Alex Reilly

Proposed Adviser Self-Custody Framework

The centerpiece of the Proposal is a new exception from the traditional QC requirement that would permit an adviser to self-custody client crypto assets in limited circumstances. The SEC recognizes that the number of QCs capable of supporting many crypto assets remains limited. In particular, advisers seeking exposure to a new or novel crypto asset may encounter circumstances in which no QC offers custody services for that asset. The Proposal would require that, to self-custody a client’s crypto assets, including crypto assets of a regulated fund, an adviser must make certain determinations and meet the requirements outlined below.

QC Determination. The Proposal would require that an adviser make a written “QC determination” prior to taking self-custody of each crypto asset, and no less frequently than quarterly thereafter, that the adviser has a reasonable basis, after due inquiry, for believing that no QC will maintain the crypto asset. The Proposal follows (and would not withdraw) existing no-action letters granted under Section 17(f) of the 1940 Act regarding any QC determination made with respect to the account of a regulated fund.

Safeguarding Expertise and Systems. The Proposal requires an adviser that self-custodies crypto assets to demonstrate expertise in safeguarding each crypto asset and document the basis for that determination. The adviser would also need to adopt, implement and maintain safeguarding systems designed to protect those crypto assets against loss, theft, misuse and misappropriation, and implement measures mitigating the heightened cybersecurity risks associated with crypto assets. The SEC views these requirements as essential to enhancing investor protection because the adviser assumes responsibilities ordinarily handled by an independent QC.

Internal Controls, Audits and Reporting:

• Annual Review. The Proposal requires advisers that have self-custody of client crypto assets to review, within a year of taking custody of each crypto asset and then no less frequently than annually: (1) the adviser’s safeguarding systems and (2) the cybersecurity controls implemented pursuant to the proposed cybersecurity requirement.
• Internal Control Report. The Proposal would require an adviser that takes self-custody of client crypto assets to obtain (within six months of taking custody and then at least annually) an internal control report (ICR) prepared by an independent public accountant.
• Self-Custody Account Statements to Clients. Advisers would send account statements, or, alternatively, transmit or arrange for the transmission of information required in account statements, at least quarterly to advisory clients for which they self-custody crypto assets. Exceptions to the account statement requirement would be: (1) an account of a limited partnership that undergoes a financial statement audit at least annually and upon liquidation; or (2) an adviser that holds crypto assets in self-custody with respect to an account of a regulated fund.

Implications Regarding Self-Custody of Crypto Assets

The Proposal acknowledges that the current custody frameworks were developed largely with traditional financial assets in mind and that advisers may be more appropriately suited to self-custody client crypto assets, including those of a regulated fund. The Proposal extends to regulated funds and business development companies (BDCs) seeking to maintain crypto assets through adviser self-custody arrangements. A fund may rely on the framework to the extent its adviser complies with self-custody requirements and additional fund-specific conditions are satisfied. In the Proposing Release, the SEC explains that, absent regulatory changes, investors may be unable to obtain exposure to certain crypto assets because suitable custodians are unavailable. The Proposal seeks to address that concern while requiring safeguards against loss, theft, misuse and misappropriation.

Expanded Board Responsibilities. Before an adviser self-custodies a fund's crypto assets, the fund’s board would be required to determine that the assets would be subject to reasonable care under the proposed arrangement. A fund board would be required to review the adviser's QC determination that no eligible custodian is available for the relevant asset, and to pursue ongoing board oversight and determinations, including, but not limited to, quarterly reviews and an annual determination that the crypto assets would be subject to reasonable care.

State Trust Companies as Crypto Custodians. The Proposal adds state trust companies as an additional category of permitted custodians for crypto assets, subject to certain safeguarding and asset segregation conditions, without determining that those companies qualify as “banks” under the Advisers Act or 1940 Act.[2] Before engaging a state trust company as a custodian for crypto assets, and annually thereafter, an adviser or regulated fund would be required to receive and review the company’s audited annual financial statements and most recent ICR, and would also need to make a reasonable basis determination that the company meets certain conditions. The Proposal codifies no-action relief granted in September 2025 and provides an express regulatory framework regarding the use of state trust companies as crypto asset custodians.[3]

Safekeeping remains paramount, regardless of technical requirements. Crypto assets are potentially easier to lose control over, and more challenging to replace if lost, than traditional securities. Hacks and other incidents, including the recent Binance incident, continue to demonstrate risks of holding crypto assets.[4]

Broader Implications for Advisers

The Proposal would address custody issues for advisers well beyond the crypto space, including codifying past guidance and addressing long-standing industry concerns.

Discretionary Trading Authority. The Proposal would resolve a long-standing issue related to discretionary trading of securities that settle outside of DVP. The SEC recognizes that the Advisers Act custody rule is not generally intended to address risks related to settlement failure and proposes a conditional exception that would apply to discretionary trading authority involving both DVP and non-DVP transactions. Consequently, non-DVP settlement would not, by itself, require an adviser to comply with the custody rule where its discretionary trading authority and actual trading satisfy the proposed conditions.

Standing Letters of Authorization. The Proposal would exempt an adviser whose custody arises solely from a qualifying standing letter of authorization (SLOA) from the surprise examination requirement, but not from the custody rule’s other applicable requirements. The proposed exception follows a similar position taken in existing SEC staff no-action relief.[5]

Inadvertent Custody

The Proposal would except from compliance with the Advisers Act custody rule advisers with custody of client funds and securities solely due to a custodian arrangement under which:

• The adviser did not recommend, request or require that the client select the QC maintaining such funds and securities.
• Either: (1) the adviser has neither a copy of the client’s custodian agreement nor any awareness of a custodial arrangement between the client and a QC conferring custody upon the adviser; or (2) if the adviser is aware of such an arrangement, the adviser promptly notifies the client and QC in writing repudiating such authority. The adviser must also request in writing that such authority be removed from the custodial agreement or be superseded by a new agreement, which does not confer custody on the adviser.

The Proposal would not require advisers to review every client custodial arrangement; however, it suggests advisers have reasonably designed policies and procedures in place to address circumstances where they realize they have custody inadvertently from a custodial agreement.[6]

Broader Implications for Regulated Funds

The proposed amendments would modernize the use of broker-dealers as custodians including by removing all conditions in current Rule 17f-1 related to segregation, rehypothecation, liens, examination, inspection and possession, and rescinding Form N-17f-1. Further, the Proposal would remove the requirements for the custodial contract to be ratified annually by the fund’s board and filed with the SEC. Instead, funds generally could maintain custody of fund assets with broker-dealers that comply with existing customer protection rules.[7] The Proposal states that, under the proposed rules, relevant assets of a regulated fund would “receive the same level of protections as other customers of the broker-dealer, while eliminating antiquated and duplicative regulatory burdens.”[8]

The SEC acknowledges and asks for comments on other challenges for regulated funds, including assets maintained at custodians that are affiliated with the fund’s investment adviser in certain ways, certain types of uncertificated securities (e.g., regulated fund shares, privately offered securities, and loans) and collateral for certain types of cleared swap contracts. For example, the SEC seeks comment on whether transfer agents should be permitted to custody fund assets or whether an exception, similar to that under the Advisers Act for privately offered securities, should replace the vaulting, access, notation and examination requirements for uncertificated interests.

Implications for Private Funds

Removal of the Stub Year Audit Requirement. The Proposal would allow a pooled investment vehicle formed during the last 90 days of its fiscal year to avoid a separate audit for that initial stub period, provided it distributes financial statements for the stub period (which may be unaudited) to investors within 90 days after the first fiscal year ends. After the end of the second fiscal year, the vehicle would then distribute audited financial statements covering both the initial stub period and the entire second fiscal year.

Codifies Fund-of-Funds Guidance. The Proposal would increase the deadline for auditors to prepare audited financial statements for fund of funds and fund of funds of funds to 180 days and 260 days, respectively.

Generally Accepted Accounting Principles (GAAP) Audits. The Proposal would permit an adviser to use non-U.S. GAAP (e.g., International Accounting Standards) financial statements, if such financial statements contain information that is substantially similar to financial statements prepared in accordance with U.S. GAAP and contain a footnote reconciling any material variations between such comprehensive body of accounting standards and U.S. GAAP.

Removal of the PCAOB Requirement. The Proposal would remove the requirement that accountants and auditors be registered with, and subject to regular inspection by, the PCAOB. An independent public accountant would still be required to audit a pooled investment vehicle’s annual financial statements, and to conduct a surprise examination or prepare an ICR.

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