United States: Hold on! SEC Proposes Updates to Custody Rules

By: Thoreau A. Bartmann, Lance C. Dial, Jon-Luc Dupuy, and Pablo J. Man

The United States Securities and Exchange Commission (SEC) has long been concerned with investment advisers having access to client assets and investment companies’ safeguarding of fund assets. The custodial framework for investment companies dates back to 1941, and Rule 206(4)-2 (the Custody Rule) for investment advisers was adopted in 1962. Despite amendments and SEC staff guidance over the years, critics argue these rules have not been sufficiently flexible to evolve with modern markets, particularly digital assets.

On 1 October 2026, the SEC issued a proposal that would address custody of crypto assets and modernize the custody rules for investment companies and investment advisers (the Proposal).

Crypto

The Proposal would establish a framework for advisers and regulated funds to custody crypto assets. Among other things, the Proposal would permit certain state-chartered trust companies to serve as crypto custodians, largely codifying existing no-action positions, and would for the first time permit limited self-custody of digital assets if the asset manager determines that no eligible third-party custodian is available.

Investment Company Act Modernization

Proposed amendments to Rule 17f-1 would let funds use any registered broker-dealer as custodian, so long as custody is subject to the broker-dealer customer protection rule, rather than limiting eligible broker-dealers to exchange members. The amendments would also eliminate the largely obsolete Rule 17f-3 governing “free cash accounts.”

Advisers Act Modernization

The Proposal addresses several longstanding industry concerns. Most notably, if adopted, the amendments would create an exception for “authorized discretionary trading,” which would address a long-running debate over DVP and non-DVP transactions by focusing on an adviser’s authority to transfer client assets rather than settlement mechanics. The amendments would also codify certain staff FAQs and no-action guidance for fund of funds’ delivery of financials under the pooled-fund audit provisions, standing letters of authorization, and inadvertent custody. The amendments would also add certain recordkeeping obligations.

Conclusion

The Proposal is a welcome step toward modernizing a custody framework that has struggled to keep pace with evolving markets and technology. Custody, however, is highly technical, and advisers and funds should take a close look to ensure the Proposal would work as designed in practice.