On March 12, 2019, the staff of the SEC’s Division of Investment Management issued a letter to the Investment Adviser Association (IAA) seeking industry input on the application of Rule 206(4)-2 under the Investment Advisers Act of 1940 (the Custody Rule) to digital assets, as well as on issues arising from custodial trading practices that are not processed or settled on a delivery versus payment (Non-DVP) basis. In general, the staff is seeking to determine whether revisions to the Custody Rule could be helpful in addressing these topics.

Under the Custody Rule, it is a fraudulent, deceptive or manipulative practice for an investment adviser to have custody of client assets unless the adviser complies with certain requirements or an exception applies. In 2003, the SEC amended the Custody Rule’s definition of “custody” to include, among other things, arrangements under which an adviser is permitted to withdraw client funds or securities maintained with a custodian upon the adviser’s instruction to the custodian. In a footnote to the adopting release for the 2003 amendments, the SEC discussed what is commonly referred to as the “authorized trading” exception. The SEC stated that an adviser’s authority to issue instructions to a broker-dealer or a custodian to effect or to settle trades does not constitute “custody.” Custodians, the SEC explained, are generally under instructions to transfer funds (or securities) out of a client’s account only upon corresponding transfer of securities (or funds) into the account—i.e., a “delivery versus payment” arrangement which minimizes the risk that an adviser could misappropriate client funds or securities. As the SEC staff noted in its recent letter to the IAA, the footnote did not address authorized trading of securities that do not settle on a delivery versus payment basis. The SEC staff stated that questions surrounding Non-DVP trading should be considered by the SEC, adding that amendments to the Custody Rule are on the SEC’s agenda. The staff, through the Division’s Analytics Office, has launched an information gathering initiative on Non-DVP practices.

As to digital assets, the SEC staff—noting the rapid growth in the digital asset market—seeks to inform its consideration of how digital assets’ characteristics impact the application of the Custody Rule.

The staff encourages input from all interested parties. Comments should be submitted to IMOCC@sec.gov with “Custody Rule and Non-DVP Trading” or “Custody Rule and Digital Assets,” as applicable, inserted in the subject line. The staff did not provide a deadline for comments.

The SEC staff’s letter to the IAA, which includes various questions on the foregoing topics, is available at: https://www. sec.gov/investment/non-dvp-and-custody-digital-assets-031219-206