SEC and FINRA Issue Joint Statement on Custody Issues of Digital Assets

SEC and FINRA Issue Joint Statement on Custody Issues of Digital Assets


The U.S. Securities and Exchange Commission ("SEC" or "Commission") the Financial Industry Regulatory Authority ("FINRA") released a joint statement on July 8, 2019 clarifying issues related to broker-dealer custody of digital asset securities. The statement focuses on FINRA and the SEC's approach to broker-dealer regulation and investor protection, including assets deemed to be securities under the 1970 Securities Investor Protection Act and factors related to approving a broker-dealer application of crypto-related companies. The same fundamental elements of the broker-dealer financial responsibility rules apply whether a security is paper or digital.

Firms seeking to participate in the marketplace for digital asset securities must comply with the relevant securities laws. An entity that buys, sells or is involved in effecting transactions in digital asset securities for customers or its own account is subject to the federal securities laws and may be required to register with the Commission as a broker-dealer and comply with the rules of the relevant self-regulatory organization, which in most cases is FINRA. If the entity is a broker-dealer, it must comply with the broker-dealer financial responsibility rules, including custodial requirements of Rule 15c3-3 under the Securities Act of 1934 (the "Customer Protection Rule"). The Customer Protection Rule, generally, requires broker-dealers to safeguard customer assets and to keep customer assets separate from the firm's assets.

Among other risks associated with safeguarding customer assets pursuant to the Customer Protection Rule, firms and custodians cannot currently provide assurance that security keys or other such credentials are secure. Such security keys are necessary to access a "crypto wallet," in which digital assets are typically kept. Guaranteeing the safety of such security keys has posed a problem across industries that utilize crypto wallets or otherwise engage in digital asset transactions. To compound this risk, given the current state of the related technology, it would be virtually impossible to recall or repossess digital assets that were fraudulently accessed once they had left a particular crypto wallet.

"The ability of a broker-dealer to comply with aspects of the Customer Protection Rule is greatly facilitated by established laws and practices regarding the loss or theft of a security, that may not be available or effective in the case of certain digital assets," the statement noted. The SEC and FINRA have indicated that they look forward to continuing the dialogue with market participants, as such market participants work toward developing methodologies for establishing possession or control over customers' digital asset securities.



To read the full joint public statement, please click on the link below.


If you have any questions about this Alert, please contact Daniel G. Viola (Partner) or Eliott Frank (Partner).


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