Private fund industry pushes back on SEC’s custody rule proposal

Private fund industry pushes back on SEC’s custody rule proposal

Author: The Carta Policy Team
Read time:  8 minutes
Published date:  May 11, 2023
Bank fallout continues as FDIC proposes special assessment for large banks.


  • Biden and McCarthy at odds over debt limit with June “X-date” approaching

  • Private fund industry blasts SEC custody rule 

  • FDIC proposes assessing large banks to cover losses from bank failures

  • Congress scoping regulatory regime for crypto, but Republicans and Democrats differ

  • Tax-writing committee readies economic package

Biden and McCarthy clash in debt limit meeting

President Biden and congressional leaders met to discuss the debt ceiling, though little progress (if any) was made in the negotiations. Both sides dug into their respective positions: Democrats want a clean debt ceiling increase and are willing to consider a spending package separately, while Republicans want a joint measure that raises the debt cap and cuts spending. Staff meetings continue, and the principals are expected to reconvene early next week. Ongoing engagement is positive, though the path forward remains unclear and time is an issue: The “X-date” is likely sometime in early June, and Speaker McCarthy notes the parties likely need an agreement in principle by next week to process everything by June 1. 

Why it matters: Breaching the debt limit would likely have substantial economic consequences—including potential downgrade to U.S. credit rating, which may drive borrowing costs higher for the government, businesses, and consumers. Such a credit contraction, coupled with the resulting uncertainty around it, could further undermine the already fragile economic conditions. Even if policymakers agree to a deal, it is not likely to happen until shortly before the deadline, which will result in economic volatility—and fallout—in the lead up. As we have said before: it likely gets worse before it gets better. 

Private fund industry blasts SEC custody rule overhaul

The comment period for the SEC’s controversial proposal to overhaul its custody rules closed this week, and industry participants did not hold back expressing concerns. The proposal would significantly expand the scope of the custody rule and require virtually all assets—crypto, physical assets, private securities—to be held by a qualified custodian, as well as fundamentally alter the relationship between qualified custodians and the asset management industry. The proposed rules would also have a significant impact on how SEC-registered private fund advisers, who typically self-custody private securities under the privately offered securities exemption. While the SEC maintained this exemption, it significantly narrowed its utility and imposed extensive new and burdensome conditions that will make it effectively unusable. To qualify for the exemption under the proposal:

  • The adviser would have to reasonably determine the private asset could not be maintained by a qualified custodian, a vague standard that could lead to second-guessing by regulators;

  • Independent public accountants would have to verify transactions in real time, which would be costly (if not impossible) and could negatively impact liquidity;

  • Audit requirements would be expanded to include verification of all private assets—not just a sampling as currently required.

Why it matters: These changes represent a significant departure from current industry practice and in some cases, may be impossible to implement. To the extent the proposal can be implemented, the changes will increase frictions and costs—negative impacts that will ultimately be borne by private fund investors. Further, there is no evidence that the existing safeguards around custody and adviser fiduciary obligations are not working or are insufficient to protect inventors. With such widespread opposition from all sides of the debate— advisers, custodians, banks, and accountants—there will most certainly be pressure from Congress for the agency to scale back its changes.

FDIC proposes assessing large banks to cover losses from bank failures 

On Thursday, the FDIC proposed charging larger banks an additional fee to recover costs following the failures of SVB and Signature Bank, which the FDIC estimates at ~$18 billion. FDIC Chairman Martin Gruenberg noted the proposed rule will impact an estimated 113 banks, with 95% of the impacted banks having total assets over $50 billion. Collection of the special assessment is set to begin the first quarter of 2024 and continue for the next eight quarters beyond Q1 2024. Public comment on the rule is open for the next 60 days; expect sizable pushback from the large banks.

The House Financial Services Committee is continuing its oversight of recent bank failures with a series of hearings. The committee unveiled several pieces of legislation, though none are likely to be signed into law. The measures target:

  • FSOC: bring the Financial Stability Oversight Council (FSOC) under the congressional appropriations umbrella

  • Congressional oversight of regulators: require banking regulators to testify semiannually before the House Financial Services and Senate Banking Committees, and provide committee leadership with additional disclosures

  • Agency reporting: require banking regulators to report to Congress on emergency financial stabilization activities and enhance other disclosures made by the FDIC and Federal Reserve

Why it matters: Deposit insurance remains a key topic as policymakers assess how to bolster confidence in the banking sector. The FDIC’s action, if adopted, will recover losses, but also illustrate the tradeoffs on deposit insurance: The FDIC must either pre-fund the deposit insurance fund by charging higher fees, or assess charges later to cover losses in the event of failures. Either way, banks will need to pay for expanded coverage, and those costs are likely to be passed onto businesses and consumers. 

Congress set on determining ‘rules of the road’ for crypto, but appear to be far apart

The respective digital asset subcommittees for the House Financial Services and House Agriculture Committees held a rare joint hearing on digital assets regulation. The Republican leaders of the subcommittees are working on a bill that will set clear definitions for digital assets (security vs.commodity, etc.), thus settling the regulatory jurisdiction debate between the SEC and CFTC. Throughout the hearing, Democrats seemed hesitant about a Republican approach that would most likely give more authority to the CFTC, citing concerns about the CFTC’s funding restraints and lack of investor protection mandate. The bill is set to be announced sometime in the next few weeks, though it seems unlikely to garner bipartisan support at this point.

New York takes action

Absent federal action, states are charting a path forward on crypto regulation as well. New York Attorney General Letitia James announced legislation that would impose a regulatory framework to increase transparency, eliminate conflicts of interest, and protect investors through measures such as mandatory reimbursements to customers who are the victims of fraud. 

Why it matters:The U.S. seems to be playing catch-up when it comes to crypto legislation, a sentiment that was further buoyed by SEC Commissioner Hester Peirce, who noted at a conference in London on Wednesday that Europe’s new regulations could attract crypto firms across the Atlantic and harm American competitiveness. While the joint hearing represents key collaboration between committees with overlapping authority of the fluid digital asset markets, Republicans and Democrats seem far apart on the path forward. Meanwhile, expect the SEC to continue their current approach of regulation through enforcement.

Ways and Means Committee readies economic package

An economic package being prepared by the House Ways and Means Committee could extend several expired or expiring tax provisions. The details are still being negotiated, but the package is expected to include:

  • R&D: restore immediate deduction of research and development expensing

  • Bonus depreciation: include 100% bonus depreciation, which would allow businesses to write off the costs of acquiring most depreciable business assets in the year they were purchased

  • Interest expense: reinstate pre-2022 interpretation of the business interest expense limitation, which would allow a larger threshold of earning to be used when calculating the deduction. 

Members of the Ways and Means Committee were briefed on the package this week, but it will likely be several weeks before it is released publicly. The issues around the debt limit may further delay the package and complicate any prospects of bipartisanship.

Why it matters:This tax package is unlikely to be signed into law, but it helps build the case on policies that can drive the innovation economy. It also presents an opportunity to attach bills like the Small Business Investment Act, which would expand the scope of businesses that are eligible for the QSBS. Expanding QSBS would make it easier and less costly for innovative startup companies to raise capital, which aligns well with the goals of the forthcoming economic package. Carta will continue to advocate for QSBS, but such changes will not happen overnight, so these efforts are important building blocks. 

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The Carta Policy Team
Carta’s Policy Team aims to connect the policymaking community and venture ecosystem to build an ownership economy and advance policies that support private companies, their employees, and their investors.