Cryptocurrency exchange and brokerage giant Coinbase announced this week, to much fanfare, that it had onboarded 10 customers for its new institutional-grade custody service. However, it seems that
the firm’s partner in the venture, Electronic Transaction Clearing
(ETC), has a less-than-stellar reputation when it comes to safeguarding
customer funds.
Though Coinbase is in the process of acquiring regulatory approval to operate as a broker-dealer, a development made possible after a slew of acquisitions intended to fast-track the firm’s journey to regulatory compliance, it did not need to obtain formal approval from the Securities and Exchange Commission (SEC) to launch the custody service.
That’s because the firm released the product in partnership with ETC,
a broker-dealer already operating as an institutional custodian.
As Coinbase said in its announcement:
“Coinbase Custody leverages the expertise and systems of
our partner Electronic Transaction Clearing (ETC). ETC is a
SEC-registered broker-dealer and FINRA member subject to regulated
financial reporting and independent audits.”
However, as first identified by New York Times reporter Nathaniel
Popper, ETC was recently the subject of an SEC enforcement action.
In March, four months after Coinbase had first announced its
institutional custody product and less than four months before its
formal launch, the SEC charged ETC with “repeatedly putting customers assets at risk.”
According to the SEC, the firm, tasked with safeguarding customer
assets, “illegally placed more than $25 million of customers’ securities
at risk in order to fund its own operations.”
In one instance, ETC used a client’s $8 million deposit to cover its
margin requirements on funds that it had borrowed. In another, the firm
used $17 million in customer deposits as collateral for a loan.
Incidents such as these occurred at “numerous times” in 2015, the SEC
said.
No customer funds were directly affected by ETC’s alleged wrongdoing.
Nevertheless, all of these actions violated a provision in the Customer
Protection Rule that requires custodians to maintain physical
possession or control of customer assets. ETC ultimately agreed to pay
an $80,000 penalty without admitting or denying the SEC’s allegations.
A person familiar with the matter told CCN that ETC’s alleged
wrongdoing occurred under previous management and noted that minor
infractions are common in the heavily-regulated custodial industry.
Indeed, even large enforcement actions are not uncommon in the financial industry, and top firms such as JPMorgan have paid billions of dollars in fines without experiencing a significant decline in demand for their traditional financial products.
What’s not clear, though, is whether this incident will make
already-hesitant institutions even more nervous to trial a nascent
product such as Coinbase Custody.
