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Federal Register / Vol. 86, No. 37 / Friday, February 26, 2021 / Rules and Regulations
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is in fact holding the traditional securities reflected on its books and records and financial statements, thereby providing objective processes for examining the broker-dealers compliance with the Customer Protection Rule. Also, the traditional securities infrastructure has established processes to reverse or cancel mistaken or unauthorized transactions. Thus, the traditional securities infrastructure contains checks and controls that can be used to verify proprietary and customer holdings of traditional securities by broker-dealers, as well as processes designed to ensure that both parties to a transfer of traditional securities agree to the terms of the transfer.
Digital assets that are issued or transferred using distributed ledger technology may not be subject to the same established clearance and settlement process familiar to traditional securities market participants.10 The manner in which digital assets, including digital asset securities, are issued, held, or transferred may create greater risk that a broker-dealer maintaining custody of this type of asset, as well as the broker-dealers customers, counterparties, and other creditors, could suffer financial harm.
For example, the broker-dealer could be victimized by fraud or theft, could lose a private key necessary to transfer a clients digital assets, or could transfer a clients digital assets to an unintended address without the ability to reverse a fraudulent or mistaken transaction. In addition, malicious activity attributed to actors taking advantage of potential vulnerabilities that may be associated with distributed ledger technology and its associated networks could render the broker-dealer unable to transfer a customers digital assets.
The express language of the Customer Protection Rule includes cash and securities held at the broker-dealer.
Therefore, customers holding digital assets that are not securities through a broker-dealer could receive less protection for those assets than customers holding securities. The potential liabilities caused by the theft or loss of non-securities property from a broker-dealer, including digital assets that are not securities, could cause the broker-dealer to incur substantial losses or even fail, impacting customers and 10 The clearance and settlement of securities that are not digital assets are characterized by infrastructure whereby intermediaries such as clearing agencies and securities depositories serve as key participants in the process. The clearance and settlement of digital asset securities, on the other hand, generally rely on few, if any, intermediaries and remain evolving areas of practices and procedures.

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other creditors. As a consequence, the broker-dealer may need to be liquidated in a proceeding under SIPA. SIPA
protection does not extend to all assets that may be held at a broker-dealer.
Consequently, in a SIPA liquidation of a broker-dealer that held non-security assets, including non-security digital assets, investors may be treated as general creditors, to the extent their claims involve assets that are not within SIPAs definition of security. 11
III. Discussion A broker-dealer that maintains custody of a fully paid or excess margin digital asset security for a customer must hold it in a manner that complies with Rule 15c33, including that the digital asset security must be in the exclusive physical possession or control of the broker-dealer.12 A digital asset security that is not in the exclusive physical possession or control of the broker-dealer because, for example, an unauthorized person knows or has access to the associated private key and therefore has the ability to transfer it without the authorization of the brokerdealer would not be held in a manner that complies with the possession or control requirement of Rule 15c33 and thus would be vulnerable to the risks the rule seeks to mitigate.
As noted above, the loss or theft of digital asset securities may cause the firm and its digital asset customers to incur substantial financial losses. This, in turn, could cause the firm to fail, imperiling its traditional securities customers as well as the broker-dealers counterparties and other market participants. However, there are measures a broker-dealer can employ to comply with Rule 15c33 and mitigate these risks.
One step that a broker-dealer could take to shield traditional securities 11 Generally, SIPA defines the term security to include, among other things, any note, stock, treasury stock bond, debenture, evidence of indebtedness, any investment contract or certificate of interest or participation in any profit-sharing agreement, provided that such investment contract or interest is the subject of a registration statement with the Commission pursuant to the Securities Exchange Act of 1933 15 U.S.C. 77a et seq., and any put, call, straddle, option, or privilege on any security, or group or index of securities. See 15
U.S.C. 78lll14. Generally, in a SIPA liquidation, customers claims receive priority to the estate of customer property generally cash and securities received acquired or held by the broker-dealer for the securities accounts of customers over other creditors. See 15 U.S.C. 78fff & 78fff2c. In addition, to the extent that the estate of customer property is insufficient to satisfy the net equity claims of customers, the trustee can advance up to $500,000 for each customer, of which up to $250,000 can be used for cash claims. See 15 U.S.C.
78fff3a & d.
12 See 17 CFR 240.15c33b.

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customers, counterparties, and market participants from the risks and consequences of digital asset security fraud, theft, or loss would be to limit its business exclusively to dealing in, effecting transactions in, maintaining custody of, and/or operating an alternative trading system for digital asset securities. Thus, to operate in a manner consistent with the Commissions position, the brokerdealer could not deal in, effect transactions in, maintain custody of, or operate an alternative trading system for traditional securities. In addition, by limiting its activities exclusively to digital asset securities, the broker-dealer would shield its customers from the risks that could arise if the firm engaged in activities involving non-security digital assets, which are not expressly governed by the Customer Protection Rule. For example, to the extent that the requirements of the Customer Protection Rule do not apply to non-security digital assets, such assets could receive less protection than securities, which would increase the risk of theft or loss and could ultimately cause the broker-dealer to fail, impacting customers and other creditors.
A second step the broker-dealer could take is to establish, maintain, and enforce reasonably designed written policies and procedures to conduct and document an analysis of whether a digital asset is a security offered and sold pursuant to an effective registration statement or an available exemption from registration, and whether the broker-dealer has fulfilled its requirements to comply with the federal securities laws with respect to effecting transactions in that digital asset security, before undertaking to effect transactions in and maintain custody of such asset. Such policies and procedures should provide a reasonable level of assurance that any digital assets transacted in or held in custody by the broker-dealer are in fact digital asset securities. Utilizing such policies and procedures should help ensure that the broker-dealer is confining its business to digital asset securities and that such digital asset securities are being offered, sold, or otherwise transacted in compliance with the federal securities laws.
A third step the broker-dealer could take is to establish, maintain, and enforce reasonably designed written policies and procedures to conduct and document an assessment of the characteristics of a digital asset securitys distributed ledger technology
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