SEC Updates Guidance to Facilitate Broker-Dealer Involvement in Crypto
Commentary by Steven Lofchie
The SEC Division of Trading and Markets (the Division) updated FAQs clarifying broker-dealer obligations and regulatory considerations for crypto asset activities and distributed ledger technology. The Division and FINRA's Office of General Counsel also withdrew a 2019 Joint Statement regarding broker-dealer custody of digital asset securities.
On Custody: In the newly issued FAQ, the Division confirmed that SEA Rule 15c3-3 (the "Customer Protection Rule") does not apply to crypto assets that are not securities, but broker-dealers may establish control over crypto asset securities under paragraph (c), even if not in certificated form. Under the now withdrawn joint statement the SEC had highlighted challenges broker-dealers face in complying with Rule 15c3-3 financial recordkeeping and reporting rules with respect to transactions in digital asset securities. (See previous coverage.)
On SIPA: The Division addressed related issues regarding the application of the Securities Investor Protection Act ("SIPA") to digital asset securities. The Division said that under SIPA, crypto assets that are unregistered investment contracts are not protected by the Securities Investor Protection Corporation (“SIPC”). The Division said that non-security crypto assets are not SIPC-covered, (though parties may consider Article 8 of the UCC to help preserve customer ownership in insolvency). The Division said that broker-dealers should maintain robust records for non-security crypto businesses.
On ETPs and Capital: The Division stated that broker-dealers may facilitate in-kind creations and redemptions for spot crypto Exchange Traded Products ("ETPs") and may treat proprietary bitcoin or ether positions as readily marketable under the net capital rule.
On Transfer Agent Functions: The Division said that entities performing transfer agent functions must register if engaged in activities defined in Section 3(a)(25)("Transfer Agent"). The Division said it would not object to use of blockchain as a Master Securityholder File if all SEC recordkeeping rules are met and sensitive data is properly safeguarded.
Commentary
The new FAQ is quite meaningful, insofar as it permits broker-dealers to participate in the creation of ETPs that hold crypto. It also gives ready market capital treatment to bitcoin and ether, subject to a 20% haircut.
By contrast, the 2019 SEC Joint Statement on custody—and its withdrawal—are not particularly meaningful, since the Statement was wholly impractical to implement and few firms—if any—relied on it. The 2019 Statement served more as a pretense for the former Administration to show it was attempting to address issues related to both crypto-securities and non-securities crypto.
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The SEC and FINRA addressed issues concerning the application of customer protection, recordkeeping and reporting rules to digital asset securities and transactions.
