Another week, and more SEC shilling for entrenched financial powers.

This time it was a rule passed 4 to 1 that would require Registered Investment Advisors (RIAs) to keep customer funds with “qualified custodians.”

Most Crypto exchanges—at least currently—don’t qualify, and it appears uncertain whether they could.

The rule change would effectively expand powers under a “2009 Custody Rule,” bringing all “asset classes” under custody rules that entrench powers with traditional financial institutions.

Under the rule only chartered banks or trust companies, broker-dealers registered with the SEC or futures commission merchants registered with the Commodity Futures Trading Commission (CFTC), would be able to custody funds of any asset class regulated by the SEC.

The rule would have the practical effect of compelling the use of new middle players, adding costs and effectively stripping crypto exchanges of present features, forcing them to use traditional financial players that no doubt stand to earn a cut of the crypto pie.

As for cryptos that many contend aren’t securities? Gensler and his cronies, via the rule, effectively treat them all as securities.

SEC Demand Bank Custody, While Discouraging Banks from Servicing Crypto Firms

But wait. The just passed rule also appears to directly conflict with SEC efforts to discourage banks from providing services to crypto businesses. We detailed that line of government bureaucratic attack on the sector in “GARY GENSLER, THE ‘FAUCI OF CRYPTO’,” (14 Feb 2023).

Another aspect is that RIAs will have an added burden, having to work with another layer of entities in their investment advising businesses.

SEC member Hester Pierce, who voted against the rule, commented:

“The proposal would expand the reach of the custody requirements to crypto assets while likely shrinking the ranks of qualified crypto custodians. By insisting on an asset neutral approach to custody we could leave investors in crypto assets more vulnerable to theft or fraud, not less.”

Cointelegraph noted that while the proposed rule would technically apply to all asset classes under the SEC’s purview, it would have the most impact on cryptos.

Gensler said after the rule vote:

“Make no mistake: Today’s rule, the 2009 rule, covers a significant amount of crypto assets. […] Further, though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians. Rather than properly segregating investors’ crypto, these platforms have commingled those assets with their own crypto or other investors’ crypto.”

From here the SEC will now schedule a 60-day comment window for the public to weigh in, though the short answer to what formal power “public comments” have to change anything is: none.

Regarding how public comments figure into bureaucratic rule-making, the Federal Register states:

“The notice‐and‐comment process enables anyone to submit a comment on any part of the proposed rule. This process is not like a ballot initiative or an up‐or‐down vote in a legislature.  

“An agency is not permitted to base its final rule on the number of comments in support of the rule over those in opposition to it. At the end of the process, the agency must base its reasoning and conclusions on the rulemaking record, consisting of the comments, scientific data, expert opinions, and facts accumulated during the pre‐rule and proposed rule stages.  

“To move forward with a final rule, the agency must conclude that its proposed solution will help accomplish the goals or solve the problems identified.  It must also consider whether alternate 

solutions would be more effective or cost less.”