SEC Staff Lets Franklin Templeton Funds Self-Custody Affiliated OnChain Fund Shares

The SEC's Division of Investment Management said that it would not recommend enforcement action against Franklin Templeton funds that hold shares of an affiliated, blockchain-integrated money market fund without fully complying with the Investment Company Act's ("ICA") self-custody rule.

The relief covers the funds' investments in the Franklin OnChain U.S. Government Money Fund, whose affiliated transfer agent, Franklin Templeton Investor Services, keeps the official record of share ownership on a system combining an internal book-entry ledger with one or more public blockchains. Because the transfer agent is an affiliate of the investing funds, the arrangement is self-custody under ICA Section 17(f) ("Transactions of certain affiliated persons and underwriters") and ICA Rule 17f-2 ("Custody of investments by registered management investment company"). Rule 17f-2 otherwise requires those securities to be held in the safekeeping of a bank or similar federally supervised or state-supervised depository and physically segregated, a signed notation for every deposit and withdrawal, and verification by an independent public accountant at least three times a fiscal year.

Franklin Templeton argued in its request that those provisions were designed for physical or certificated securities and that the blockchain component does not change the core custody analysis, leaning on a 1992 no-action letter that let a feeder fund hold master fund shares on the same affiliated transfer agent's book-entry system. The staff granted relief from paragraphs (b), (e), and (f) of Rule 17f-2, based on 12 representations set out in the firm's letter: board approval and at least annual review, segregated records and a separate blockchain wallet for each investing fund, limits on who may transmit instructions, passwords or other authentication and cryptographic tools, confirmations sent to people other than those who placed the instructions, daily reconciliation of confirmations against transaction authorizations, and at least three accountant verifications each fiscal year, two of them unannounced.