July 9, 2019 | AtoZ Markets – The United States Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) have published a new statement, in which both regulatory bodies discussed security, protection and compliance-related issues pertinent to cryptocurrency custodians.
In the announcement published July 8, both organisations shed light on how can a cryptocurrency custodian meet the SEC’s Customer Protection Rules, which reads: “Put simply, the Customer Protection Rule requires broker-dealers to safeguard customer assets and to keep customer assets separate from the firm’s assets, thus increasing the likelihood that customers’ securities and cash can be returned to them in the event of the broker-dealer’s failure.”
Possessing the key does not mean you are the owner!
Both financial watchdogs stressed in their report that holding the key of the wallet does not sufficiently demonstrate the ownership of the wallet.
“In particular, a broker-dealer may face challenges in determining that it, or its third-party custodian, maintains custody of digital asset securities. If, for example, the broker-dealer holds a private key, it may be able to transfer such securities reflected on the blockchain or distributed ledger. However, the fact that a broker-dealer (or its third party custodian) maintains the private key may not be sufficient evidence by itself that the broker-dealer has exclusive control of the digital asset security (e.g., it may not be able to demonstrate that no other party has a copy of the private key and could transfer the digital asset security without the broker-dealer’s consent). In addition, the fact that the broker-dealer (or custodian) holds the private key may not be sufficient to allow it to reverse or cancel mistaken or unauthorized transactions. These risks could cause securities customers to suffer losses, with corresponding liabilities for the broker-dealer, imperiling the firm, its customers, and other creditors.” As the report noted under the sub-header Considerations for Digital Asset Securities, under The Customer Protection Rule.
Customers are eligible for up to $500,000 in protection
According to the Securities Investor Protection Act of 1970, “a broker-dealer that fails and is unable to return the customer property that it holds would be liquidated in accordance with SIPA. Under SIPA, securities customers have a first priority claim to cash and securities held by the firm for securities customers. Customers also are eligible for up to $500,000 in protection (of which up to $250,000 can be used for cash claims) if the broker-dealer is missing customer assets. These SIPA protections apply to a “security” as defined in SIPA and cash deposited with the broker-dealer for the purpose of purchasing securities. They do not apply to other types of assets, including, importantly, assets that are securities under the federal securities laws but are excluded from the definition of “security” under SIPA.” As the SEC published on its website.
In retrospect, both the SEC and FINRA had scheduled a broker-dealer meeting in Chicago on June 27 to discuss cryptocurrency-related issues, including “regulatory hot topics” and cybersecurity, in addition to digital assets in general.