Document ID: SEC-2021-0281-0001
Agency: sec
Document Type: Rule
Title: Custody of Digital Asset Securities by Special Purpose Broker-Dealers
Posted Date: 2021-02-26T05:00Z

[Federal Register Volume 86, Number 37 (Friday, February 26, 2021)]
[Rules and Regulations]
[Pages 11627-11632]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-28847]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-90788; File No. S7-25-20]

Custody of Digital Asset Securities by Special Purpose Broker-
Dealers

AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Commission statement; request for comment.

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SUMMARY: The Commission is issuing a statement and requesting comment 
regarding the custody of digital asset securities by broker-dealers.

DATES: 
    Effective date: April 27, 2021.
    Comments due: You may submit comments at any time throughout the 
five-year term of this Commission Statement.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.htm); or
     Send an email to rule-comments@sec.gov. Please include 
File No. S7-25-20 on the subject line.

Paper Comments

     Send paper comments to Secretary, Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-25-20. This file number 
should be included on the subject line if email is used. To help the 
Commission process and review your comments more efficiently, please 
use only one method of submission. The Commission will post all 
comments on the Commission's website (http://www.sec.gov). Comments are 
also available for website viewing and printing in the Commission's 
Public Reference Room, 100 F Street NE, Washington, DC 20549, on 
official business days between the hours of 10:00 a.m. and 3:00 p.m. 
All comments received will be posted without change. Persons submitting 
comments are cautioned that we do not redact or edit personal 
identifying information from comment submissions. You should submit 
only information that you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Associate Director, at 
(202) 551-5521; Randall W. Roy, Deputy Associate Director, at (202) 
551-5522; Raymond A. Lombardo, Assistant Director, at 202-551-5755; 
Timothy C. Fox, Branch Chief, at (202) 551-5687; or A.J. Jacob, Special 
Counsel, at (202) 551-5583, Division of Trading and Markets, Securities 
and Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: 

I. Introduction

    The Commission is issuing this statement and request for comment to 
encourage innovation around the application of the Customer Protection 
Rule to digital asset securities.\1\ The

[[Page 11628]]

Commission envisions broker-dealers performing the full set of broker-
dealer functions with respect to digital asset securities--including 
maintaining custody of these assets--in a manner that addresses the 
unique attributes of digital asset securities and minimizes risk to 
investors and other market participants.\2\ Consequently, as discussed 
below, the Commission's position in this statement is premised on a 
broker-dealer limiting its business to digital asset securities to 
isolate risk and having policies and procedures to, among other things, 
assess a given digital asset security's distributed ledger technology 
and protect the private keys necessary to transfer the digital asset 
security. In this way, the Commission is cognizant of both investor 
protection and potential capital formation innovations that could 
result from digital asset securities.
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    \1\ For purposes of this statement, the term ``digital asset'' 
refers to an asset that is issued and/or transferred using 
distributed ledger or blockchain technology (``distributed ledger 
technology''), including, but not limited to, so-called ``virtual 
currencies,'' ``coins,'' and ``tokens.'' The focus of this statement 
is digital assets that rely on cryptographic protocols. A digital 
asset may or may not meet the definition of a ``security'' under the 
federal securities laws. See, e.g., Report of Investigation Pursuant 
to Section 21(a) of the Securities Exchange Act of 1934: The DAO, 
Exchange Act Release No. 81207 (July 25, 2017). As used in this 
statement, a ``digital asset security'' means a digital asset that 
meets the definition of a ``security'' under the federal securities 
laws. A digital asset that is not a security is referred to herein 
as a ``non-security digital asset.''
    \2\ See 17 CFR 240.15c3-3. The Commission staff has issued a 
joint statement with the Financial Industry Regulatory Authority on 
broker-dealer custody of digital asset securities (``Joint 
Statement''), as well as a no-action letter regarding the Joint 
Statement to broker-dealers operating alternative trading systems 
(``ATSs''). See Joint Staff Statement on Broker-Dealer Custody of 
Digital Asset Securities, dated July 8, 2019, available at https://www.sec.gov/news/public-statement/joint-staff-statement-broker-dealer-custody-digital-asset-securities. See also Letter to Ms. Kris 
Dailey, Financial Industry Regulatory Authority, ATS Role in the 
Settlement of Digital Asset Security Trades, dated September 25, 
2020 (discussing a three-step process broker-dealers use when 
operating an alternative trading system for the purpose of trading 
digital asset securities), available at https://www.sec.gov/divisions/marketreg/mr-noaction/2020/finra-ats-role-in-settlement-of-digital-asset-security-trades-09252020.pdf. Staff statements 
represent the views of the staff. They are not rules, regulations, 
or statements of the Commission. The Commission has neither approved 
nor disapproved their content. These staff statements, like all 
staff guidance, have no legal force or effect: they do not alter or 
amend applicable law, and they create no new or additional 
obligations for any person.
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    Rule 15c3-3 under the Securities Exchange Act of 1934 (hereinafter 
the ``Customer Protection Rule'' or ``Rule 15c3-3'') \3\ requires a 
broker-dealer to promptly obtain and thereafter maintain physical 
possession or control of all fully-paid and excess margin securities it 
carries for the account of customers.\4\ Market participants have 
raised questions concerning the application of the Customer Protection 
Rule to the potential custody of digital asset securities for customers 
by broker-dealers. The Commission is requesting comment in this area to 
provide the Commission and its staff with an opportunity to gain 
additional insight into the evolving standards and best practices with 
respect to custody of digital asset securities. The Commission intends 
to consider the public's comments in connection with any future 
rulemaking or other Commission action in this area.
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    \3\ See 17 CFR 240.15c3-3.
    \4\ See 17 CFR 240.15c3-3(b).
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    As an interim step, in addition to the request for comment, the 
Commission is issuing this statement. The Commission recognizes that 
the market for digital asset securities is still new and rapidly 
evolving. The technical requirements for transacting and custodying 
digital asset securities are different from those involving traditional 
securities. And traditional securities transactions often involve a 
variety of intermediaries, infrastructure providers, and counterparties 
for which there may be no analog in the digital asset securities 
market. The Commission supports innovation in the digital asset 
securities market to develop its infrastructure.
    In particular, the Commission's position, which will expire after a 
period of five years from the publication date of this statement, is 
that a broker-dealer operating under the circumstances set forth in 
Section IV will not be subject to a Commission enforcement action on 
the basis that the broker-dealer deems itself to have obtained and 
maintained physical possession or control of customer fully paid and 
excess margin digital asset securities for the purposes of paragraph 
(b)(1) of Rule 15c3-3.\5\ These broker-dealers will be subject to 
examination by the Financial Industry Regulatory Authority (``FINRA'') 
and Commission staff to review whether the firm is operating in a 
manner consistent with the circumstances described in Section IV below.
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    \5\ Pursuant to the Congressional Review Act, the Office of 
Information and Regulatory Affairs has designated this statement as 
a ``major rule'' as defined by 5 U.S.C. 804(2). See 5 U.S.C. 801 et 
seq.
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    The five-year period in which the statement is in effect is 
designed to provide market participants with an opportunity to develop 
practices and processes that will enhance their ability to demonstrate 
possession or control over digital asset securities. It also will 
provide the Commission with experience in overseeing broker-dealer 
custody of digital asset securities to inform further action in this 
area.

II. Background

    Customers who use broker-dealers registered with the Commission to 
custody their securities (and related cash) benefit from the 
protections provided by the federal securities laws, including the 
Customer Protection Rule and, in most cases, the Securities Investor 
Protection Act of 1970 (``SIPA'').\6\ Generally, the Commission's 
Customer Protection Rule requires a broker-dealer to segregate customer 
securities and related cash from the firm's proprietary business 
activities, other than those that facilitate customer transactions.\7\ 
The rule requires the broker-dealer to maintain physical possession or 
control over customers' fully paid and excess margin securities.\8\
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    \6\ 15 U.S.C. 78aaa, et seq. Under SIPA, customers' securities 
held by a broker-dealer that is a member of the Securities Investor 
Protection Corporation and customers' cash on deposit at such a 
broker-dealer for the purpose of purchasing securities would be 
isolated and readily identifiable as ``customer property'' and, 
consequently, available to be distributed to customers ahead of 
other creditors in the event of the broker-dealer's liquidation. Id.
    \7\ See Net Capital Requirements for Brokers and Dealers, 
Exchange Act Rel. No. 21651 (Jan. 11, 1985), 50 FR 2690, 2690 (Jan. 
18, 1985) (Rule 15c3-3 is designed ``to give more specific 
protection to customer funds and securities, in effect forbidding 
brokers and dealers from using customer assets to finance any part 
of their businesses unrelated to servicing securities customers; 
e.g., a firm is virtually precluded from using customer funds to buy 
securities for its own account'').
    \8\ See 17 CFR 240.15c3-3(b)(1).
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    Broker-dealer custody of securities is an integral service provided 
to the securities markets. However, broker-dealer custody of digital 
asset securities raises certain compliance questions with respect to 
the Customer Protection Rule. More specifically, while paragraph (b)(1) 
of Rule 15c3-3 requires that a broker-dealer ``control'' customer fully 
paid and excess margin securities, it may not be possible for a broker-
dealer to establish control over a digital asset security with the same 
control mechanisms used in connection with traditional securities. 
Moreover, there have been instances of fraud, theft, and loss with 
respect to the custodianship of digital assets, including digital asset 
securities.\9\
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    \9\ See generally, Report of the Attorney General's Cyber 
Digital Task Force: Cryptocurrency Enforcement Framework (October 
2020), at 15-16, available at https://www.justice.gov/ag/page/file/1326061/download.
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    The risks associated with digital assets, including digital asset 
securities, are due in part to differences in the clearance and 
settlement of traditional securities and digital assets. Traditional 
securities transactions generally are processed and settled through 
clearing agencies, depositories, clearing banks, transfer agents, and 
issuers. A broker-dealer's employees, regulators, and outside auditors 
can contact these third parties to confirm that the broker-dealer

[[Page 11629]]

is in fact holding the traditional securities reflected on its books 
and records and financial statements, thereby providing objective 
processes for examining the broker-dealer's compliance with the 
Customer Protection Rule. Also, the traditional securities 
infrastructure has established processes to reverse or cancel mistaken 
or unauthorized transactions. Thus, the traditional securities 
infrastructure contains checks and controls that can be used to verify 
proprietary and customer holdings of traditional securities by broker-
dealers, as well as processes designed to ensure that both parties to a 
transfer of traditional securities agree to the terms of the transfer.
    Digital assets that are issued or transferred using distributed 
ledger technology may not be subject to the same established clearance 
and settlement process familiar to traditional securities market 
participants.\10\ The manner in which digital assets, including digital 
asset securities, are issued, held, or transferred may create greater 
risk that a broker-dealer maintaining custody of this type of asset, as 
well as the broker-dealer's customers, counterparties, and other 
creditors, could suffer financial harm. For example, the broker-dealer 
could be victimized by fraud or theft, could lose a ``private key'' 
necessary to transfer a client's digital assets, or could transfer a 
client's digital assets to an unintended address without the ability to 
reverse a fraudulent or mistaken transaction. In addition, malicious 
activity attributed to actors taking advantage of potential 
vulnerabilities that may be associated with distributed ledger 
technology and its associated networks could render the broker-dealer 
unable to transfer a customer's digital assets.
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    \10\ The clearance and settlement of securities that are not 
digital assets are characterized by infrastructure whereby 
intermediaries such as clearing agencies and securities depositories 
serve as key participants in the process. The clearance and 
settlement of digital asset securities, on the other hand, generally 
rely on few, if any, intermediaries and remain evolving areas of 
practices and procedures.
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    The express language of the Customer Protection Rule includes cash 
and securities held at the broker-dealer. Therefore, customers holding 
digital assets that are not securities through a broker-dealer could 
receive less protection for those assets than customers holding 
securities. The potential liabilities caused by the theft or loss of 
non-securities property from a broker-dealer, including digital assets 
that are not securities, could cause the broker-dealer to incur 
substantial losses or even fail, impacting customers and other 
creditors. As a consequence, the broker-dealer may need to be 
liquidated in a proceeding under SIPA. SIPA protection does not extend 
to all assets that may be held at a broker-dealer. Consequently, in a 
SIPA liquidation of a broker-dealer that held non-security assets, 
including non-security digital assets, investors may be treated as 
general creditors, to the extent their claims involve assets that are 
not within SIPA's definition of ``security.'' \11\
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    \11\ Generally, SIPA defines the term ``security'' to include, 
among other things, any note, stock, treasury stock bond, debenture, 
evidence of indebtedness, any investment contract or certificate of 
interest or participation in any profit-sharing agreement, provided 
that such investment contract or interest is the subject of a 
registration statement with the Commission pursuant to the 
Securities Exchange Act of 1933 (15 U.S.C. 77a et seq.), and any 
put, call, straddle, option, or privilege on any security, or group 
or index of securities. See 15 U.S.C. 78lll(14). Generally, in a 
SIPA liquidation, customers' claims receive priority to the estate 
of customer property (generally cash and securities received 
acquired or held by the broker-dealer for the securities accounts of 
customers) over other creditors. See 15 U.S.C. 78fff & 78fff-2(c). 
In addition, to the extent that the estate of customer property is 
insufficient to satisfy the net equity claims of customers, the 
trustee can advance up to $500,000 for each customer, of which up to 
$250,000 can be used for cash claims. See 15 U.S.C. 78fff-3(a) & 
(d).
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III. Discussion

    A broker-dealer that maintains custody of a fully paid or excess 
margin digital asset security for a customer must hold it in a manner 
that complies with Rule 15c3-3, including that the digital asset 
security must be in the exclusive physical possession or control of the 
broker-dealer.\12\ A digital asset security that is not in the 
exclusive physical possession or control of the broker-dealer because, 
for example, an unauthorized person knows or has access to the 
associated private key (and therefore has the ability to transfer it 
without the authorization of the broker-dealer) would not be held in a 
manner that complies with the possession or control requirement of Rule 
15c3-3 and thus would be vulnerable to the risks the rule seeks to 
mitigate.
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    \12\ See 17 CFR 240.15c3-3(b).
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    As noted above, the loss or theft of digital asset securities may 
cause the firm and its digital asset customers to incur substantial 
financial losses. This, in turn, could cause the firm to fail, 
imperiling its traditional securities customers as well as the broker-
dealer's counterparties and other market participants. However, there 
are measures a broker-dealer can employ to comply with Rule 15c3-3 and 
mitigate these risks.
    One step that a broker-dealer could take to shield traditional 
securities customers, counterparties, and market participants from the 
risks and consequences of digital asset security fraud, theft, or loss 
would be to limit its business exclusively to dealing in, effecting 
transactions in, maintaining custody of, and/or operating an 
alternative trading system for digital asset securities. Thus, to 
operate in a manner consistent with the Commission's position, the 
broker-dealer could not deal in, effect transactions in, maintain 
custody of, or operate an alternative trading system for traditional 
securities. In addition, by limiting its activities exclusively to 
digital asset securities, the broker-dealer would shield its customers 
from the risks that could arise if the firm engaged in activities 
involving non-security digital assets, which are not expressly governed 
by the Customer Protection Rule. For example, to the extent that the 
requirements of the Customer Protection Rule do not apply to non-
security digital assets, such assets could receive less protection than 
securities, which would increase the risk of theft or loss and could 
ultimately cause the broker-dealer to fail, impacting customers and 
other creditors.
    A second step the broker-dealer could take is to establish, 
maintain, and enforce reasonably designed written policies and 
procedures to conduct and document an analysis of whether a digital 
asset is a security offered and sold pursuant to an effective 
registration statement or an available exemption from registration, and 
whether the broker-dealer has fulfilled its requirements to comply with 
the federal securities laws with respect to effecting transactions in 
that digital asset security, before undertaking to effect transactions 
in and maintain custody of such asset. Such policies and procedures 
should provide a reasonable level of assurance that any digital assets 
transacted in or held in custody by the broker-dealer are in fact 
digital asset securities. Utilizing such policies and procedures should 
help ensure that the broker-dealer is confining its business to digital 
asset securities and that such digital asset securities are being 
offered, sold, or otherwise transacted in compliance with the federal 
securities laws.
    A third step the broker-dealer could take is to establish, 
maintain, and enforce reasonably designed written policies and 
procedures to conduct and document an assessment of the characteristics 
of a digital asset security's distributed ledger technology

[[Page 11630]]

and associated network \13\ prior to undertaking to maintain custody of 
the digital asset security and at reasonable intervals thereafter. The 
assessment could examine at least the following aspects of the 
distributed ledger technology and its associated network, among others: 
(1) Performance (i.e., does it work and will it continue to work as 
intended); (2) transaction speed and throughput (i.e., can it process 
transactions quickly enough for the intended application(s)); (3) 
scalability (i.e., can it handle a potential increase in network 
activity); (4) resiliency (i.e., can it absorb the impact of a problem 
in one or more parts of its system and continue processing transactions 
without data loss or corruption); (5) security and the relevant 
consensus mechanism (i.e., can it detect and defend against malicious 
attacks, such as 51% attacks \14\ or Denial-of-Service attacks, without 
data loss or corruption); (6) complexity (i.e., can it be understood, 
maintained, and improved); (7) extensibility (i.e., can it have new 
functionality added, and continue processing transactions without data 
loss or corruption); and (8) visibility (i.e., are its associated code, 
standards, applications, and data publicly available and well 
documented). The assessment also could examine the governance of the 
distributed ledger technology and associated network and how protocol 
updates and changes are agreed to and implemented. This would include 
an assessment of impacts to the digital asset security of events such 
as protocol upgrades, hard forks, airdrops, exchanges of one digital 
asset for another, or staking.\15\ Such assessments would allow a 
broker-dealer to be able to identify significant weaknesses or other 
operational issues with the distributed ledger technology and 
associated network utilized by the digital asset security, or other 
risks posed to the broker-dealer's business by the digital asset 
security, which would allow a broker-dealer to take appropriate action 
to identify and reduce its exposure to such risks. Accordingly, if 
there are significant weaknesses or other operational issues with the 
distributed ledger technology and associated network, the broker-dealer 
would be able to determine whether it could or could not maintain 
custody of the digital asset security.
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    \13\ For the purposes of this statement, a digital asset 
security's distributed ledger technology and associated network 
includes the protocols and any smart contracts or applications 
integral to the operation of the digital asset security.
    \14\ For the purposes of this statement, a ``51% attack'' is an 
attack on a blockchain or distributed ledger in which an attacker or 
group of attackers controls a majority of the network's hash rate, 
mining or computing power, allowing the attacker or group of 
attackers to prevent new transactions from being confirmed.
    \15\ For purposes of this statement, ``hard forks'' refer to 
backward-incompatible protocol changes to a distributed ledger that 
create additional versions of the distributed ledger, potentially 
creating new digital assets. ``Airdrops'' refer to the distribution 
of digital assets to numerous addresses, usually at no monetary cost 
to the recipient or in exchange for certain promotional services. 
``Staking'' refers to the use of a digital asset in a consensus 
mechanism.
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    A fourth step the broker-dealer could take is to establish, 
maintain, and enforce reasonably designed written policies, procedures, 
and controls for safekeeping and demonstrating the broker-dealer has 
exclusive possession or control over digital asset securities that are 
consistent with industry best practices to protect against the theft, 
loss, and unauthorized and accidental use of the private keys necessary 
to access and transfer the digital asset securities the broker-dealer 
holds in custody. These policies, procedures, and controls could 
address, among other matters: (1) The on-boarding of a digital asset 
security such that the broker-dealer can associate the digital asset 
security to a private key over which it can reasonably demonstrate 
exclusive physical possession or control; (2) the processes, software 
and hardware systems, and any other formats or systems utilized to 
create, store, or use private keys and any security or operational 
vulnerabilities of those systems and formats; (3) the establishment of 
private key generation processes that are secure and produce a 
cryptographically strong private key that is compatible with the 
distributed ledger technology and associated network and that is not 
susceptible to being discovered by unauthorized persons during the 
generation process or thereafter; (4) measures to protect private keys 
from being used to make an unauthorized or accidental transfer of a 
digital asset security held in custody by the broker-dealer; and (5) 
measures that protect private keys from being corrupted, lost or 
destroyed, that back-up the private key in a manner that does not 
compromise the security of the private key, and that otherwise preserve 
the ability of the firm to access and transfer a digital asset security 
it holds in the event a facility, software, or hardware system, or 
other format or system on which the private keys are stored and/or used 
is disrupted or destroyed. These policies, procedures, and controls for 
safekeeping and demonstrating the broker-dealer has exclusive 
possession or control over digital asset securities should serve to 
protect against the theft, loss, and unauthorized and accidental use of 
the private keys and therefore the customers' digital asset securities.
    A fifth step the broker-dealer could take is to establish, 
maintain, and enforce reasonably designed written policies, procedures, 
and arrangements to: (1) Specifically identify, in advance, the steps 
it intends to take in the wake of certain events that could affect the 
firm's custody of the digital asset securities, including blockchain 
malfunctions, 51% attacks, hard forks, or airdrops; (2) allow the 
broker-dealer to comply with a court-ordered freeze or seizure; and (3) 
allow the transfer of the digital asset securities held by the broker-
dealer to another special purpose broker-dealer, a trustee, receiver, 
liquidator, a person performing a similar function, or another 
appropriate person, in the event the broker-dealer can no longer 
continue as a going concern and self-liquidates or is subject to a 
formal bankruptcy, receivership, liquidation, or similar proceeding. 
These policies and procedures should include measures for ensuring 
continued safekeeping and accessibility of the digital asset 
securities, even if the broker-dealer is wound down or liquidated, and 
thus would provide a reasonable level of assurance that a broker-dealer 
has developed plans to address unexpected disruptions to the broker-
dealer's control over digital asset securities.
    A sixth step the broker-dealer could take is to provide written 
disclosures to prospective customers about the risks of investing in or 
holding digital asset securities. The disclosures could include, among 
other matters: (1) Prominent disclosure explaining that digital asset 
securities may not be ``securities'' as defined in SIPA \16\--and in 
particular, digital asset securities that are ``investment contracts'' 
under the Howey test \17\ but are not registered with the Commission 
are excluded from SIPA's definition of ``securities''--and thus the 
protections afforded to securities customers under SIPA may not apply 
with respect to those securities; (2) a description of the risks of 
fraud, manipulation, theft, and loss associated with digital asset 
securities; (3) a description of the risks relating to valuation, price 
volatility, and liquidity associated with digital asset securities; and 
(4) a description of the processes, software and hardware systems, and 
any other formats or systems utilized by the broker-dealer to create, 
store, or use the broker-dealer's private keys and protect them from 
loss, theft, or unauthorized or accidental use (including, but not 
limited to, cold storage, key sharding,

[[Page 11631]]

multiple factor identification, and biometric authentication). The 
purpose of such disclosures is to provide the prospective customers 
with sufficient and easily understandable information about the risks 
to enable them to make informed decisions about whether to invest in or 
hold digital asset securities through the broker-dealer.
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    \16\ 15 U.S.C. 78lll(14).
    \17\ See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
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    A seventh step the broker-dealer could take is to enter into a 
written agreement with each customer that sets forth the terms and 
conditions with respect to receiving, purchasing, holding, safekeeping, 
selling, transferring, exchanging, custodying, liquidating, and 
otherwise transacting in digital asset securities on behalf of the 
customer.\18\ This step would ensure documentation of the terms of 
agreement between the customer and the broker-dealer providing custody 
of the customer's digital asset security, which would provide greater 
clarity and certainty to customers regarding their rights and 
responsibilities under the agreement with the broker-dealer.
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    \18\ The agreement should contain such provisions and 
disclosures as are required by applicable laws, rules, and 
regulations.
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IV. Commission Position

    The Commission's position \19\ is expressly limited to paragraph 
(b) of Rule 15c3-3 under the Securities Exchange Act of 1934 
(``Exchange Act''). Furthermore, the Commission's position does not 
modify or change any obligations of a broker-dealer, or other party, to 
otherwise comply with the federal securities laws, including the 
broker-dealer financial responsibility rules, obligations regarding 
proxy voting and beneficial ownership communications, as well as the 
broker-dealer's obligation to become a member of FINRA and to comply 
with applicable anti-money laundering and countering the financing of 
terrorism obligations under the Bank Secrecy Act.\20\ All terms used in 
this Commission position will have the definitions set forth in Rule 
15c3-3. Finally, the Commission's position, which will expire after a 
period of five years from the publication date of this statement, 
applies only to the exercise of its enforcement discretion with respect 
to compliance with paragraph (b)(1) of Rule 15c3-3 under the 
circumstances set forth below. During this period, the Commission will 
continue to evaluate its position, and the circumstances set forth 
below, on an ongoing basis as it considers responses to the request for 
comments as well as further action in this area, including any future 
rulemaking.
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    \19\ The Commission's position is an agency statement of general 
applicability with future effect designed to implement, interpret, 
or prescribe law or policy.
    \20\ See Heath Tarbert, Chairman, U.S. Commodity Futures Trading 
Commission, Kenneth A. Blanco, Director, Financial Crimes 
Enforcement Network, and Jay Clayton, Chairman, Commission, Leaders 
of CFTC, FinCEN, and SEC Issue Joint Statement on Activities 
Involving Digital Assets, dated Oct. 11, 2019 (reminding persons 
engaged in activities involving digital assets of their anti-money 
laundering (``AML'') and countering the financing of terrorism 
(``CFT'') obligations under the Bank Secrecy Act, and stating that 
broker-dealers are required to implement reasonably-designed AML 
programs and report suspicious activity, and that such requirements 
are not limited in their application to activities involving digital 
assets that are ``securities'' under the federal securities laws), 
available at https://www.sec.gov/news/public-statement/cftc-fincen-secjointstatementdigitalassets.
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    After considering the minimum steps that can be taken to mitigate 
the risks posed by broker-dealer custody of digital asset securities, 
for a period of five years, the Commission's position is that a broker-
dealer in the following circumstances would not be subject to a 
Commission enforcement action on the basis that the broker-dealer deems 
itself to have obtained and maintained physical possession or control 
of customer fully paid and excess margin digital asset securities:
    1. The broker-dealer has access to the digital asset securities and 
the capability to transfer them on the associated distributed ledger 
technology;
    2. The broker-dealer limits its business to dealing in, effecting 
transactions in, maintaining custody of, and/or operating an 
alternative trading system for digital asset securities; provided a 
broker-dealer may hold proprietary positions in traditional securities 
solely for the purposes of meeting the firm's minimum net capital 
requirements under Rule 15c3-1,\21\ or hedging the risks of its 
proprietary positions in traditional securities and digital asset 
securities.
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    \21\ 17 CFR. 240.15c3-1.
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    3. The broker-dealer establishes, maintains, and enforces 
reasonably designed written policies and procedures to conduct and 
document an analysis of whether a particular digital asset is a 
security offered and sold pursuant to an effective registration 
statement or an available exemption from registration, and whether the 
broker-dealer meets its requirements to comply with the federal 
securities laws with respect to effecting transactions in the digital 
asset security, before undertaking to effect transactions in and 
maintain custody of the digital asset security;
    4. The broker-dealer establishes, maintains, and enforces 
reasonably designed written policies and procedures to conduct and 
document an assessment of the characteristics of a digital asset 
security's distributed ledger technology and associated network prior 
to undertaking to maintain custody of the digital asset security and at 
reasonable intervals thereafter;
    5. The broker-dealer does not undertake to maintain custody of a 
digital asset security if the firm is aware of any material security or 
operational problems or weaknesses with the distributed ledger 
technology and associated network used to access and transfer the 
digital asset security, or is aware of other material risks posed to 
the broker-dealer's business by the digital asset security;
    6. The broker-dealer establishes, maintains, and enforces 
reasonably designed written policies, procedures, and controls that are 
consistent with industry best practices to demonstrate the broker-
dealer has exclusive control over the digital asset securities it holds 
in custody and to protect against the theft, loss, and unauthorized and 
accidental use of the private keys necessary to access and transfer the 
digital asset securities the broker-dealer holds in custody;
    7. The broker-dealer establishes, maintains, and enforces 
reasonably designed written policies, procedures, and arrangements to: 
(i) Specifically identify, in advance, the steps it will take in the 
wake of certain events that could affect the firm's custody of the 
digital asset securities, including, without limitation, blockchain 
malfunctions, 51% attacks, hard forks, or airdrops; (ii) allow for the 
broker-dealer to comply with a court-ordered freeze or seizure; and 
(iii) allow for the transfer of the digital asset securities held by 
the broker-dealer to another special purpose broker-dealer, a trustee, 
receiver, liquidator, or person performing a similar function, or to 
another appropriate person, in the event the broker-dealer can no 
longer continue as a going concern and self-liquidates or is subject to 
a formal bankruptcy, receivership, liquidation, or similar proceeding;
    8. The broker-dealer provides written disclosures to prospective 
customers: (i) That the firm is deeming itself to be in possession or 
control of digital asset securities held for the customer for the 
purposes of paragraph (b)(1) of Rule 15c3-3 based on its compliance 
with this Commission position; and (ii) about the risks of investing in 
or holding digital asset securities that, at a minimum: (a) Prominently 
disclose that digital asset securities may not be ``securities'' as 
defined in SIPA--and in particular, digital asset securities that are 
``investment contracts'' under the

[[Page 11632]]

Howey test but are not registered with the Commission are excluded from 
SIPA's definition of ``securities''--and thus the protections afforded 
to securities customers under SIPA may not apply; (b) describe the 
risks of fraud, manipulation, theft, and loss associated with digital 
asset securities; (c) describe the risks relating to valuation, price 
volatility, and liquidity associated with digital asset securities; and 
(d) describe, at a high level that would not compromise any security 
protocols, the processes, software and hardware systems, and any other 
formats or systems utilized by the broker-dealer to create, store, or 
use the broker-dealer's private keys and protect them from loss, theft, 
or unauthorized or accidental use; \22\ and
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    \22\ The broker-dealer will need to retain these written 
disclosures in accordance with the broker-dealer record retention 
rule. See 17 CFR 240.17a-4(b)(4).
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    9. The broker-dealer enters into a written agreement with each 
customer that sets forth the terms and conditions with respect to 
receiving, purchasing, holding, safekeeping, selling, transferring, 
exchanging, custodying, liquidating and otherwise transacting in 
digital asset securities on behalf of the customer.\23\
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    \23\ The broker-dealer will need to retain these written 
agreements in accordance with the broker-dealer record retention 
rule. See 17 CFR 240.17a-4(b)(7).
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V. Request for Comment

    The Commission is seeking comment on the specific questions below. 
When responding to the request for comment, please explain your 
reasoning.
    1. What are industry best practices with respect to protecting 
against theft, loss, and unauthorized or accidental use of private keys 
necessary for accessing and transferring digital asset securities? What 
are industry best practices for generating, safekeeping, and using 
private keys? Please identify the sources of such best practices.
    2. What are industry best practices to address events that could 
affect a broker-dealer's custody of digital asset securities such as a 
hard fork, airdrop, or 51% attack? Please identify the sources of such 
best practices.
    3. What are the processes, software and hardware systems, or other 
formats or systems that are currently available to broker-dealers to 
create, store, or use private keys and protect them from loss, theft, 
or unauthorized or accidental use?
    4. What are accepted practices (or model language) with respect to 
disclosing the risks of digital asset securities and the use of private 
keys? Have these practices or the model language been utilized with 
customers?
    5. Should the Commission expand this position in the future to 
include other businesses such as traditional securities and/or non-
security digital assets? Should this position be expanded to include 
the use of non-security digital assets as a means of payment for 
digital asset securities, such as by incorporating a de minimis 
threshold for non-security digital assets?
    6. What differences are there in the clearance and settlement of 
traditional securities and digital assets that could lead to higher or 
lower clearance and settlement risks for digital assets as compared to 
traditional securities?
    7. What specific benefits and/or risks are implicated in a broker-
dealer operating a digital asset alternative trading system that the 
Commission should consider for any future measures it may take?

    By the Commission.

    Dated: December 23, 2020.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2020-28847 Filed 2-25-21; 8:45 am]
BILLING CODE 8011-01-P