The Expanded Safeguarding Rule: Can This SEC Rule Protect Your Crypto from Bankruptcy?

Introduction

In the realm of financial regulations, one rule stands out for its significance in ensuring the safety of client assets: the custody rule. This requirement, imposed by the SEC (Securities and Exchange Commission), mandates that investment advisors and similar entities must protect client securities and funds while in their possession. The custody rule is designed to prevent the commingling of client assets with those of the advisor and mitigate risks such as theft, misappropriation, and bankruptcy. Recent developments, notably the investigation into the cryptocurrency exchange FTX, have exposed instances of unauthorized access and co-mingling of client assets, prompting a reassessment of regulations governing cryptocurrencies and similar assets.

The Expanded Safeguarding Rule

In response to these challenges, the SEC has proposed an enhanced regulation known as the safeguarding rule. This updated version of the custody rule significantly broadens its scope, encompassing a wider range of assets than previously considered. The SEC's proposal states that the safeguarding rule would apply not only to “funds, securities, or other positions held in a client's account,” but also “all other assets that investment advisers custody for their clients.” Furthermore, the regulation explicitly includes an adviser's discretionary authority to trade client assets within the definition of custody.

According to legal experts at Skadden Arps, the safeguarding rule carries a comprehensive mandate, extending to virtually all assets held by regulated entities. This encompasses cryptocurrencies, digital assets, investment-related contracts, collateral linked to swap contracts, physical assets (such as real estate, artwork, precious metals, and commodities), and even “other positions” that may not be recorded as balance sheet assets (e.g., short positions and written options). The SEC's decision to maintain an “evergreen” definition of “assets” ensures that the safeguarding rule automatically covers emerging categories of investments without necessitating specific updates. This addresses the regulatory challenges posed by cryptocurrencies, where companies have exploited regulatory loopholes by simultaneously treating crypto assets as investments exempt from regulation and securities subject to oversight.

Impact on Cryptocurrency Exchanges

The expanded safeguarding rule will particularly impact cryptocurrency exchanges, as it will require them to adapt their business practices. These exchanges, along with investors, brokers, and other regulated entities, will be obligated to keep all client assets secure in separate and insured accounts. The proposed regulation aims to strengthen investor protection in the cryptocurrency space and ensure greater transparency and compliance with regulatory standards.

Protecting Your Investments

While the custody rule and the forthcoming safeguarding rule play crucial roles in safeguarding client assets, it is important to remember that they are part of a broader framework of regulations implemented by the SEC to protect investors. To ensure the safety of your investments, seeking the guidance of a financial advisor is highly recommended. A financial advisor can assist you in creating a comprehensive financial plan tailored to your needs and goals. Finding a suitable financial advisor is now easier with SmartAsset's free tool, which connects you with up to three vetted financial advisors in your area. You can interview these advisors at no cost to determine the best fit for your requirements. Begin your journey toward achieving financial security by finding an advisor who can help you navigate the complex landscape of investment protection.

Conclusion

The proposed safeguarding rule represents a significant step in bolstering investor protection and addressing the evolving landscape of asset management. By expanding the scope of the custody rule, the SEC aims to close regulatory gaps and enhance safeguards for client assets. With the guidance of a knowledgeable financial advisor and adherence to regulatory requirements, investors can better protect their investments and achieve their financial goals.