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Chamber Submits Comments to SEC on Proposed Safe Harbor for Broker-Dealer Custody of Digital Asset Securities Highlighting Concerns on Bifurcated Treatment of Broker-Dealers Based Purely on Technology

April 9, 2021

On Monday, April 5, we filed a letter in response to the Securities and Exchange Commission (the “Commission”) Statement and Request for Comment regarding “Custody of Digital Asset Securities by Special Purpose Broker-Dealers” (the “Statement”), which was originally issued by the Commission on December 23, 2020.  While the safe harbor indicates an important willingness to enable this industry to grow, its narrow focus on a single technology, limiting broker-dealer custody to digital asset securities only, without sufficient basis, creates an unworkable framework that creates enhanced, yet inaccurate, perceptions of risk.

The Statement sets forth a five-year temporary safe harbor for broker-dealers seeking to custody “digital asset securities.”  The temporary safe harbor becomes automatically effective April 27, 2021. In the Statement, the Commission establishes, and solicits input on, a bifurcated regulatory structure for broker-dealers seeking the ability to custody securities based on whether the broker-dealer operates in the traditional securities space or in the digital asset securities space.

The Statement requires a broker-dealer seeking to custody digital asset securities to limit its business to digital asset securities only in order to isolate certain perceived risk.  The Commission also establishes, and solicits input on, a range of unique policies and procedures that a special purpose broker-dealer would be required to adopt.

The Chamber supports the Commission’s issuance of the Statement as a positive and constructive step toward grappling with the complex requirements of federal securities laws, and the Customer Protection Rule in particular, as they apply to digital asset securities and transactions in those securities.

We also, however, note our concern that the Commission is imposing a bifurcated and relatively onerous regulatory framework on broker-dealers without providing a compelling basis for doing so.  Specifically:

    • It is unrealistic for a broker-dealer to operate successfully if its business is limited to operating in the digital asset securities space should they seek to self-custody even one digital asset security – We note that the temporary safe harbor would create a significant hardship for existing or future broker-dealers operating under this model;
    • Digital asset securities do not impose greater investor risk than traditional securities – Digital asset securities intentionally created in connection with the issuance of debt or equity by a traditional issuer may differ significantly from non-security digital assets and “inadvertent” digital asset securities when it comes to risk of theft or loss of keys. In addition, we discuss why blockchain is actually a far superior option for complying with recordkeeping and reporting obligations under the securities laws and have characteristics that make them particularly well suited to serving as the source of truth;
    • Broker-dealers cannot operate successfully with self-custodied digital asset securities without also custodying non-security digital assets – We strongly support allowing broker-dealers to self-custody these non-security digital assets to promote more efficient settlement processes around the secondary trading of digital asset securities;
    • The temporary safe harbor is not technology neutral – The Commission is imposing a bifurcated regulatory structure on broker-dealers, and potentially significantly limiting their business model, based solely on an issuer’s choice of technology representing its securities and regardless of whether the broker-dealer can meet the current regulatory requirements related to the custody of traditional book-entry securities;
    • The scope of the temporary safe harbor should be clarified – The Commission should clarify that the provisions of the temporary safe harbor apply only to broker-dealers seeking to self-custody digital assets securities for customers in order to provide certainty that other broker-dealers operating in the digital asset security space may continue to operate under existing regulations;
    • The definition of “digital asset security” is extremely broad and should be narrowed – The Commission should clarify that securities that have non-controlling blockchain components do not fall within the definition of “digital asset securities and should consider how applicable state law provides for “possession or control” to occur;
    • Broker-Dealers need clarity that they can use third-party custody providers – The Commission should clarify that broker-dealers can satisfy the Customer Protection Rule by maintaining digital asset securities at a good control location, such as a bank, transfer agent or other regulated entity, and that the Commission provide additional clarity on what is deemed a “good control location” for digital asset securities; and
    • The Commission should seek customary industry input prior to implementation of the temporary safe harbor – The Commission is implementing the temporary safe harbor without soliciting prior public comment or providing a cost/benefit analysis around the enumerated requirements which is reflected in many of the problematic aspects of the Statement.

While we welcome the Statement as a move in the right direction to provide the digital asset industry with a much-needed framework for broker-dealers seeking to custody digital asset securities, we encourage the Commission to address the concerns enumerated in our letter prior to implementation of the temporary safe harbor to ensure it achieves its intended purpose to enable this industry to grow in a safe manner.

We are grateful for the tireless effort and countless hours expended by our Members in addressing the issues raised by the Statement.