Wall Street’s top regulator is set to release a proposal to toughen safeguards around investors’ assets, after the collapses of several high-profile crypto companies last year revealed that customer funds were not as safe as had been advertised.
The US Securities and Exchange Commission, which is scheduled to vote on the proposal on Wednesday, wants to force investment advisers to secure all the client assets that they manage, including so-called alternatives, such as cryptocurrencies and art, with qualified custodians.
In a separate move the SEC will vote on adopting new rules that would halve the two-day window for finalising share deals, an initiative that gained urgency after brokers such as Robinhood were shaken by a surge in trading during the 2021 meme stocks frenzy.
The crackdown on custody of crypto assets follows a series of failures in the digital asset market when companies promoted funds as segregated and separate, only for consumers to discover in a bankruptcy that their holdings were treated as unsecured assets and part of the estate of the collapsed company.
While the custody rules cover a range of assets, SEC chair Gary Gensler drew attention to problems in the crypto industry.
“Though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians,” Gensler said in remarks introducing the proposal. “[This] proposal, in covering all asset classes, would cover all crypto assets — including those that currently are covered as funds and securities and those that are not funds or securities.”
In expanding the scope of existing rules, the SEC would be tapping powers granted to it in 2010 following the Madoff scandal, when clients of fraudster Bernard Madoff were found to have lost billions in what was effectively a Ponzi scheme.
The proposals also come after a year of acute turbulence for crypto markets, which has left millions of creditors waiting in line at bankruptcy court following the collapse of several firms including lending platform Celsius and exchange FTX. Many crypto exchanges act as custodians of customer assets but also borrow from, and lend assets to, customers. Some of FTX’s former managers have been charged with misuse of customer funds.
“Make no mistake: based on how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians,” Gensler said.
The SEC wants investment advisers to make written agreements with qualified custodians to ensure a client’s assets are segregated and protected in case the custodian collapsed. Qualified custodians are typically heavily regulated financial groups such as banks, broker-dealers and trust companies.
If the SEC votes in favour of the custodian proposal, it will be subject to public comment as well as a second vote before implementation.
SEC commissioners’ scheduled vote on share deals would impose a final rule that halves the time allowed to settle securities transactions in the $30tn equities market to a single day.
Retail broker Robinhood complained that the two-day process to reconcile deals and legally transfer assets from seller to buyer was a critical factor in its decision to restrict some trading in stocks such as GameStop at the height of the market frenzy two years ago.
Market makers and brokers have argued the window poses risks to the US financial system. In volatile periods the clearing house, which stands between a buyer and seller and oversees the transfer, may demand more margin, or insurance, to cover any deal failures.
The SEC has proposed the switchover, which will require banks and brokers to spend millions of dollars to upgrade their back office systems, will take place at the end of May next year.