Statement on Proposed Rules Regarding Investment Adviser Custody

  • Source: sec.gov

Treliant Takeaway:

Treliant can help firms in both designing and implementing internal controls as it relates to client asset segregation and client asset protection framework including conducting an independent audit and testing of the crypto custodians.

Highlights:

Following recent high profile crypto failures such as Celcius, FTX etc., SEC has amended the 2009 Custody rule which will now impact all custodians including digital asset custodians. The proposed rule changes cover 3 important elements:

  1. Have an expanded scope of coverage to protect a broader array of client assets and advisory activities to the rule’s protections. The primary objective is to ensure client assets are properly segregated and held in accounts designed to protect the assets in the event of a qualified custodian bankruptcy or other insolvency. Qualified custodians are typically heavily regulated financial groups such as banks, broker-dealers and trust companies;
  2. Enhance the custodial protections that client assets receive. The safeguarding rule would require advisers with custody of client assets to maintain those assets with a qualified custodian, with very limited exceptions under the rule; and
  3. Update related recordkeeping and reporting requirements for investment advisers. The rule now requires investment advisers to keep additional, more detailed records of trade and transaction activity and position information for each client account of which it has custody. This investment adviser can be subjected to a surprise examination by an independent public accountant to verify client assets.

Looking back into the past, the common breaches noticed with regards to client asset segregation and client asset protection include:

  • Failure to implement adequate organizational arrangements for safeguarding client assets;
  • Maintain records and accounts on a global, rather than entity-specific level;
  • Failure to conduct external reconciliations between the firms’ records and accounts and those of affiliate group companies that the firms appointed as sub-custodians;
  • Failing to protect client money by recklessly relying on the existence of an undocumented and opaque offshore facility to correct a deficit that had arisen in the firm’s client money; and
  • Outright fraud where a firm uses client money for its own purposes and has complete disregard for the client asset protection custody rules.

This development is quite welcome and it most certainly addresses some of the challenges encountered by the traditional custody firms in safeguarding client assets who are now poised to offer crypto custody services.

Author

Kishore Ramakrishnan

Kishore Ramakrishnan is Managing Director, Capital Markets Advisory at Treliant. He has over 24 years of global industry and consulting experience across the banking, capital markets, asset, and wealth management businesses. Kishore is a trusted advisor and respected thought leader in the risk, regulation, and compliance domains covering multiple asset…