Twenty-Six Trade Associations Criticize SEC's Custody Proposal
Commentary by Steven Lofchie
Twenty-six trade associations banded together to urge the SEC not to adopt a proposed amendment to Advisers Act Rule 206(4)-2 ("Custody of Funds or Securities of Clients by Investment Advisers") because it would make "fundamental changes" to an already "well-established and demonstrably effective custody framework without a clear policy rationale."
In a joint comment letter addressed to SEC Chair Gary Gensler, the trade associations argued that the proposed expansion of "custody" and "assets" would be inconsistent with, and duplicative of, both the CFTC's existing framework for futures commission merchants and the SEC's margin regulations for uncleared security-based swaps (see previous coverage). While the letter indicated that many of its signatories have already submitted separate comments in opposition to the SEC's proposal, the trade associations stated that the joint letter was meant to showcase the "diverse range of investors and other end users" that would be harmed if the proposal were adopted. The trade associations argued that the proposal would (i) "disrupt the core banking model" of facilitating payments by requiring qualified custodians to hold client cash in segregated, off-balance sheet accounts; (ii) effectively prohibit advisory clients from investing in assets by requiring individual transaction verification for assets that cannot be custodied; and (iii) increase fees for custodial services and diminish investment returns.
Commentary
The SEC's custody proposal is particularly troubling. It would be impractically expensive or operationally impossible for many products. The major question raised is not whether the proposal is a good idea; the real question is whether the SEC has a good handle of how settlement and custody work in products other than the reasonably plain vanilla.
In the ordinary course, trade associations and financial institutions are fearful of challenging the SEC even when it arguably goes beyond the law or arguably does not follow required procedures. Now that the private fund rule has been challenged in court, and now that the SEC has lost the "Bitcoin trust" case, it is not hard to imagine at least some number of the trade associations challenging this rule amendment. The SEC will have a tough time explaining how the new requirements can be implemented as to a broad range of products, never mind whether that can be accomplished in a cost-sensible manner.
Related Articles
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The SEC proposed to significantly amend and redesignate the Advisers Act "Custody Rule," expanding its requirements. The proposal also amends related recordkeeping and reporting obligations.
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Trade associations representing a variety of constituencies urged the SEC not to adopt a proposal that would expand requirements under the Custody Rule.