SEC's Proposed Crypto Custody Rules Favor Big Firms Over Small Advisers

The US Securities and Exchange Commission (SEC) has proposed new crypto custody rules that could broaden investment choices, but may also create a barrier for small advisers to offer this service. The proposed fallback would allow advisers to hold covered client crypto assets when an eligible custodian is unavailable, subject to safeguards. However, the expense of safeguarding assets and arranging independent oversight may lead smaller firms to decline to offer the service. The SEC's economic analysis estimates that the annual cost for an adviser using the fallback option would be $433,833, which includes an independent internal control report costing $376,000.

The proposed conditions include safeguarding expertise, cybersecurity protections, annual reviews, reporting, and client disclosures. Advisers would need asset-specific expertise and systems for key management, authorization by two or more designated people, and segregation of each client's assets. The first independent control report would be due within six months of taking self-custody, and at least once each calendar year thereafter. Quarterly client reporting would also apply, with electronic alternatives and exceptions for qualifying audited pools and regulated funds.

SEC Commissioner Hester Peirce distinguished adviser 'self-custody' from investors holding their own assets, noting that the intermediary would hold clients' key materials, potentially including a non-controlling portion. The proposal does not specify a single transfer deadline for every situation, and advisers could incur costs to support an asset and later have to move it out of adviser custody. The SEC expects many direct costs could be passed on to clients through fees or expenses.