In a broadcast open meeting on February 15, 2023, SEC commissioners voted 3-2 to adopt and amend rules under the Securities Exchange Act of 1934 to shorten the standard settlement cycle for most securities transactions from the current T+2 to T+1. In the same meeting, they voted 4-1 to propose expanding and amending the scope of the current SEC Rule 206(4)-2 under the Advisers Act of 1940 (the “Custody Rule”) to include any client assets for which an adviser has custody, redesignating the Custody Rule as the new Advisers Act Rule 223-1 (the “Safeguarding Rule”).

Under the proposed Safeguarding Rule, the SEC contends that it’s modernizing the Custody Rule, last updated in 2009,  due to “changes that have taken place in technology, advisory services, and custodial practices, which have created new and different ways for client assets to be placed at risk of loss.” The proposal most notably now includes all client assets held in custody by an adviser, including digital (or crypto) assets “even in the instances where such assets are neither funds nor securities.” This is one sea change in the Advisers Act that this proposal presents – “physical assets, including artwork, real estate, precious metals, or physical commodities (e.g., wheat or lumber), would be within the scope of the proposed rule.” In addition, the Custody Rule requirement that client assets be maintained by a qualified custodian is being enhanced under new Rule 223-1 by further articulating:

• The definition of a qualified custodian
• The means by which advisers contract with qualified custodians
• That custodians must explicitly indemnify clients
• The way in which custodians maintain client assets in bankruptcy-remote accounts separate and distinct from an adviser’s assets 

The meeting discussion among SEC Staff and the commissioners portends great debate and possible rule updates preceding any final rule effectiveness. For further discussion of the proposed changes to the Custody Rule, read Gary Fox’s reflections in another blog post linked here.

Less controversial is the new T+1 trade settlement rule with a scheduled compliance date of May 28, 2024. The SEC stated bluntly in its February 15 Fact Sheet, “two recent episodes of increased market volatility — in March 2020 following the outbreak of the COVID-19 pandemic and in January 2021 following the heightened interest in certain stocks — highlighted potential vulnerabilities in the U.S. securities market that shortening the standard settlement cycle and improving institutional trade processing can mitigate.” In their discussion at the meeting, the SEC chairman and the commissioners noted that the meme stock craze in January 2021 developed into extreme short-term stock price volatility and significant margin call accumulations, which would have been somewhat mitigated by the reduction of the time it takes to settle a trade, rendering the “market plumbing more resilient, timely, orderly, and efficient.”