U.S. SEC’s new guidance targets paragraph (b)(1) of Rule 15c3-3

U.S. SEC Division of Trading and Markets has released today a statement guiding the application of Rule 15c3-3 on physical possession requirements to broker-dealers. According to the statement, five specific circumstances have been outlined under which the U.S. SEC would not object to deeming physical possession as a valid means of identification. 

The statement aims to provide detailed guidance on how broker-dealers can comply with custody obligations for crypto asset securities under existing federal rules. The U.S. SEC stated that the guidance is part of an effort to provide clarity on the application of the federal securities laws to crypto asset securities. Hester M. Peirce, SEC Commissioner, praised the statement’s clarity and called for prompt recommendations on potential amendments to the Rule 15c3-3. 

U.S. SEC’s new guidance targets paragraph (b)(1) of Rule 15c3-3 

Crypto asset securities have been defined as tokenized representations of equity or debt securities recorded on distributed ledger technology, according to the statement. The new guidance is part of paragraph (b)(1) of Rule 15c3-3 under the Securities Exchange Act of 1934, which allows and regulates broker-dealers to promptly obtain and maintain physical possession or control of all fully paid and excess margin securities carried for customer accounts.  

The U.S. SEC Division of Trading and Markets outlined that the new guidance applies to any broker-dealer handling crypto assets for customers, including firms engaged in both traditional securities operations and digital asset activities. The release follows inquiries from the market participants seeking a clearer rule applying to blockchain-based assets.   

According to the U.S. SEC Division for Trading and Markets, its views are confined to physical possession and do not extend to the control aspect, except for broker-dealer financial responsibility rules and additional federal securities law requirements. The staff noted that the statement carries no legal enforcement, does not modify applicable laws, and imposes no new or further obligations. 

Hester M. Peirce, U.S. SEC Commissioner, released a separate statement praising the clarity. She said the guidance now offers valuable clarity for broker-dealers that aim to provide custody services, especially through requirements for private key protection that align with industry best practices. Peirce thanked Jamie Selway, Director of the Trading and Markets division, and the staff for their efforts and urged the Division to prepare recommendations for the full Commission on amending Rule 15c3-3 to fully accommodate crypto asset custody. 

U.S. SEC issues five conditions for crypto possession compliance

The SEC crypto task force staff issued five circumstances in which they would not recommend enforcement action against a broker-dealer for taking physical possession of customer crypto asset securities. The first circumstance requires the broker-dealer that maintains direct custody to have immediate access to the asset and the technical ability to transfer it across the blockchain.  

Secondly, the broker-dealer must establish, maintain, and enforce reasonable, written policies and procedures for thorough assessments of the blockchain and its associated networks. The U.S. SEC further noted that the evaluations must be conducted before initiating custody and at reasonable subsequent intervals.

According to the U.S. SEC Division for Trading and Markets, key evaluation factors to be considered during assessments of the blockchain include performance reliability, transaction speed and throughput, scalability for increased activity, resilience in times of failure, and security features. Furthermore, the U.S. SEC stated that consensus mechanisms, complexity for maintenance, extensibility for new features, visibility through public code, and documentation are essential factors to consider during assessments.

Governance processes such as protocol upgrades, changes, airdrops, and token exchanges are also expected to be reviewed under the new guidance to detect weaknesses that may impair possession. 

The division’s third circumstance prevents claiming possession if the broker-dealer is aware of material security vulnerabilities, operational deficiencies, and other potential risks directly tied to custody of assets on the specific blockchain, independent of market or reputational concerns. 

The fourth circumstance requires the broker-dealer to have robust policies, procedures, and controls that are consistent with the industry best practices in safeguarding private keys against theft. 

Lastly, the fifth circumstance requires a pre-planned policy and procedures that address potential disruptions. These procedures are in response to events such as blockchain malfunctions or failures. Additionally, the pre-planned arrangements should include mechanisms to comply with court orders to seize, freeze, burn tokens, or blockchain transfers. 

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