SEC to Wyoming (Division of Banking): Interpreting Federal Securities Laws and Rules is our Domain

In early November 2020, the staff of the U.S. Securities and Exchange Commission (“SEC”) Division of Investment Management (“IM Division”), in consultation with the SEC’s “FinHub” staff, issued a statement in response to a No-Action Letter from the Wyoming Division of Banking purporting to provide interpretive guidance on both Wyoming and federal securities laws, including in the area of custody of digital assets.

In sum, the SEC staff’s statement provides the following takeaways.  Unfortunately, these are neither newsworthy nor helpful in terms of regulatory clarity.

  1. The SEC is still trying to formulate the confines of who should and can be a “qualified custodian” with respect to digital assets.
  2. The SEC, not the states, is the ultimate authority on federal securities laws.

The SEC staff’s statement does serve as an important reminder, however, for industry participants to be mindful of regulatory jurisdiction and the circumstances under which it is appropriate (or not) to rely on the statements of a particular regulator in the broader context of goods and services offered.  In this case, think twice!

In its letter, the Wyoming Division of Banking shared its understanding of the definitions of “bank” and “qualified custodian” under the federal securities laws.  In particular, the Wyoming Division of Banking determined that a Wyoming-chartered public trust company was a bank under the Investment Adviser Act of 1940 because it “exercises genuine fiduciary powers as a substantial portion of its business.”  It further indicated that the public trust company could serve as a “qualified custodian” and provide custodial services for both digital and traditional assets under both Wyoming state law and the SEC’s Custody Rule.[1]

Even though the Wyoming Division of Banking specifically stated that it was not purporting to represent the views of the SEC, or provide interpretive guidance on its behalf, the SEC staff’s response nonetheless reiterated that the SEC is the ultimate authority on the Custody Rule and encouraged parties to engage directly with SEC staff.  The SEC staff further iterates in its statement that being deemed a “qualified custodian” is a “complicated, and facts and circumstances based” analysis.  As such, SEC staff encouraged stakeholders to submit comments expressing views and issues regarding the Custody Rule.  Of particular interest to the SEC are industry views on: (i) state chartered trust company characteristics that align with being a qualified custodian; (ii) how custodial services provided by state chartered trust companies are equivalent to and differ from other fiduciaries and any potential gaps in regulatory protection; (iii) how advisers assess entities offering custodial services; and (iv) whether there are any entities currently included in the definition of a qualified custodian who should in fact be excluded.

Unfortunately, we are left without clarity on what the SEC considers to be “custody” with respect to digital assets.  It appears that the SEC is still in fact-gathering and listening mode, as it has been since as early as January 2018.[2]

Despite the lack of direction in this important area over the past few years, the SEC continues to tease a flicker of hope that it may provide the industry with the long-overdue guidance it needs to address custody of crypto assets.  For example, in its statement relating to Wyoming, SEC staff cited to the SEC’s Spring 2020 “Reg Flex” Agenda for rulemaking that noted that the IM Division was considering recommending amendments to existing rules, or proposing new rules, to improve and modernize the regulations around the custody of funds or investments of clients by investment advisers.  But based on history thus far, we are not overly optimistic that this will bear fruit.  The SEC will undergo a leadership change soon (Chairman Clayton already announced his intention to leave the agency by year-end).  Any potential rulemaking mentioned on past Reg Flex Agendas that the SEC has not already proposed has little chance of moving forward.  And all bets are off when the SEC reconvenes under a new Biden-appointed Chair in 2021.

We will continue to monitor (and hope) for substantive guidance from the SEC on this front.

[1] 17 C.F.R. § 275.206(4)-2.

[2] See January 2018 letter from the Director of the IM Division to the Investment Company Institute (“ICI”) and Securities Industry and Financial Markets Association (“SIFMA”).  See also March 2019 response from the Deputy Director and Chief Counsel of the IM Division to ICI.  See also July 2019 joint statement from SEC and FINRA staff on broker-dealer custody of digital assets.