More than two years after the U.S. Securities and Exchange Commission (SEC) introduced a new class of “special purpose broker-dealers” authorized to custody crypto asset securities, the first special purpose broker-dealer (SPBD) appears to have been approved. Prometheum Ember Capital LLC, a registered broker-dealer, now also appears to be approved to operate as an SPBD.

SPBDs

The SPBD regime was first introduced by the SEC in December 2020. Unlike other broker-dealers and alternative trading systems, which could transact in crypto asset securities upon FINRA (the Financial Industry Regulatory Authority) approval, but could not custody these assets, SPBDs are permitted to both custody and transact in crypto asset securities. However, the SPBD regime is also subject to a number of stringent conditions. Among other things, an entity registering as an SPBD must:

• have access to the crypto asset securities it proposes to hold and the capability to transfer them on the associated distributed ledger technology (DLT);
• not hold proprietary positions in traditional (i.e., non-crypto asset) securities other than for net capital and hedging purposes;
• not maintain custody of a crypto asset security if the firm is aware of any material security or operational problems with the DLT and associated network used to access and transfer the crypto asset security;
• provide certain written disclosures to its customers, including about material risks of crypto asset securities;
• enter into a written agreement with each customer that sets forth the terms and conditions with respect to transacting in crypto asset securities; and
• have policies and procedures to:
  • determine whether a crypto asset is a security offered and sold pursuant to an effective registration statement or an exemption from such registration;
  • assess a crypto asset security’s DLT and associated network; and
  • demonstrate that the SPBD has exclusive control over the crypto asset securities it holds in custody, and to protect against the theft or loss of the private keys associated with such crypto asset securities.

What’s Next?

Some of the conditions required for SPBDs may have made being an SPBD an unattractive option for many broker-dealers. For example, many brokers viewed as overly restrictive the fact that SPBDs cannot custody or transact in crypto asset non-securities (such as bitcoin), or in crypto assets that are not registered or exempt from registration under the federal securities laws. These two restrictions prevented SPBDs from custodying or transacting in the vast majority of crypto assets, including the most liquid assets, as well as the ones with high market capitalizations.

Now that an SPBD appears to have been approved, the likely next question is to ask which crypto assets are available for this entity to trade. There seem to only be a handful of crypto asset securities that are either registered or issued pursuant to an available exemption, and these securities have typically been very thinly traded. Will the SEC relax some or all of the conditions for SPBDs, including on the types of crypto assets it can trade? We must continue to watch this space.

If you have questions about the SPBD regime and registration process, or about crypto assets more generally, please contract Amy Caiazza (202 973 8887), Neel Maitra (202 973 8827), or another member of Wilson Sonsini’s fintech and financial services practice.