The SEC and FINRA issued new guidance addressing emerging digital asset models. It recognizes that while the general rules of securities custody apply regardless of whether securities are paper or digital form, existing securities regulations do not necessarily fit perfectly with the custody needs of those handling digital asset securities. The guidance divides digital asset security landscapes into noncustodial and custodial; among the noncustodial models that have been proposed are the following:
- Trade matching in which a broker-dealer instructs a customer to pay for, and an issue to issue, a digital asset security to a customer’s digital wallet,
- Over-the-counter secondary market transactions in which the buyer and seller directly transact such that the digital asset security never goes through a broker dealer, and
- The use of an introducing broker-dealer in a secondary market transaction where the broker-dealer refers the seller and buyer to a platform where the seller and buyer directly settle.
The guidance also addresses various issues that may arise in compliance with the SEC’s financial responsibility rules set under five categories: customer protection, making of records, record retention, financial reports, and quarterly security counts. The most emphasized issue is the potential for theft of digital asset securities. The guidance lays out the customer protection rule to address the concern of theft. The purpose of the customer protection rule is to ensure the safeguarding of customer securities and funds held by broker-dealers in order to prevent loss of other harm in the event that a broker-dealer fails, and to give the SEC the capability to monitor broker-dealers’ activities. The guidance next lays out other financial responsibility rules to provide a record of broker-dealer assets and liabilities and to enable further SEC monitoring of broker-dealer activities. The guidance brings up a big issue that arises with digital asset securities: how a broker-dealer would evidence the existence of a digital asset security. Finally, Securities Investor Protection Act (SIPA) considerations are mentioned. SIPA functions to ensure investors who use broker-dealers can recover their property if their broker-dealer fails. This relates to the issue of how broker-dealers will evidence the existence of digital asset securities because SIPA’s definition of “security” would likely not cover those that are not evidenced.
For more information visit https://www.sec.gov/news/public-statement/joint-staff-statement-broker-dealer-custody-digital-asset-securities and http://www.finra.org/newsroom/2019/joint-statement-broker-dealer-custody-digital-asset-securities .