On December 23, 2020, the Securities and Exchange Commission issued a statement, directed to special purpose broker-dealers, provides that the Commission will not bring an enforcement action against the BD for a five-year period so long as certain circumstances apply.

In an effort to encourage innovation in the robust and ever-expanding digital asset space, the SEC recently issued a statement and request for comment regarding the operation of its custody rule in connection with digital instruments. Specifically, the agency release titled Custody of Digital Asset Securities by Special Purpose Broker-Dealers, considers the application of Securities Exchange Act Rule 15c3-3 to digital asset securities for those broker-dealers limiting their business to digital asset securities.

Safety from enforcement liability. The Commission statement sets forth the agency position that for a period of five years, a broker-dealer operating under certain noted circumstances will not be subject to an SEC enforcement action. The SEC’s position on this score is premised on the basis that a broker-dealer will have deemed itself to have obtained and maintained physical possession or control of customer fully paid and excess margin digital asset securities for the purposes of Rule 15c3-3.

The SEC further indicated that the noted five-year period will provide market participants with an opportunity to develop practices and processes that will enhance their ability to demonstrate possession or control over digital asset securities. Moreover, it will provide the Commission with experience in overseeing broker-dealer custody of digital asset securities which will inform further action in this area.

Applicable circumstances. In addition to the requirement that the broker-dealer limit its business to digital asset securities, the SEC statement identified a number of other circumstances that must apply so as to avoid enforcement exposure for the noted five-year period. Some of these circumstances include:

  • The broker-dealer establishes and implements policies and procedures reasonably designed to mitigate the risks associated with conducting a business in digital asset securities;
  • The broker-dealer provides customers with certain disclosures regarding the risks of engaging in transactions involving digital asset securities;
  • The broker-dealer has access to the digital asset securities and the capability to transfer them on the associated distributed ledger technology;
  • The broker-dealer establishes, maintains, and enforces reasonably designed written policies and procedures to conduct and document an assessment of the characteristics of a digital asset security’s distributed ledger technology and associated network prior to undertaking to maintain custody of the digital asset security and at reasonable intervals:
  • The broker-dealer establishes, maintains, and enforces reasonably designed written policies, procedures, and controls that are consistent with industry best practices to demonstrate the broker-dealer has exclusive control over the digital asset securities it holds in custody and to protect against the theft, loss, and unauthorized and accidental use of the private keys necessary to access and transfer the digital asset securities the broker-dealer holds in custody;
  • The broker-dealer establishes, maintains, and enforces reasonably designed written policies, procedures, and arrangements to specifically identify, in advance, the steps it will take in the wake of certain events that could affect the firm’s custody of the digital asset securities, including, without limitation, blockchain malfunctions, 51 percent attacks, hard forks, or airdrops; and,
  • The broker-dealer enters into a written agreement with each customer that sets forth the terms and conditions with respect to receiving, purchasing, holding, safekeeping, selling, transferring, exchanging, custodying, liquidating and otherwise transacting in digital asset securities on behalf of the customer.

Comment requested. The SEC is also requesting comment to provide the Commission and its staff with an opportunity to gain additional insight into the evolving standards and best practices with respect to custody of digital asset securities. The Commission statement and request for comment will become effective 60 days after publication in the Federal Register.

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