Paradigm Files Comment Letter in Response to Proposed Amendments to the Custody Rule

TLDR: Today Paradigm submitted a comment letter to the SEC regarding the Commission’s proposed amendments and redesignation of rule 206(4)-2 (better known as the Custody Rule).

The SEC has characterized these potential changes as an attempt to enhance the protections of customer assets managed by registered investment advisers. However, this argument is flawed. In reality, the Proposed Rule would expand the application of the custody requirements far beyond what Congress intended and effectively prohibit (or significantly curtail) investment advisers from investing in many crypto assets on behalf of their clients. In other words, the Proposed Rule would attempt to make investors “safer” by blocking their access to the asset class, an action that is in contravention to the Advisers Act of 1940 itself.

In addition, the Proposed Rule would hurt competition in a nascent industry. By limiting the number of crypto custodians, the rule would result in concentration of service providers, contrary to the explicit pro-competition goals of the Biden Administration. With the Proposed Rule, the SEC is fighting the Administration’s own efforts to increase competition and doing so in one of the most nascent and dynamic sectors of the economy.

To more appropriately meet the articulated goals, Paradigm has provided recommendations and alternative considerations including tailoring the Proposed Rule to more appropriately suit the unique characteristics of crypto assets. Specifically,

Consider expanding the exception currently in place for privately offered securities and physical assets subject to heightened controls,
Permit flexibility for other custodial solutions including using MPC technology subject to additional controls,
Permit transaction execution via nonqualified affiliates of qualified custodians subject to certain conditions,
Engage with the crypto community, nonprofits, financial regulators to more robustly consider implications, and
Offer more guidance on areas including how to safeguard assets when they cannot be reduced to traditional custody, how to handle bans on commingling assets when necessary, etc.