Proposed Custody Rules for Investment Advisers and Registered Funds: Where to Comment (And Why)

Yes, but only under limited circumstances and subject to extensive conditions. The self-custody exception would be available only for “crypto assets” (defined below)—other types of assets would remain subject to existing custody requirements (as potentially refined by other aspects of the Proposal).

As discussed more fully below, the conditions for self-custody are extensive and complex. Industry participants should carefully evaluate how the proposed self-custody framework would apply to their specific operations and business models and should consider submitting comments to the SEC addressing the practical and operational challenges the framework may present.

The Proposal would permit a registered adviser to self-custody crypto assets on behalf of its clients—including its registered fund and BDC clients—where no qualified custodian¹ is available to maintain the particular crypto asset. An adviser would be required to place a particular crypto asset with a qualified custodian as soon as reasonably practicable after determining that a qualified custodian has become available. This proposed framework is intentionally limited and is designed to provide a “viable option” for custody only during the gap period until custodial services for a particular crypto asset become available, which is more likely to be necessary for nascent or novel crypto assets.

An adviser relying on self-custody would be subject to extensive conditions, which would likely entail significant costs and technological and compliance burdens. These conditions would include:

• Determination That There is No Available Qualified Custodian. A reasonable determination, after due inquiry, and redetermination no less than quarterly thereafter, that no qualified custodian is available to maintain the particular crypto asset;
• Safeguarding Expertise. Expertise in safeguarding the particular crypto asset, documented in writing;²
• Safeguarding Systems and Risk Management. Systems necessary to safeguard the particular crypto asset against loss, theft, misuse and misappropriation, addressing at minimum private key management, joint authorization of transfers and segregation of each client’s assets;
• Cybersecurity Risk Mitigation. Mitigation of cybersecurity risks through (i) periodic, but no less than annual, written assessments of cybersecurity risks; (ii) measures reasonably designed to detect, mitigate and remediate cybersecurity threats and vulnerabilities; and (iii) measures reasonably designed to detect, respond to and recover from a cybersecurity incident;
• Internal Control Report. An annual written internal control report prepared by an independent public accountant, with the initial report due within six months of taking self-custody;
• Annual Review. An annual review of the effectiveness of an adviser’s safeguarding and cybersecurity systems;
• UCC Financial Asset Election. A written agreement with the relevant client to treat the particular crypto assets as a “financial asset” under the Uniform Commercial Code; and
• Recordkeeping. Maintenance of records documenting compliance with the foregoing, including the written determinations described above, cybersecurity assessments, internal control reports, client account statements and transaction-level records sufficient to reconstruct each client’s crypto positions.

For crypto assets self-custodied on behalf of registered fund and BDC clients, see “For Registered Funds and BDCs, What Role Would the Fund’s Board and Officers Have Overseeing an Adviser’s Self-Custody of Crypto Assets?” below.

The scope of crypto assets potentially subject to the self-custody exception depends on the type of client for which the assets are held:

• For clients other than registered funds and BDCs, only crypto assets that are within the scope of the current custody rule under the Advisers Act (Custody Rule)—namely “funds” (e.g., certain payment stablecoins or tokenized deposits) and “securities” (including tokenized securities)—would be subject to the self-custody conditions.³
• For registered fund and BDC clients, Section 17(f) of the Investment Company Act applies more broadly to “securities and similar investments,” and the Proposal extends that same broad scope to crypto assets held in self-custody for a registered fund or BDC, including native digital commodities that would not otherwise be “securities” (e.g., bitcoin).
• For registered fund and BDC clients, crypto assets held in self-custody by the fund’s adviser under proposed Rule 17f-9 (discussed below) would not be subject to the conditions of Rule 17f-2 under the Investment Company Act, which in other contexts governs self-custody by registered funds and BDCs.

An adviser would have “self-custody” of a client’s crypto asset if it possessed any portion of that asset’s “key materials.” “Key materials” means the cryptographic private keys, or any part of them, necessary to access and effectuate transactions in the crypto asset. The SEC extended the definition to “any portion” of the key materials because losing, or losing control of, even a non-controlling share could permanently cut off access to the crypto asset, and because the SEC believes that holding any share of the key material creates misappropriation risk. Under the “any portion” standard, an adviser holding just one key in a multi-signature solution would have self-custody of the crypto asset and would need to comply with the self-custody conditions. Industry participants who use multi-signature or other solutions that involve sharing key materials with clients or their agents as a security measure may want to comment on this aspect of the Proposal, as these solutions would no longer be available if the rule is adopted as proposed.

An adviser has “self-custody” only where the adviser actually possesses a portion of the key materials, not merely where it has the authority to obtain possession of them (although having authority to obtain possession of the keys may separately be considered to be custody under the Custody Rule).

Not entirely. The Proposal defines a “crypto asset” to mean “any digital representation of value that is recorded on a cryptographically secured distributed ledger.” While the definition does not itself distinguish between crypto assets recorded on permissionless and permissioned systems, and the self-custody conditions would apply the same way regardless of network type, the Proposal separately acknowledges the distinction, noting that custodial risks may be heightened on permissionless networks and asks specific questions about whether additional safeguards should apply to records maintained on private or permissioned networks not controlled by the adviser.

Industry participants who are considering acting as either the issuers or purchasers of tokenized securities may want to comment in particular on this aspect of the Proposal to ensure that the SEC appropriately recognizes the differences in risk presented by permissioned as opposed to permissionless systems (including permissioned layers on permissionless systems), as the application of the proposed self-custody requirements to tokenized securities (or other tokenized real-world assets) may significantly shape the development and use of tokenized securities.

In the Proposal, the SEC states that “an adviser that fails to take reasonable steps to safeguard self-custodied crypto assets or that misappropriates or misuses those assets would be acting in a manner inconsistent with the client’s best interests and the adviser’s fiduciary duty.” The SEC also states in the Proposal that “[l]oss of client crypto assets in the adviser’s self-custody resulting from the adviser’s failure to take such reasonable steps may be a violation of its duty of care, while an adviser that misappropriates client crypto assets in self-custody would be breaching its duty of loyalty.”

The SEC notes that QC Determinations would not require boundless analysis or identifying every possible custodian. Rather, according to the SEC, an adviser’s reasonable basis should come from due inquiry into material facts such as the crypto asset’s characteristics, its custodial marketplace and whether generally known custodians in that marketplace offer services for it. For example, a QC Determination could be formed where reasonable due diligence of generally known custodians shows they have not developed the infrastructure to support custody of that particular crypto asset. The costs associated with engaging a qualified custodian could not be a determinative factor for a QC Determination.

Commenters may want to ensure that the SEC understands that it is often clients, rather than advisers, who determine which custodian to engage, and so an adviser may not be able to move a client’s crypto assets to a qualified custodian even if the adviser determines that a qualified custodian has become available. Further, commenters may want to encourage the SEC to adopt a clearer standard or guidance that permits an adviser to consider the quality of a proposed qualified custodian before requiring the adviser to place assets with that custodian.

No, the self-custody exception is only from specific requirements of the Custody Rule—namely, the qualified custodian requirement, the related notice requirement and the requirement to have a reasonable basis for believing the qualified custodian sends quarterly account statements. Advisers remain subject to the other applicable rule provisions unless a separate, specific exception applies. For example, the surprise examination requirement would still apply to an adviser self-custodying crypto assets, unless the adviser separately qualifies for the pooled investment vehicle audit exception (i.e., the adviser manages a pooled investment vehicle subject to an annual financial statement audit by an independent public accountant).

Under proposed Rule 17f-9 under the Investment Company Act, a fund would be permitted to place and maintain crypto assets with its investment adviser, provided the adviser complies with the self-custody conditions described above and subject to board oversight conditions described below. Assets subject to proposed Rule 17f-9 would not be subject to current Rule 17f-2.

Before an adviser begins maintaining a fund’s crypto asset, and quarterly thereafter, the fund’s board (including a majority of board members who are not interested persons) must review the adviser’s written report documenting the basis for its determination that no qualified custodian is available to maintain the crypto asset. The board must also, before the adviser begins self-custody and annually thereafter, determine that the crypto asset would be subject to reasonable care if maintained with the adviser, in light of the factors relevant to the safekeeping of the crypto asset. To facilitate that evaluation, an adviser must furnish, and the board must evaluate, at minimum:

• a written report documenting the basis for the adviser’s determination that it has the expertise and systems to safeguard the crypto asset;
• the adviser’s most recent written annual review of its safeguarding systems and cybersecurity controls, if available; and
• the adviser’s most recent written internal control report, if available.⁴

Separately, the SEC expects that “serious safeguarding issues” must be brought to the board’s attention promptly rather than delayed until the next scheduled board meeting. This would include prompt notice if any of the fund’s crypto assets are lost, stolen, misused or misappropriated, as well as significant cybersecurity events that materially raise the risk of harm to the fund or an internal control report in which the auditor does not issue an unmodified opinion.

Yes, but only if the crypto asset continues to be maintained by the adviser under the self-custody exception, by another permitted custodian, or under another exception to the requirement to maintain the crypto asset with a permitted custodian. The Proposal notes that DeFi activities—including depositing crypto assets in a smart contract in connection with DeFi protocols and applications, such as for staking or earning yield—carry meaningful risk, including that a malicious actor or a third party with administrative privileges over the smart contract could exploit code vulnerabilities to steal the deposited assets.

The SEC specifically requests comment on the circumstances in which crypto assets deployed in DeFi activities (for example, through staking) would continue to be treated as maintained by an adviser in self-custody or by a permitted custodian—including whether the analysis should turn on whether ownership and control of the asset have changed, and whether the degree of a protocol’s decentralization should matter to that analysis. Commenters should consider engaging with the SEC on this issue, and in particular may wish to address how, for example, the proposed self-custody exception applies to DeFi protocols that provide users receipt tokens or similar tokens.

The Proposal would establish a presumption that discretionary trading authority confers custody under the rule, but except certain forms of trading from the definition of “custody” where a series of conditions is met.

This approach would replace prior SEC guidance that has traditionally excepted authorized trading from the definition of “custody.” While the amendments related to discretionary trading authority are characterized as an exception from custody under the rule, in practice they would significantly expand the reach of the Custody Rule, including routine execution and settlement activities necessary to effect trading in many asset classes.

To understand the history of this issue, investment advisers should review the specific language of the 2003 Custody Rule adopting release.⁵ In that release, the SEC stated:

“An adviser with power of attorney to sign checks on a client’s behalf, to withdraw funds or securities from a client's account, or to dispose of client funds or securities for any purpose other than authorized trading has access to the client’s assets.”

This statement was accompanied by the following footnote:

“An adviser’s authority to issue instructions to a broker-dealer or a custodian to effect or to settle trades does not constitute ‘custody.’ Clients’ custodians are generally under instructions to transfer funds (or securities) out of a client’s account only upon corresponding transfer of securities (or funds) into the account. This ‘delivery versus payment’ arrangement minimizes the risk that an adviser could withdraw or misappropriate the funds or securities in its client’s custodial account.”

The plain language of the 2003 release states that an adviser with access to client accounts for purposes other than authorized trading has custody, and that an adviser’s authority to issue instructions to effect or settle trades does not constitute “custody.” In the corresponding footnote, the SEC states that certain forms of settlement minimize the risk that an adviser could misappropriate client assets, but this observation does not qualify the interpretation regarding authorized trading activities that do not confer custody under the rule. As referenced in the Proposal, this statement has been the subject of engagement between SEC staff and the investment adviser community for several years. While the staff asserts that authorized trading in markets that do not settle on a DvP basis confers custody, the industry generally refutes that interpretation based on the actual language of the 2003 release.

The Proposal would resolve the issue by withdrawing prior SEC guidance, establishing a presumption that discretionary trading authority confers custody, and setting out a series of prescriptive conditions that must be met in order to be “excepted” from the requirements of the rule.

Commenters may want to ensure that the SEC understands that in practice this is not an exception from the rule, but an expansion of the scope of the rule. Commenters may also consider highlighting the significance and cost of this fundamental change in approach, and addressing statements in the Proposal that appear designed to minimize the issue. For example, the Proposal states that, “While the discussion in the 2003 Adopting Release identifies authorized trading as outside of the Custody Rule, it only identifies its inapplicability in the context of DVP trading.” As noted above, this statement is inconsistent with the actual language of the 2003 adopting release.

An investment adviser with discretionary trading authority would be excepted from having “custody” under the proposed amendments if:

• the adviser executes (and only has authority to execute) trades only from and into designated client accounts in the client’s name or the transfer is recorded in the client’s name by the issuer;
• the adviser has no authority (under the discretionary trading arrangement or otherwise) to transfer client funds and securities to an affiliated account or to any account that is not the client’s, or to cause the issuer to record such a transfer, absent client direction; and
• the adviser complies with the rule with respect to any activities that would otherwise cause it to have custody.

The first proposed condition would, in practice, confer custody on any adviser that executes trades through omnibus accounts, even if the omnibus account is used on a temporary basis for execution, allocation, or other pre-settlement purposes.⁶ Investment advisers that trade loans or other assets through omnibus accounts should consider commenting on this aspect of the Proposal, particularly if they trade in markets where the use of omnibus accounts is a practical necessity to effect client transactions. Commenters may also consider whether this condition should be tied to the transfer of funds in connection with the settlement of a securities transaction, rather than the execution of the transaction.

The second proposed condition would also confer custody on investment advisers that engage in routine trading for clients in several asset classes. Advisers would be deemed to have custody if they have the authority to “transfer” client funds or securities in connection with authorized trading, unless “such transfer is directed by the client in connection with such trading.” Absent further guidance, the proposed revision would appear to confer custody when an adviser directs the transfer of margin or collateral in connection with a derivatives transaction, directs the transfer of funds or securities in connection with corporate actions, and engages in many other routine trading activities.⁷

Commenters may consider recommending that the SEC narrowly define a “transfer” for purposes of this condition to exclude transfers of funds or securities that are effected in pursuit of the execution or settlement of a transaction or (as in the case of a derivatives transaction) that are necessary to avoid a default or otherwise protect the interests of a client in an existing investment. Commenters may also consider whether a better approach to the protection of investors in connection with transactions that settle on a non-DvP basis would be through a condition that advisers adopt policies and procedures designed to reasonably safeguard client assets in connection with such transactions in order to avoid “custody” under the rule.

In short, the SEC does not provide any new proposals on this topic.

“Document custody” refers to the practice of storing the agreements and other documents that establish a fund’s ownership of a private security (e.g., a subscription agreement for an equity investment or a credit agreement or assignment agreement for a loan investment) with the fund’s custodian, even though these instruments do not convey ownership of the underlying assets. As a general matter, theft or loss of these documents would not result in theft or loss of the underlying asset.

While the SEC does not make any proposals concerning document custody in the Proposal, it requests comment on current practices and whether changes to the custody rules might be appropriate. As a result, there is an opportunity for industry members to provide comments to encourage the SEC to address and modernize this important area.

The SEC requests comment regarding whether the custody rules under the Investment Company Act should adopt an exception for privately offered securities, similar to the exception in the current Custody Rule.

Allowing registered funds and BDCs to mirror the approach to custody of non-certificated private securities used by private funds likely would create significant efficiencies for the industry. Current practices vary depending on instrument type and custodian, but typically either involve pursuing a document custody approach as discussed above or registering the custodian as the owner of the relevant securities on behalf of the relevant fund. Both processes involve significant inefficiencies, and the willingness and ability of custodians to service these arrangements is often limited. Accordingly, funds that make, or expect to make, significant investments in private assets may wish to encourage the SEC to adopt a more flexible approach to custody of private assets.

As with custody of private assets in general, the SEC does not propose any changes to the custody rules for funds or advisers that expressly address loans. But the SEC did request comment on whether it should codify the conditions in the K&L Gates No-Action Letter, which permits registered funds and BDCs to dispense with document custody practices and rely instead on alternative procedures and the asset verification process during the fund’s annual audit.

Unfortunately, the SEC does not resolve the limitations and challenges with the K&L Gates No-Action Letter. In particular, the letter addressed only broadly syndicated loans and did not address other types of loans or private assets. Further, one of the conditions of that letter is that neither the funds, nor their adviser, would be affiliated with the administrative agents for the relevant loans, which is a common arrangement in the private credit sector.

Yes. The SEC makes several proposals relevant to discretionary trading, accommodation reporting, and asset segregation, each of which is relevant to the custody of private assets and loans, as discussed in detail below.

• Privately Offered Securities. The SEC does not propose any changes to the existing “privately offered securities” exception from the Custody Rule. However, the SEC requests comment on whether the privately offered securities exception should be modified to better accommodate loans, CLOs, derivatives, and private fund interests, in light of the new discretionary trading exception.
• Accommodation Reporting. The SEC proposes to provide guidance to advisers that custodians should provide disclosure to clients that the custodian does not safeguard assets reported on account statements on an accommodation basis. Private investments, including loans, typically cannot be held by custodians directly and custodians will not accept custodial liability for such assets. But some custodians provide information about such assets on account statements based on the adviser’s own records—reproduced by the custodian without independent verification—on an accommodation basis.
• Segregation and Commingling. In the Proposal, the SEC states that it views segregation of client assets from the proprietary assets of the adviser, its related person, and the client’s custodian as a “foundational principle” of the Custody Rule. But despite this focus on segregation, the SEC indicates that it may provide interpretive guidance clarifying that deposit accounts held at bank custodians do not violate the Custody Rule’s asset segregation requirements despite these funds being held on the bank’s balance sheet, and permitting certain escrow accounts used in the sale of portfolio companies from private funds. Loan industry participants may wish to seek similar guidance from the SEC regarding the treatment of administrative agent arrangements, where advisers may invest in loans on a proprietary basis alongside clients and payments in respect of such loans are directed to and from participants by the loan’s administrative agent through commingled bank accounts.

The proposed amendments to Rule 17f-1 under the Investment Company Act (17f-1 Amendments) would significantly reduce the burdens on funds’ use of broker-dealers as custodians. Current Rule 17f-1, which was originally adopted in 1940, imposes stringent conditions that have made it largely impracticable for funds to engage members of a national securities exchange as custodians in the modern era.

The 17f-1 Amendments would “update and modernize” the requirements applicable to the use of members of a national securities exchange as custodians by registered funds and BDCs (together referred to as funds unless the context otherwise requires). Under the 17f-1 Amendments, a registered fund or BDC would be permitted to place and maintain its securities and similar investments with any broker-dealer registered under Section 15(b)(1) of the Securities Exchange Act of 1934 (Exchange Act), where such broker-dealer’s custody of the securities or similar investments is subject to the customer protection rules thereunder, with no other conditions.

Following the SEC’s acknowledgement in adopting Rule 18f-4 that “similar financing transactions” could include a “fund’s purchase of a security on margin,” an increasing number of funds have started considering using prime brokerage and margin financing arrangements. Funds currently generally satisfy margin posting obligations to their prime brokers by transferring assets to triparty accounts at their bank custodians, subject to triparty account control agreements, and could not hold securities purchased on margin with their prime brokers. Under the 17f-1 Amendments, a fund would be permitted to place and maintain assets with registered broker-dealers, and a prime broker or a margin lender that is a registered broker-dealer therefore could potentially act as custodian with respect to fund-posted margin and funds’ securities purchased on margin.

Under applicable regulations governing uncleared swaps, for any uncleared swap/security-based swap between a swap dealer/security-based swap dealer and a counterparty that is a registered fund or BDC, the swap dealer/security-based swap dealer and the registered fund or BDC are generally required to exchange collateral as initial margin or variation margin. While the SEC did not address the topic, it also appears that a dually-registered broker-dealer and security-based swap dealer/swap dealer likewise could act as custodian with respect to a fund’s assets posted in satisfaction of margin obligations in connection with uncleared swaps and security-based swaps.

Funds that lend cash to banks or broker-dealers pursuant to uncleared repos generally place and maintain purchased securities received under the transaction with their custodian or a clearing bank. The 17f-1 Amendments would permit broker-dealers to custody securities purchased by funds in repos. This could, among other things, facilitate funds’ transactions in hold-in-custody repos with broker-dealer counterparties. Hold-in-custody repos are a kind of repo where the repo seller does not deliver purchased securities to the repo buyer, but rather segregates the purchased securities on its books and holds them for the benefit of the buyer. Hold-in-custody repos can often pay higher rates than traditional repos where the purchased securities are delivered to the buyer’s custodian or clearing bank.

The 17f-1 Amendments could help facilitate the posting of margin by funds through their clearing agents that are registered broker-dealers. In the release adopting the U.S. Treasury clearing mandate⁸ in 2023, the SEC granted time-limited no-action relief from Rule 17f-1 to permit funds to use broker-dealers to post assets as margin to a clearing agency registered with the SEC (a covered clearing agency) in connection with cleared repos. If adopted as proposed, the 17f-1 Amendments would largely obviate the SEC’s time-limited no-action relief from the requirements of Rule 17f-1. However, the time-limited no-action relief with respect to covered clearing agency custody of fund assets would still be required to allow funds to post margin to the covered clearing agency.⁹

Market participants may wish to consider whether, in view of the 17f-1 Amendments, it would be beneficial to amend or make permanent the time-limited no-action relief with respect to covered clearing agency custody of fund assets.

In the Proposal, the SEC indicated that although the 17f-1 Amendments would eliminate the written contract requirement currently in Rule 17f-1, the SEC would “anticipate that as part of standard business practices, regulated funds will continue to maintain written custodial contracts with any custodian they engage, including broker-dealers.” The SEC also specifically asks for feedback on whether it should retain the written contract requirement. Market participants may wish to consider providing feedback in response to these questions from the SEC and discuss how a written custody contract requirement could affect prime brokerage, margin lending, derivatives and repo arrangements.

Rule 17f-6 currently permits registered funds and BDCs to place and maintain fund assets with non-affiliated futures commission merchants (FCMs) registered under the Commodity Exchange Act in amounts necessary to effect the fund’s transactions in “commodity futures contracts, options on commodity futures contracts, and options on physical commodities” traded on or subject to the rules of either a designated contract market (DCM) or “any board of trade or exchange outside the United States.”

Pursuant to relief granted through SEC staff no-action letters, regulated funds also have been permitted to place and maintain fund assets with certain registered derivatives clearing organizations (DCOs), or clearing members of those DCOs that are registered FCMs, for purposes of meeting the DCO or clearing member FCM’s margin requirements¹⁰ for certain swaps cleared by the DCO.

The scope of products currently addressed by Rule 17f-6 and SEC staff no-action guidance is more limited than the universe of exchange-traded and cleared derivatives. For example, many event contracts, including those based on sports, politics, cultural, and weather-related events, are not among the categories of derivatives instruments identified by Rule 17f-6 or related guidance for which a regulated fund may place and maintain fund assets with a DCO or FCM in order to satisfy margin requirements, notwithstanding that the event contract is listed on a DCM and does not introduce risk of loss or misappropriation that are distinguishable from other contracts listed on the DCM.

The SEC also indicates that it was considering cross-referencing “cleared swaps” as defined in CFTC Regulation 22.1. That term, which itself references section 1a(7) of the CEA, would not generally include any swap that is not cleared by a registered DCO. As non-U.S. DCOs are not necessarily required to be registered with the CFTC, the effect of this could be to exclude swaps cleared by a DCO that is not registered or required to be registered with the CFTC.

Market participants may wish to comment that Rule 17f-6 should permit a fund to place and maintain assets with an FCM in connection with any derivatives instrument traded on or subject to the rules of a “registered entity” (as defined in CFTC Regulation 1.3) or any board of trade or exchange outside the United States that is exempt from registration or otherwise not required to be registered with the CFTC.

The ICE, CME and LCH letters permit funds to place and maintain assets in the custody of the relevant DCOs as well as the custody of a DCO’s FCM clearing members, subject to the applicable conditions. Although the letters do not expressly discuss the concept of direct clearing, the ability for a fund to place and maintain assets directly with the DCO is not inconsistent with a direct model. Certain exchange-traded derivatives, including many event contracts, are currently permitted by the CFTC to be directly cleared with a DCO. Market participants should consider whether Rule 17f-6 should expressly address the circumstances in which a regulated fund may place and maintain assets directly with a DCO.

As noted above, Rule 17f-6 only permits funds to place assets with a non-affiliated registered FCM (i.e., an FCM that is not an affiliated person of the fund or an affiliated person of such person). This restriction creates complications for multi-sleeve sub-advised funds. In this regard, the sub-adviser to one sleeve of a fund could not cause the fund to post margin to an FCM that is an affiliated person of a sub-adviser to another sleeve of the same fund. Coordination among the primary adviser and its sub-advisers to ensure compliance with this restriction is operationally burdensome. The SEC adopted provisions allowing separate sleeves of a fund to be treated as separate funds for purposes of Rule 10f-3, Rule 12d3-1, Rule 17a-6, Rule 17a-10, and Rule 17e-1 based on a view that it would be unlikely that the affiliated person would be able to take advantage of the fund.¹¹ Notably, Rule 17f-1 has never been subject to a similar restriction on custody with an affiliated person, and the SEC has not proposed such a requirement. Market participants should consider whether the scope of Rule 17f-6 should extend to both affiliated and non-affiliated FCMs, and if not, whether the rule should allow separate sleeves of a fund to be treated as separate funds for purposes of determining affiliate status.

Yes. The Proposal would amend the Custody Rule and add a new Investment Company Act rule (Rule 17f-8) to include State trust companies as an additional, enumerated category of permitted custodian, subject to certain conditions. State trust companies could only act as custodians for crypto assets and related cash and/or cash equivalents under the Proposal, although the SEC asks whether they should be permitted custodians for other assets and, if so, which assets and why.

Prior to engaging a State trust company as a custodian, and on an annual basis thereafter, an adviser would have to form a reasonable basis, after due inquiry, to believe that the State trust company:

• is authorized by the relevant State banking authority to engage in custodial activities; and
• maintains and implements policies and procedures reasonably designed to safeguard the crypto assets and cash/cash equivalents from the risk of theft, loss, misuse, and misappropriation, with such policies and procedures addressing, among other topics, private key management and cybersecurity.

In addition, the adviser must review the State trust company’s audited financial statements and internal control report annually. All crypto assets and related cash/cash equivalents held in the custody of a State trust company must be segregated from the State trust company’s assets, although segregation from the assets of other clients of the State trust company would not be required. An adviser would also be required to disclose use of State trust company custodians in its Form ADV and act in the best interests of its clients in the selection of a custodian consistent with its fiduciary duty of care.

A prior no-action letter issued in September 2025 (State Trust Company NAL) permitted the use of State trust companies as custodians for crypto assets, provided an adviser or regulated fund (as applicable) determined that a State trust company qualifies as a “bank” under the custody rules. Under the Proposal, an adviser or regulated fund (as applicable) would not need to make such a determination; however, a registered adviser or regulated fund could nonetheless determine that a State trust company qualifies as a “bank” and not be subject to the conditions discussed above. The Proposal would rescind the State Trust Company NAL.

The SEC indicates that it considered proposing other additional conditions, including a requirement that the registered adviser or regulated fund have a reasonable basis after due inquiry to conclude that the State trust company has insurance coverage for custodied crypto assets or that the State trust company is subject to capital requirements under applicable law or posts sufficient collateral to the adviser or regulated fund. To that end, the SEC asks whether it should delay the rescission of the State Trust Company NAL following the adoption of the Proposal to allow for a transition period to come into compliance with the conditions for State trust companies. The SEC asks whether State trust companies should be required to be subject to state regulatory regimes with specific requirements (e.g., capital requirements) and whether non-trust entities (such as those with a New York BitLicense) should be permitted custodians of crypto assets.

Yes. The proposed amendments to Item 9 of Form ADV Part 1A (the section where custody information is primarily reported) would require advisers to identify with check boxes the custody exceptions in Rule 223-1 on which the adviser relies. This section would require advisers to continuously monitor the specific exception(s) on which they rely for each client and file an other-than-annual amendment within 30 days of reliance on a new exception (e.g., promptly after obtaining fee deduction authority for the first time, relying on a standing letter of authorization, becoming aware that a client’s custodial agreement confers broad authority, etc.). Commenters should consider requesting that this reporting (if retained) be required only on an annual basis looking back over the preceding year.

Other changes to Form ADV Part 1A would add new reporting with respect to self-custody in Item 9, in Section 5.K for separate accounts, and in Section 7.B.1 for private funds. Section 7.B.1 would also include new reporting questions for “tokenized funds,” including the name of each crypto network used to record ownership of the fund.

Unlike a majority of recent SEC rulemakings, the Proposal includes no transition period and would require compliance as of the effective date of the final rules. Amendments to reporting forms (Form ADV, Form N-CEN) would be required as soon as SEC staff announce the forms have been updated and filing systems can accept them.

The proposed omission of any transition or compliance period could result in a number of compliance challenges (and potential foot faults) for advisers. For example, commenters should consider the extent to which they could be impacted by the following:

Discretionary trading. The Proposal provides that advisers could demonstrate compliance with the conditions to avoid custody through discretionary trading authority by amending IMAs or other arrangements to expressly prohibit the adviser or its related persons from transferring client funds or securities to itself or related persons or to any account that is not the client’s unless directed by the client. Although many contracts already contain similar language, many also make reference to the exercise of authority solely in connection with authorized trading. Advisers should conduct—and should have adequate time during a transition period to conduct—a review of client agreements to ensure appropriate contractual limitations to trading authority are included.

Form ADV. The proposed amendments to Item 9 of Form ADV Part 1A would require advisers to submit other-than-annual amendments promptly (i.e., within 30 days) of the effective date of the final rule. This would be a significantly truncated period for advisers to understand the amended form, obtain necessary data and information from appropriate teams internally, and engage with consultants or legal counsel to ensure compliance with new requirements. Commenters should consider requesting a transition period or an exception from the automatic effective date that would postpone compliance with amended Form ADV until each adviser’s first annual update.

Inadvertent custody of crypto assets. Advisers that have or may come into possession of portions of key material associated with certain crypto assets held by clients would inadvertently have custody of these assets as of the effective date of the final rule. A transition period would provide appropriate time for advisers to remove key material from their possession.

Operational, contractual, and recordkeeping obligations. The Proposal would require—and commenters should consider—other operational, contractual, and recordkeeping shifts necessary to come into compliance with the proposed rules. For example, advisers will need to ensure account statements are included or added to all notices and would violate proposed Rule 223-1(a)(2) if any notice does not include an account number as of the effective date of the final rule. In addition, advisers will need to ensure they have maintained all records required under the proposed amendments to Advisers Act Rule 204-2, including copies of any standing letters of authorization relied upon within the preceding five years.

The Proposal seeks to modernize various aspects of the custody rules. In some cases, the Proposal would incorporate concepts piloted in staff guidance to address interpretive and implementation challenges in the existing rules. For example, the Proposal contemplates:

• Codifying additional time for audits. For pooled investment vehicles relying on the audit exception under the Advisers Act custody rule, the Proposal would allow additional time for funds of funds (and funds of funds of funds) to deliver audited financial statements. The proposed 180-day and 260-day periods, respectively, reflect existing staff guidance.¹²
• Removing PCAOB registration requirement. The Custody Rule requires that an auditor performing certain engagements for purposes of complying with the rule must be registered with the PCAOB.¹³ The Proposal would remove this requirement. The SEC explained that, “[b]ecause the PCAOB does not currently examine or inspect accountants with respect to the services required under the Custody Rule, the PCAOB registration and inspection requirements are not an appropriate proxy for the quality of the audit and examination services required under the rule.”¹⁴
• Standing letters of authorization. The Proposal would provide that, if an adviser has custody solely because of a standing letter of authorization, it is not required to obtain a surprise exam. This position is similar to the view the staff expressed in a letter to the Investment Adviser Association in 2017.¹⁵
• Inadvertent custody. The Proposal would codify a position similar to existing staff guidance, under the Custody Rule, with respect to inadvertent custody.¹⁶ In particular, it would provide that an adviser need not comply with the rule to the extent that it has custody solely as a result of terms of a custodial agreement if (1) the adviser was not involved with selecting the custodian and (2) the adviser does not have knowledge of the agreement or has knowledge and notifies the client and custodian that it repudiates the authority giving rise to custody.
• BDC clarification. The custody rules would be updated to reflect that BDCs are subject to the Investment Company Act rules rather than the Advisers Act rule. Although this follows from Section 59 under current law, the rules (and Form ADV) have never been updated to reflect this treatment.

The Proposal does not, however, reflect a comprehensive codification of staff guidance. Accordingly, commenters may wish to review the existing positions on which they rely and consider advocating for these to be included. Unlike SEC rules, staff positions can change without the notice and comment process required under the Administrative Procedures Act and do not receive deference from courts. Commenters may wish to review, for example, positions related to the following:

• Loan administration. In the Madison Capital Funding No-Action Letter, the staff provided guidance that facilitated the ability of loan administrators to maintain agency accounts. Compliance can be a challenge under the Custody Rule because agency accounts may include both client and third party assets and because quarterly account statements would not provide meaningful information. Although the Madison conditions have proven onerous and would benefit from simplification, the letter was not cited or addressed in the Proposal. The comment period may provide an opportunity to advocate for a simplified and more durable position.
• Liquidation audits. Navigating the confusing and potentially expensive requirements for a liquidation audit is a perennial challenge for private funds in winddown. The SEC did not take this opportunity to clarify this requirement, which may benefit from attention in the comment file.¹⁷
• Privately offered securities. The Custody Rule provides a valuable exception for privately offered securities. The exception recognizes that the requirement to maintain securities with a qualified custodian is impractical for certain investments and unnecessary when alternative protections are available, such as limitations on transfer. As noted above, the SEC requested comment on whether to extend this exception to the Investment Company Act custody rules, and commenters may wish to encourage the SEC to do so. The Proposal does not, however, take this opportunity to update the exception in the Advisers Act rule. For example, the exception could benefit from codifying staff guidance concerning certificated securities that do not enable transfer.¹⁸ Commenters may wish to suggest improvements to this exception, either through codification of existing staff guidance or other improvements, such as expanding the exception to cover situations where limited transferability should not render the exception unavailable or clarifying that ownership of a privately offered security may be recorded by the issuer or its transfer agent using blockchain/distributed ledger technology.¹⁹

For privately offered securities whose ownership is maintained by a registered transfer agent, the SEC’s recent proposal to substantially modernize the regulatory framework for registered transfer agents may provide some assurance that maintaining custody with registered transfer agents mitigates the custodial risks of holding privately offered securities outside a permitted custodian. The transfer agent modernization proposal would introduce substantive new requirements covering written compliance policies and procedures, cybersecurity and operational risk management and business continuity planning.

• Escrow accounts and SPVs. The staff has previously provided guidance with respect to the use of escrow accounts and SPVs.²⁰ The guidance provides helpful clarification regarding treatment of assets in these accounts and vehicles for purposes of various Custody Rule provisions, including the audit provision. The Proposal previews the SEC’s intention to adopt the staff guidance on escrows as Commission-level guidance. However, the Proposal did not address the portion of the staff guidance related to SPVs. Commenters may wish to consider whether enhancements could be made to the escrow guidance and whether similar treatment should be afforded the guidance on SPVs.
• Regulated Fund Shares Held at Transfer Agents. The staff has previously granted no-action relief under the Investment Company Act custody rules—namely Rules 17f-2 and 17f-4—permitting a regulated fund to hold uncertificated shares of another regulated fund at the acquired fund’s registered transfer agent, including where that transfer agent was an affiliated person of the acquiring fund. Most recently, the staff extended this relief to a transfer agent that maintains the official record of share ownership using a blockchain-integrated recordkeeping system.²¹ Although the Proposal discusses this line of no-action relief and requests comment on whether the custody rules should address registered transfer agents, it does not attempt to modernize these rules—nor withdraw these prior letters—at this time. Commenters may nonetheless wish to suggest enhancements to the custody rules that would formally permit registered transfer agents to hold uncertificated shares of regulated funds in custody.