Gensler flags breaches by custody providers.

Crypto custody companies are flagrantly breaching the rules currently in place to protect clients. This was stated by the SEC Chair Gary Gensler.

We @SECGov just proposed to expand & enhance the role of qualified custodians when registered investment advisers custody assets on behalf of investors.

Thru our rule, investors would get the time-tested protections—and qualified custodians—they deserve.

What does this mean? ⬇️ pic.twitter.com/RerUGnpArI

— Gary Gensler (@GaryGensler) February 15, 2023

The remarks were heard after the Commission’s decision by a 4-to-1 vote to expand and strengthen the role of qualified custodians with respect to cryptocurrencies.

“The current model essentially presumes ownership of coins and their commingling with the funds of thousands, and often hundreds of thousands or even millions of other accounts,” Gensler explained.

According to the official, the business of crypto-asset platforms currently does not meet the standards for a qualified custodian, under the asset custody rule established in 2009.

The SEC initiative could be a response to the recent wave of bankruptcies in the industry, as a result of which clients FTX, Celsius, BlockFi and Voyager may not recover their funds in full. The SEC’s current guidelines require firms to create conditions to maximise creditor payouts.

In Celsius, assets deposited by customers effectively belonged to the platform. Tightening the rules could entail relinquishing custody of funds and transferring them to banks or other traditional financial institutions.

Gensler noted that the current law defining custodians includes the words “bank” and “broker-dealer”.

He reminded that in the past such services were also provided by trust companies and state-licensed lending institutions, as well as federally licensed banks. The regulatory field regarding these entities is shaped by other agencies.

In response to questions about the Commission’s latest steps, Gensler pointed to the absence of Kraken’s registration efforts [for the staking service].

“Create alignment with the standards. Provide investors with time-tested information and protections,” he explained.

Gensler compared digital assets to the peer-to-peer lending industry through marketplaces, which the Commission in 2009 deemed to be based on investment contracts.

Gensler explained that fintech firms have aligned their activities with securities law, something not currently observed among participants in the digital assets industry.

“Some platforms publicly state: ‘We will never register.’ Some of them we will eventually charge. The runway is getting shorter,” he warned.

Commissioner Hester Peirce opposed tightening custodial norms for industry participants. She criticized the pace of the proposal’s adoption, questioned its feasibility and the agency’s authority.

My statement on today’s custody proposal. Looking forward to comments from the public. This one affects crypto, among many other issues: https://t.co/1eWT6P45Ya

— Hester Peirce (@HesterPeirce) February 15, 2023

“This rule has broad implications for investors, financial advisers and custodians. We need a robust public response. The proposed sixty days do not provide sufficient time to analyse all aspects — especially given the already crowded list of documents,” she explained.

In terms of the SEC’s powers, Peirce noted that the Commission is effectively seeking to regulate qualified custodians indirectly, though this is not within its mandate.

The community also criticised the regulator’s initiative.

The Blockchain Association’s policy chief Jack Chervinsky said it constitutes a breach of the SEC’s mission by reducing investor safety and by creating barriers to capital formation. It effectively amounts to a ban on investments in American crypto companies, he said.

Today, the SEC proposed changes to the investment adviser custody rule that seem designed to prohibit US firms from investing in US crypto companies.

This proposal would flagrantly violate the SEC’s mission by making investors *less* safe and by *discouraging* capital formation.

— Jake Chervinsky (@jchervinsky) February 15, 2023

Earlier, Gensler urged industry participants to pay attention to the Kraken episode.

As reported in February, the SEC head said that cryptocurrency regulation is among the Commission’s priorities for 2023. One item is examining asset custody.