Broker-Dealers With Custody Must Comply With Customer Protection Rule

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Countless crypto firms have been waiting to snag operating licenses from the Securities Exchange Commission (SEC). The Joint Staff Statement on Broker-Dealer Custody of Digital Asset Securities is finally broaching the law as pertains to crypto. The July 8 statement is a collaborative effort between the SEC and the Financial Industry Regulatory Authority (FINRA).

The two bodies have been in
discussions with digital asset securities industry stakeholders seeking
broker-dealer certification.  Gemini the
crypto exchange is one of the most recent firms seeking said approval. The
joint statement has, as a result, outlined factors that the regulators will use
when granting or denying the permissions to crypto companies.

Similarly, the statement has addressed
the confusion on custody solutions for digital asset securities. Companies have
sought to market them to institutional investors who cannot directly purchase
or hold the assets themselves.

The SEC Clarification

Consequently, questions have arisen as
to whether digital assets should be treated as securities as per the law. The
Securities Investor Protection Act (SIPA) of 1970 was made before digital asset
era and was therefore incapacitated in its definition.

Of the matter, the regulators have defined a cryptocurrencies as assets issued and transferred on a blockchain or distributed ledger technology. For regulatory purposes, a digital asset that qualifies as security has to be referred to as “digital asset security” by registration.

Likewise, there has been a lot of confusion over the SEC‘s Customer Protection Rule. A broker-dealer in the US has to be legally registered to operate, to protect the customers. This license gives its operator the right to purchase and sell securities either for their clients or for themselves. 

The statement withheld the need for digital asset broker-dealers to comply with the security laws. The report also adds that:

” if the entity is a broker-dealer, it must comply with broker-dealer financial responsibility rules, including, as applicable, custodial requirements under Rule 15c3-3 under the Securities Exchange Act of 1934 (the “Exchange Act”), which is known as the Customer Protection Rule.”

Customer Protection Is Essential

The rule requires a broker-dealer to either physically hold their customer’s assets or maintain them at no charges in a control location.  However, broker-dealers in the digital assets market are at a higher risk of becoming victims or perpetrators of theft, fraud, or loss of private keys due to crypto nature. 

There is additional confusion as to who should maintain the asset’s private keys between the broker-dealer and third-party custodian. The statement, therefore, emphasizes the critical need for reporting and record keeping adding that:

 ” Financial responsibility rules also require that broker-dealers routinely prepare financial statements including various supporting schedules particular to broker-dealers, such as Computation of Net Capital under Rule 15c3-1 and Information Relating to the Possession or Control Requirements under Rule 15c3-3 under the Exchange Act”

Congress set the regulatory bodies on crypto assets in the wake of the 2017 BTC Bull Run and ICO hype fall out. Seeking to curb fraud and protect the consumers, the House came up with bills that were passed to the Commodity Futures Trading Commission (CFTC) for recommendations. The CFTC took on ETH and BTC and passed the rests of the responsibility to the SEC. The SEC since then has been cracking down on crypto over registrations, threatening progress.

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