SEC crypto custody rule may price out small advisers

The Securities and Exchange Commission on Oct. 1 proposed a custody fallback that would allow registered investment advisers to hold covered client crypto assets when an eligible qualified custodian will not maintain a specific asset. The proposal requires advisers to document a reasonable basis, after due inquiry, that no qualified custodian will maintain the asset before taking custody, and to review that determination at least quarterly.

The rule would bar advisers from relying on a custodian’s price or cost as the reason for using the fallback. If a qualified custodian later becomes available for the asset, the adviser must transfer the asset to that custodian “as soon as reasonably practicable,” with timing evaluated case by case.

The SEC’s economic analysis models the annual cost of operating under the fallback at about $433,833 per adviser. That subtotal combines a modeled $376,000 annual fee for an independent internal control report and $57,833 in recurring internal compliance work, and lists a one-time initial internal compliance cost of $173,499. The independent report would be required within six months of taking custody and at least once each calendar year thereafter and must assess design, implementation and effectiveness of controls, including verification of reconciliation to the crypto network.

The agency’s subtotal excludes some technology, software and hardware expenses and separates recordkeeping and disclosure burdens into other analyses. For burden calculations the SEC assumes roughly 823 advisers, or about 5% of 16,442 registered advisers, might use the fallback and cautions that actual uptake may be lower.

Operational and governance safeguards in the proposal include asset-specific expertise, key management systems with authorization by two or more designated individuals, segregation of each client’s assets, cybersecurity protections, annual reviews, reporting and client disclosures. The proposal would require quarterly client reporting with electronic options and specific exceptions for certain audited pools and regulated funds.

The SEC’s analysis notes a size effect: smaller advisers are more likely to decline offering the fallback because fixed compliance costs would be large relative to their client base, while larger advisers could spread costs across more assets, clients or affiliated businesses. The agency also said growing demand for accountants who can assess crypto controls could raise fees or make those services harder to obtain for smaller firms.

Commissioner Hester Peirce distinguished adviser “self-custody” under the proposal from investors holding their own private keys, noting an intermediary would hold clients’ key materials and clients would depend on that intermediary’s safeguards. Acting Chairman Mark Uyeda described the conditions intended to limit misuse and operational risk when an adviser holds client key materials.

The proposal would permit eligible state trust companies to act as custodians, and national and state banks may also serve as custodians where they support the assets. Where an eligible institution maintains custody for a particular asset, clients could obtain access without their adviser maintaining the fallback infrastructure, though availability will depend on which assets those custodians support.

The SEC warned that “spending itself does not establish safeguarding competence.” The agency’s analysis says how widely clients gain access to assets under the proposal will depend on advisers’ implementation choices, the pricing and availability of independent-accountant services, and which assets eligible custodians agree to support.