Thread by @CaitlinLong_

1/ MY SUMMARY🧵re: today's SEC #Custody Rule proposal, which is here: sec.gov/rules/proposed…

*NONE OF THIS IS LEGAL ADVICE*

tl;dr--it doesn't kill #crypto custody; it's a move against state-chartered trust companies; there's one big issue, tho, which will trigger huge pushback

2/ THE BIG ISSUE (& I haven't seen anyone point this out yet)=the rqmt for custodians to indemnify for "negligence, recklessness or willful misconduct." All the banking, #WallSt, commodities & #crypto industries will push back together on this bc it could kill custody biz broadly

3/ What's the issue? Proposal wld apply Custody Rule to all asset classes incl commodities & #crypto (ie, not just securities)--OK, fine. But SEC also wants custodians to indemnify FULL asset value for losses in which custodian played ANY role (eg, an oil tanker sinks; cows die).

4/ That's the implication of expanding the Custody Rule w/ such indemnity to physical assets like oil, cattle, wheat & #crypto. History: custody originated under concept of #bailment, which is the same law as coat checks & valet parking. Bailments usually have LIMITED LIABILITY.

5/ Next time you check your coat, look at the receipt you receive--it limits liability bc YOU are expected to insure your own asset. This makes sense bc you didn't turn over legal title to the asset to your custodian--you continue to own it. Custodian typically has a duty of care

6/ So you see the issue--the SEC wld essentially require qualified custodians to blanket-indemnify clients against FULL risk of loss (ie, fully guarantee asset value) for assets that custodians don't even own. For commodities, that will upset longstanding insurance terms. No dice

7/ So, I think there will be a wall of united pushback against this indemnity provision. SEC is correct in its assessment that market practice varies widely--it does, & w/ good reason (esp for commodities) bc for physical assets it REALLY matters whether/when title is transferred

8/ For securities this is less relevant, since title to 99.9% of the securities outstanding rests with the DTCC & always stays there (ie, what's in your brokerage account are "security entitlements" that are derivatives of the real thing at the DTCC. The DTCC, not you, has title)

9/ So, there's really not much risk of loss for securities custody--bc your "securities entitlement" is just a ledger entry & you don't have title. But VERY different story for commodities & #crypto (physical/bearer instruments)--for them, if/when title transfers is *EVERYTHING.*

10/ That's why I seriously doubt the indemnity provision will end up in the SEC final rule. It won't fly to require custodian to guarantee the FULL value for losses to which it had ANY% contribution, when the customer retained title to the asset & should've insured it themselves.

11/ What about the rest of the SEC's proposal? I call it like it is--THERE'S A LOT OF GOOD IN IT (!!!) Segregation of customer assets, audits, statements--who cld argue with doing those things??

The next most controversial provision pertains to state-chartered trust companies.

12/ Most #crypto custodians today are state-chartered trust companies, so this is a big deal for crypto. But, for context, here's a tweet from @AdviserCounsel. The SEC for years has signaled it doesn't believe most trust companies are qualified custodians.

https://twitter.com/AdviserCounsel/status/1625887756210655233?s=20

13/ That the SEC has been working on this for >10yrs shows #crypto was just the trigger, not the target, for the new rule. What's the issue? I've tweeted about it since <2018: state-chartered trust companies generally can't guarantee the segregation of assets if they go bankrupt

14/ Why? bc a bankruptcy judge can generally break contracts of any corporation subject to the US Bankruptcy Code. Who's subject to the US Bankruptcy Code? Basically every corporation except for those under special statutory receivership regimes--namely, banks & broker/dealers.

15/ So, banks & broker/dealers subject to special receivership regimes can guarantee asset segregation during insolvency, when it matters most, while state-chartered trust companies generally cannot. That's a HUGE DIFFERENCE. The SEC cares a lot about that--as well it should.

16/ That the SEC moved against state-chartered trust companies surprises no one working in this area. It has been in the works for years. But will the states sit by and let the SEC do this? @NYDFS may fight. Or, states can always enact special receivership regimes for trust cos.

17/ I was pleasantly surprised the SEC left limited purpose banking entities alone (incl #Wyoming SPDI banks). Good for Wyoming!🤠It did ask for comment on overturning the dual banking system😂 by requiring all banks to be federally-regulated, thus stripping states of authority🤦‍♀️

18/ The US has long had a dual banking system, where state-chartered & federally-chartered banks have same powers. The SEC didn't distinguish btwn the two in the proposed rule tho--it only asked for comments about the *potential* to distinguish them. States wld object, of course.

19/ So, most likely there won't end up being a difference btwn state & federally-chartered banks. And there shouldn't be.

Where does that leave us, if the SEC's proposed rule is enacted?

20/ It's generally a good outcome for investors--qualified custodians must not only be able to segregate customer assets, but also to ensure those assets remain segregated in the event of insolvency. This is a reasonable policy goal & the SEC is not wrong to pursue it.

21/ I'd encourage y'all to read the 434-pg document & form your own opinions. In it, the SEC provided a lot of regulatory clarity. Many waited for that clarity for a long time. To some, it's the end of the world. I don't agree--there's a lot here both to like & to not to like.END

PS -- my earlier real-time tweets here:

https://twitter.com/CaitlinLong_/status/1625914218057764864?s=20