Wyoming’s Two Ocean Trust No Action Letter for Digital Asset Management and Custody Prompts SEC Outreach for Public Comment

Over the last few weeks, Wyoming has continued to blaze ahead other U.S. states as a digital asset friendly jurisdiction.  The Wyoming Division of Banking (“WDB”) issued a no-action letter to Two Ocean Trust confirming that its status as a “qualified custodian” extends to digital assets on October 23^rd and then, a few days later, approved Avanti as a Special Purpose Depository Institution for digital assets.  

Two Ocean’s no action letter, which the WDB provided to the Securities and Exchange Commission (SEC) prior to issuance, prompted the SEC’s Division of Investment Management to issue a Public Statement encouraging direct engagement with the SEC “on the application of the Custody Rule to digital assets, including with respect to the definition of “qualified custodian” under the rule.” 

As noted in an earlier piece surveying global digital asset laws, Wyoming is the most progressive U.S. state with regards to digital asset regulation and their legislature has been active in making their laws accommodating to digital asset businesses since 2018.  Many states lack the regulatory certainty surrounding the treatment of digital assets and thus, even if a “qualified custodian” has the authority to custody digital assets, the lack of a regulatory framework surrounding safekeeping and security specific to digital assets can raise red flags for investors and, as evidenced by the SEC’s statement, regulatory concerns in the absence of a statutory framework for the custody of such assets.   

Wyoming is unique in codifying digital assets as property under the Uniform Commercial Code with processes for perfection and custody. In addition to providing for the formation of SPDIs, a class of banks focusing on digital assets, the legislature has passed digital asset custody rules and property tax exemptions for crypto currencies.  

The No Action Letter and the SEC’s Response 

Per the no action letter, the WDB recognized that a trust’s qualified custodian status extends into digital assets within the context of Wyoming’s existing regulation. 

The significance is that per the Investment Advisers Act of 1940 (the “Advisers Act”) Registered Investment Advisers can only retain custody of client funds and securities through a “qualified custodian.” This can be limiting for investment advisers since many traditional banks and trusts refuse to custody digital assets.  Although the Office of the Comptroller of the Currency’s recent interpretive letter regarding the authority of national banks to provide cryptocurrency custody services will make it easier for banks to custody currencies like Bitcoin and Etherium, the “qualified custodian” requirement applies only to holding digital assets that are regulated as securities. 

Per Section 206(4)-2 of the Advisers Act, a “qualified custodian” includes banks, savings associations, registered broker-dealers holding client assets, futures commission merchants holding client assets, and foreign financial institutions providing, generally, that the foregoing holds financial assets in client accounts.  A “bank” includes trust companies receiving deposits or exercising fiduciary powers similar to a bank and that is supervised and examined by State or Federal authority having supervision over it.  The WDB concluded that Two Ocean was a “bank” with regards to digital assets. 

In assessing the no action letter, the SEC asked whether “state chartered trust companies possess characteristics similar to “Qualified Custodians” as defined in the Advisor’s Act?” and inquired “whether any additional enhancements were necessary for state chartered trust company[ies] to serve as qualified custodians.”  I view this as a conversation starter. It is unlikely the SEC would revise this “qualified custodian” definition to single out state chartered trust companies as there are larger challenges that both FINRA and SEC have noted with regards to applying Customer Protection Rule to digital assets…a framework, along with the CFTC’s Customer Fund Segregation Rules to a lesser extent, in need of revision to address digital assets.  

In the public statement, the SEC also asked: “Are there qualities [in a qualified custodian] that would be [specifically] important for safeguarding digital assets?” and “should the [Customer Protection Rule] prescribe different qualities based on asset class, or should the rule take a more principles-based approach . . .?” 

The SEC’s recognition of the issues potentially raised by the no-action letter and its seeking to engage in a dialogue is, arguably, a positive signal and step towards providing more regulatory clarity to the benefit of all states.   

Wyoming Is A Favorable Jurisdiction for Digital Asset Trusts 

“Two Ocean Trust’s most important differentiation is… access to Wyoming’s trust laws, low tax burden, privacy, creditor protection law and, in addition to the regulatory oversight and clarity from the no action letter there is also this raft of laws that provide investor protections for digital asset investors that are really only available at this point in Wyoming”

Joel Revill, Co-Founder & CEO, Two Ocean Trust

In the case of Wyoming, however, they have legislated a thoughtful, comprehensive regulatory framework for digital assets. For Two Ocean Trust and trusts possibly following in its footsteps, this clarity may provide assurance to investors seeking advisory services for both digital and traditional assets, as well as associated tax and estate management considerations.  

With the regulation of trusts comes obligations in addition to Wyoming’s Enhanced Digital Custody regime. Specifically, public trust companies are subject to the WDB’s regulation, supervision, and  periodic examination and have activity specific capital reserves maintenance requirements. 

In the no action letter, the WDB notes that financial institutions custodying digital assets will be held “high supervisory standards” with a specific focus on “AML/BSA/KYC/sanctions compliance, custody and fiduciary activities, capital markets, information security, [and] payment system risk.” 

Wyoming, irrespective of digital assets, is also favorable jurisdiction for public trusts. For example, Dynasty Trust rules allows trusts to be shielded from most taxation for 1,000 years, there is protection against creditor seizures, and as well as other rules to simplify trust migrations/adjustments.  

Digital assets represent unchartered territory for many high net worth individuals and the regulatory framework that Wyoming provides is likely to be particularly welcome to investors. Anticipate the ongoing evolution of digital asset regulatory standards across states as the need for the inclusion of digital assets in financial portfolios becomes more apparent.  

To learn more…I recently launched the Encrypted Economy podcast with my interview of Joel Revell, cofounder and CEO of Two Ocean Trust. There we did a deeper dive on why Wyoming is a compelling jurisdiction for asset management and particularly digital assets; his experiences working with the Wyoming digital asset community and the Division of Banking; and what is driving high net worth clients to allocate to digital assets, like Bitcoin, as part of a diversified portfolio.