Your broker cannot use funds from your wallet. At least not legally.
Contrary to expectations, this requirement stems from an SEC rule known as the “prudential rule”. Requires all investment advisers and entities of similar status to hold client securities and funds for as long as those assets are in the possession of the adviser. Basically, if you have an account with an investment advisor, trader, or broker, that person should keep their assets separate and away from yours. A financial advisor cannot pool your money with them or use it for the business.
The purpose of the custody rule is to protect client assets from adverse events such as theft, embezzlement and bankruptcy. For example, a brokerage firm cannot use a client's assets to make its own investments, putting that money at risk if the investment goes bad. You also cannot use customer money as operating money, which would put that money at risk if the business goes bankrupt.
Recently, when investigators dug through the ruins of former cryptocurrency exchange FTX, they found evidence of theft and theft that the retention rule was meant to prevent. This has led to a reassessment of the rules regarding cryptocurrencies and similar assets.
Among the results is a proposed SEC rule that would significantly expand the scope of the custody rule.
To manage your investments and understand the implications of this new rule, consider a free consultation with a licensed financial advisor.
What is the defense base?
The new rule will be called the retention rule and is an updated and revised version of the existing retention rule. More importantly, it expands the custody base to many more assets than currently envisioned. As the SEC explains, the new rule will apply to "money, securities or other positions held in a client's account and will include all other assets held by investment advisers for their clients. The hedging rule will also be expressly at the discretion of an “active business client within the meaning of the definition of custody”.
As the law firm Skadden Arps explained in a report on the matter, this would give the retention rule broad power. They write that it will effectively be applied to any type of asset held by a reporting entity. It may include "cryptocurrency and other digital assets, contracts held for investment purposes, collateral and physical assets associated with the exchange contract, including real estate, works of art, precious metals and physical commodities, and "other positions" not recorded as an asset on the balance sheet ( eg short positions and written options).
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In a small but important detail, the SEC also said the term "assets" as applied to the new rule will remain "evergreen." This means that the agency wants the updated protection rule to automatically include new categories of investments and assets as they appear, without requiring a specific update. If the taxable person holds valuable goods on behalf of a customer, or if he is authorized to market this good, the new protection rule will apply. It is intended to solve the problems created by cryptocurrencies as companies have avoided regulation. For years claiming that crypto-assets are a great investment and regulated security.
What do guarantees mean for investors and clients?
For investors and clients, this means advisors need to protect many assets.
When a custodial rule applies, companies must hold assets with third parties called “qualified custodians”. This usually means that they must place their assets somewhere safe, such as a regulated custodian bank or brokerage firm. The idea is to ensure that the company can do nothing more and nothing less than what FTX has done by accessing clients' assets when they need or want to invest capital.
Companies already have to do this with regulated securities and cash. Now, if the SEC's proposed rule is enforced, companies will also have to place nearly all assets with the custodian. For example, if you deposit art, wine, or valuables into your account, they must ensure that those assets are held by a trusted fiduciary.
It will be the same with cryptocurrency. All SEC-regulated exchanges must maintain segregation of client assets, held by fiduciary custodians. This will drastically change the way most players in the industry operate, as it is common for cryptocurrency exchanges to hold client assets with the company's own assets and funds.
Companies should also insure new assets covered, or at least make sure their custodian has insurance so customers are comprehensive in case their assets are lost anyway.
To understand the scope of this proposed rule, it is worth considering the extent of losses from failed and neglected cryptocurrency exchanges over the years. With FTX alone, clients lost over $1 billion when the company went out of business. If properly implemented, the new protection rule will prevent these assets from being put at risk by denying them access to FTX and will otherwise insure clients against such losses.
This is not the only example of a cryptocurrency exchange mismanaging customer funds. Investors have lost hundreds of millions of dollars due to business interruptions, mismanagement of their funds, and (in some cases) the loss of critical security keys.
What's next for Base Defense?
Comments are closed on May 8 due to the protection rule. This means that the SEC followed a process to seek public comment on the proposed rule. The agency will now review this notice and any updates to the proposed rule, if necessary. Then, assuming there are no major changes, the new rule is likely to pass.
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The Securities and Exchange Commission (SEC) has proposed a new rule called the Safeguard Rule. This would require investors, brokers and other regulated entities to secure all client assets in separate secure accounts. Although it is implemented on a large scale, it will specifically change the number of cryptocurrency exchanges that work.
Tips to protect your investment
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Could this SEC rule protect your cryptocurrency or tech investment from bankruptcy? This first appeared on the SmartAsset blog.