US SEC and FINRA Issue Statement on Crypto Custody Issues

The United States Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) outlined regulatory compliance issues for cryptocurrency custodians in an announcement on July 8.

According to the joint statement, the organizations have yet to discover a set of circumstances in which a crypto custodian could comply with the SEC’s Customer Protection Rule, which is described as follows:

“Put simply, the Customer Protection Rule requires broker-dealers to safeguard customer assets and to keep customer assets separate from the firm’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.”

The report further claims that a crypto custody service may not be able to sufficiently demonstrate that it actually controls the assets it purports to hold.

The SEC and FINRA discuss how simply holding a private key, for instance, is not sufficient to demonstrate ownership of crypto. They say that another party could have a copy of the private key, and thus perform transactions that the custodian did not approve. 

Furthermore, if such a transaction were performed, the custodian would not be able — at least not in virtue of holding a private key — to reverse it. This would also apply more generally to any transactions that the custodian might desire to cancel or reverse, as per the statement.

In addition to addressing custodial services, the report also touches on issues for registering noncustodial services such as over-the-counter (OTC) platforms and broker-dealer transactions more broadly. Other areas of compliance concerns include bookkeeping policies and liquidation via the Securities Investor Protection Act.

The SEC and FINRA previously scheduled a broker-dealer meeting in Chicago for June 27 to discuss crypto. The meeting was intended to cover “regulatory hot topics” including cybersecurity and digital assets. 

As previously reported by Cointelegraph, the SEC requested feedback in March on how it might regulate crypto settlements. The SEC also was interested in the role of custodians in non-delivery versus payment trading and what safeguards are currently in place.