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SEC/FINRA Joint Statement on Custody

The SEC’s Division of Trading and Markets and the Office of the General Counsel of FINRA (Financial Industry Regulatory Authority) published on July 8, 2019, a joint staff statement(Custody Release) on broker-dealer custody of digital assets. The statement has been eagerly awaited by market participants, including broker-dealers, given significant uncertainty in the application of securities laws to novel digital asset transactions.  

In the new digital world, broker-dealers currently grapple with possession and control to safeguard customers’ digital asset securities and their own duties and responsibilities under Rule 15c3-3 of the Securities Exchange Act of 1934, also known as the Customer Protection Rule. This rule requires broker-dealers to safeguard customer assets and to keep customer assets separate from the broker’s assets, thus increasing the likelihood that customers’ securities and cash can be returned to them in the event of the broker-dealer’s failure. Digital assets present heightened risk for broker-dealers charged with maintaining custody of the assets. Unlike having possession of a tangible stock certificate stored in a vault, in the digital asset realm, a broker-dealer could be victimized by fraud or theft through the loss of a “private key” necessary for the transfer of the asset, and potentially have no recourse.

The Custody Release additionally addresses financial responsibility rules, the maintenance of books and records, noncustodial broker-dealer models, regulatory approvals needed for existing broker-dealers engaging in digital asset securities for the first time, and limited coverage under SIPA (Securities and Investor Protection Act of 1970) unless the security meets the definition of a “security” under SIPA (which is different than under the Securities Act of 1933 by, in general, limiting it to securities which are subject to a filed and approved registration statement).  If the digital asset security does not meet the definition of “security” under SIPA, protection likely would not apply in the event of failure of the broker-dealer and holders of those digital asset securities would have only unsecured general creditor claims against the failed broker-dealer.

As a practical matter, the Custody Release makes clear that broker-dealers are encouraged to engage with the SEC Staff to discuss solutions for compliance issues. Unregistered broker-dealer entities that intend to engage in broker-dealer activities involving digital assets will be required to submit New Membership Applications to FINRA. Existing registered broker-dealer firms will be wise to now evaluate the need for a Continuing Membership Application (CMA). Under FINRA rules, an existing broker-dealer is prohibited from changing its business operations to incorporate material digital asset securities activities for the first time without FINRA’s prior approval of the CMA.

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About this Author

Rebecca DiStefano, Greenberg Traurig Law Firm, Boca Raton, Corporate and Investment Law Attorney

Rebecca G. DiStefano concentrates her practice in the areas of securities regulation, corporate finance, corporate governance, private equity, venture capital, and mergers and acquisitions law. Rebecca counsels public and private companies in areas including angel financing, debt and equity financing, registration of securities under the Securities Act of 1933, registration under the Investment Advisers Act of 1940, continuing disclosure requirements of the Securities Exchange Act of 1934, initial and continued listing of securities on the stock exchanges and electronic...