The issue of custody over client funds and securities seems to be one of the most variant issues among regulators. One common form of custody is an advisor’s authorization to have fees deducted directly from client accounts. While the SEC and most states consider this practice a custody situation, the procedures advisor firms must implement vary from regulator to regulator. Therefore it is important for all investment advisors to fully understand and comply with the custody requirements that apply to their firm.
For example, Nebraska state-registered advisors that deduct advisory fees directly from client accounts should be disclosing on Form ADV Part 1A that the firm has custody of client “cash and bank accounts” or “securities”. Firms that deduct advisory fees from money market funds kept in client brokerage accounts should mark Item 9.A.(2) on Part 1A. Firms that deduct advisory fees from bank accounts or deduct fees from idle cash in a client brokerage account will need to mark Item 9.A.(1). The firm’s authorization to deduct fees from client accounts does not affect the firm’s net capital requirement as all state registered firms domiciled in Nebraska must maintain a net capital of $25,000. However, advisor firms that follow the safeguards set forth in Form ADV Part 1B, Item 2.1.(1) are provided a waiver from the Nebraska audited financial statement requirements. In order to avoid the audited financial statement requirements, the following safeguards must be met. Advisor firms must (1) attain the client’s written authorization to have fees deducted from the account, (2) send a copy of the fee invoice to the custodian or trustee at the same time it is sent to the client, and (3) ensure the client’s custodian sends quarterly statements indicating all disbursements from the account including the amount of the advisory fees. It is important to note that the invoice sent to a client must indicate the amount of the fee that will be deducted, the manner in which the fee was calculated, any adjustments to the fee and an explanation of such adjustment. It is vital that advisor firms actually implement procedures to fulfill these safeguards. Too many advisor firms mark the items under Form ADV Part 1B, but never follow through with sufficient procedures to ensure the safeguards are met and, therefore, are in violation of the Nebraska custody requirements.
If you have questions concerning Nebraska’s requirements, your home state’s custody regulations, or your firm’s procedures regarding the deduction of advisory fees, please feel free to give us a call. Stay tuned to RIA Compliance Consultants as we try to stay on top of this ever-evolving issue.
Posted by Bryan Hill