Stradley Ronon’s FinTech Practice Group Chair Authors Article on Digital Asset Custody for 40 Act Funds

Stradley Ronon’s Fintech Practice Group Chair and Derivatives & Commodities Group Co-Chair Susan Gault-Brown recently authored an article published in The Review of Securities & Commodities Regulation. In the article, Gault-Brown offers a framework to interested individuals and fund sponsors that may respond to the SEC staff’s requested feedback on whether a registered fund investing in digital assets could satisfy the 1940 Act’s custody requirements. For background, in January 2018 the then-Director of the Division of Investment Management, Dalia Blass, sent a letter inviting industry groups and registered fund sponsors to engage with the SEC staff on issues surrounding registered funds holding digital assets. The article addresses one of the main issues in the SEC staff letter- how can a registered fund investing in digital assets satisfy 1940 Act custody requirements?

The article notes that under the custody rules “Every registered management company shall place and maintain its securities and similar investments in the custody of (A) certain banks; (B) certain national securities exchange members or (C) the fund itself, “but only in accordance with such rules and regulations or orders as the Commission may from time to time prescribe for the protection of investors.” Later the SEC promulgated rules clarifying “self-custody” arrangements under Rule 17f-2. The article states that when it comes to digital assets, ownership is considered “synonymous with ownership of a private key (a string of numbers and letters), which is a cryptographic tool that grants access to the digital asset.” The article notes that a physical form of this key, such as “a cold storage device” could be kept at a bank (the article notes several issues with gaining access to the key). The article goes on to note other issues with this arrangement including proper segregation and auditor verification requirements, among others.

The article also examines whether revisions to Rule 17f-4 in 2003 allow a path forward for digital asset custody. The author states that due to a variety of factors “it is unlikely that a registered fund seeking to invest in digital assets could comply with 1940 Act custody requirements through reliance on the current version of Rule 17f-4.” The article also notes that it is unlikely registered funds could rely on current SEC no-action letters and instead argues that responses to the SEC must “consider whether and how current digital asset custody methodologies support the policy goals and history of the 1940 Act custody requirements.”

Click here to read the article “Responding to the SEC Staff on the Custody of Digital Assets Under the 1940 Act.”