin No. 121[4] had already effectively deterred companies from safeguarding crypto-assets by forcing on-balance sheet recognition of crypto-assets. The net effect was a proposal that told advisers to use custodians that, for practical and accounting reasons, were largely unavailable or unwilling to serve in that capacity.

Today's proposal presents a workable path to compliance without compromising the protections the custody rules are designed to provide[5].

Self-Custody

For novel crypto assets, self-custody by an adviser or fund may be the only available option when no qualified custodian is willing or able to hold those assets. The proposal recognizes this reality, while also recognizing that self-custody creates an inherent conflict of interest and an adviser's fiduciary duty still applies when it holds client crypto assets. Rather than ignore that tension or prohibit self-custody outright and leave advisers with no compliant path, the proposal permits self-custody in circumstances where an adviser determines that no qualified custodian is available, subject to guardrails. These include safeguarding expertise, cybersecurity protections, annual reviews, internal reporting, account statements, and disclosures to clients.

State-Chartered Trust Companies

Today's proposal would also add state-chartered trust companies as permitted custodians for crypto assets, subject to certain conditions. State-chartered trust companies have become important participants in the crypto custody ecosystem. By providing clarity on the specific requirements and conditions these entities must meet, the proposal helps ensure that client assets held with state-chartered trust companies are adequately safeguarded, while giving advisers, funds, and custodians greater flexibility and certainty about how to structure these arrangements.

Custody Modernization

Finally, the proposal includes a number of modernization measures that are long overdue. Among them, the proposal would:

• update the circumstances in which regulated funds may use broker-dealers as custodians;
• exclude authorized discretionary trading from the Advisers Act custody rule subject to conditions that limit executions to designated client accounts and prohibit transfers to accounts controlled by the adviser or related persons; and
• provide an exception from the independent verification requirement for an adviser that has custody solely because of a standing letter of authorization.

Taken together, this proposal reflects an approach that considers both the imperative of safeguarding client assets and the practical realities advisers, funds, and custodians face in an ever-changing market.

I thank the staff in the Divisions of Investment Management and Economic and Risk Analysis, the Office of the General Counsel, and the many other offices that have contributed to this rulemaking.