The staff of the Securities and Exchange Commission’s (SEC) Division of Trading and Markets has released comprehensive guidance addressing how existing federal securities laws apply to cryptocurrency activities. 

The newly published document addresses questions regarding broker-dealer financial responsibility, transfer agents, and the trading of security and non-security crypto asset pairs by National Securities Exchanges and Alternative Trading Systems, as well as Exchange-Traded Products.

Brokers are allowed to facilitate “in-kind” transactions

In 2020, the SEC issued a statement offering a safe harbor for brokers who followed specific, strict steps to custody digital assets. That statement is not mandatory. Brokers can still custody crypto securities by following the standard existing rules.

According to the update, the rule (15c3-3), which requires broker-dealers to keep customer securities safe, doesn’t apply if a crypto asset isn’t a security. But if it is a security, broker-dealers can use a different part of the rule (paragraph c) to keep it safe, even if it’s digital, not paper. 

Brokers are allowed to facilitate “in-kind” transactions. However, if the broker holds the crypto asset itself, like Bitcoin or Ether, on its own books, it must account for the risk.

Additionally, to protect non-security crypto assets held by a broker-dealer, customers may be able to have the assets treated as “financial assets” under Article 8 of the Uniform Commercial Code. 

This would mean the assets are held in a “securities account” and are more likely to be returned to customers if the broker-dealer goes bust. However, SIPC (the Securities Investor Protection Corporation) doesn’t cover these non-security crypto assets, so there’s still a risk of loss

An investor working with a crypto asset that’s a security should verify if the entity handling the asset is registered with the SEC as a transfer agent. However, it depends on the activities involved. 

If they’re registering transfers, monitoring issuances, or exchanging securities, and the asset is registered with the SEC, then registration is likely required. The investor must ensure the entity handling their crypto asset is compliant with SEC rules to avoid potential risks.

Several parties can perform these tasks for the same issuer, and specific rules govern their relationships. Therefore,  it’s not just about the entity itself. A registered transfer agent can use blockchain technology for record-keeping, provided they comply with SEC rules for accuracy and security. This is important to add an extra layer of transparency and safety for investors.

As reported by Cryptopolitan, Hester M. Peirce, US 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.

Crypto “pairs” trading are given a green light

The document also addresses the mechanics of trading on Alternative Trading Systems (ATS) and National Securities Exchanges. The Staff confirmed that federal laws do not prohibit “pairs trading.

An investor looking into exchange-traded products  (ETPs) can breathe a sigh of relief. The SEC staff wouldn’t oppose if these products operated under conditions similar to those outlined in a 2006 no-action letter for commodity-based investment vehicles. 

To that end, the crypto ETP shares would need to be listed and traded on a national securities exchange (NSE) with rules approved by the SEC. But parties involved can’t engage in prohibited activities outside the Regulation M distribution.

The rules include having the crypto ETP shares listed on an NSE with SEC-approved rules, and staying within the lines of Regulation M. Anti-fraud and anti-manipulation rules still apply. Additionally, 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. 

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