July 8, 2019 / 9:04 PM / 11 days ago

U.S. market regulator issues guidance on custody of digital asset securities

WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission (SEC) on Monday issued a notice on broker-dealer custody of digital asset securities, amid industry requests for clarity on whether they can hold such assets under federal securities laws.

FILE PHOTO: The U.S. Securities and Exchange Commission logo adorns an office door at the SEC headquarters in Washington, June 24, 2011. REUTERS/Jonathan Ernst/File Photo

The SEC’s statement, issued in conjunction with the general counsel of the Financial Industry Regulatory Authority (FINRA), clarified that entities seeking to participate in the marketplace for digital asset securities must comply with the relevant securities laws, most notably the customer protection rule.

“The requirements of the Customer Protection Rule have produced a nearly fifty year track record of recovery for investors when their broker-dealers have failed,” the SEC said in a statement.

“This record of protecting customer assets held in custody by broker-dealers stands in contrast to recent reports of cybertheft, and underscores the need to ensure broker-dealers robust protection of customer assets, including digital asset securities,” it added.

Monday’s statement follows queries from market participants over whether federal laws apply to the custody of digital asset securities, such as crypto currencies. It could potentially pave the way for more traditional investors to hold digital asset securities.

While various firms already registered as broker-dealers are seeking to expand their businesses to include digital asset securities services, the SEC says non-registered firms would likely have to register as a broker-dealer before engaging in this activity.

The SEC has been grappling with how digital asset securities fit within existing federal law, which often requires a custodian to take physical possession of a security.

Matt Comstock, who advises broker-dealers and fintech companies at Washington-based Murphy & McGonigle, said the SEC’s statement indicates it would view digital asset securities as uncertificated securities, similar to situations in some states where the ownership of a stock is evidenced by an electronic record as opposed to physical certificate.

SEC rules allow broker dealers to establish custody by employing so-called transfer agents, which are typically SEC-registered entities that maintain records of the securities’ record owners.

But he added the statement also suggests “that other solutions for custodying securities, such as holding those securities in a wallet controlled by the broker-dealer through private keys, face a more difficult path to approval.”

Reporting by Katanga Johnson; editing by Susan Thomas and Diane Craft

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