Simpson Thacher & Bartlett LLP

The SEC's Division of Investment Management has issued a no-action letter, indicating it will not recommend enforcement action against Registered Advisers or Regulated Funds for treating State Trust Companies as 'banks' for the custody of Crypto Assets and related cash. This conditional relief, which requires rigorous due diligence into the State Trust Company's authorization, internal controls, and audited financials, alongside specific custodial agreement terms (e.g., no rehypothecation without consent, asset segregation) and risk disclosure, provides critical regulatory clarity. This effectively broadens the pool of qualified custodians for institutional crypto investments, potentially facilitating greater adoption and addressing a key compliance hurdle for asset safeguarding.

Analysis

The SEC's Division of Investment Management has issued a no-action letter providing significant, albeit conditional, regulatory relief for the custody of crypto assets. The letter confirms the Division will not recommend enforcement action against Registered Advisers or Regulated Funds that treat a qualified State Trust Company as a "bank" for crypto custody purposes, addressing a key ambiguity under the Investment Company Act of 1940 and the Advisers Act. This relief is contingent upon rigorous due diligence, including annual verification that the custodian is state-authorized, maintains robust internal controls for safeguarding assets (evidenced by SOC-1 or SOC-2 reports), and provides audited GAAP financial statements. Critically, the custodial agreement must prohibit the lending or rehypothecation of client crypto assets without explicit consent and mandate asset segregation. While this is a staff-level position and not a formal Commission rule, it provides a crucial framework that legitimizes the role of specialized State Trust Companies and lowers a significant barrier to entry for institutional investment in digital assets, reflecting a strongly positive market sentiment.

Key Decisions for Investors

• Investment managers should consider this no-action letter a green light to accelerate the development of crypto-related investment products, provided they can implement the rigorous operational due diligence framework required by the SEC staff.
• Investors allocating to crypto-focused funds should now use the letter's requirements—such as demanding to see SOC reports and verifying prohibitions on rehypothecation—as a minimum standard for their own due diligence on a manager's custodial arrangements.
• The heightened legitimacy of State Trust Companies positions them as critical infrastructure plays; investors should evaluate these specialized custodians as potential investment or strategic partnership opportunities within the digital asset ecosystem.
• Given that the Commission is still considering formal rulemaking, investors should treat this relief as a temporary bridge and actively monitor for future regulations that could supersede this guidance and alter the compliance landscape for digital asset custody.