Effective Date for SEC’s New Custody Rule Is Less than 4 Weeks Away

February 14, 2010

Is your federally registered investment adviser firm ready for the SEC’s new custody rule?

Join us Thursday, February 25, 2010 for our webinar exploring the new SEC requirements for investment adviser firms with custody. We will be discussing many common investment adviser practices that result in custody as defined by the SEC and answer pressing questions about the rules impact on investment advisers. The focus of the February 25th webinar will be on the deduction of advisory fees, acceptance of third-party checks from clients, trustee relationships, and other common custody situations for investment adviser firms.

On Thursday, March 25, 2010, we will be holding a second webinar devoted to the SEC’s new custody rule. The focus of the March 25th webinar will be on investment adviser firms that are or have affiliated qualified custodians and investment adviser firms that own or operate pooled investment vehicles such as hedge funds, private real estate deals and other private placement securities.

Late last year, the SEC passed changes to Rule 206(4)-2 under the Investment Advisers Act of 1940. The definition of custody did not materially change. In fact the only real change is that the new definition clearly covers custody by a related person of the investment adviser. According to the SEC rule, custody means “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. You have custody if a related person holds, directly or indirectly, client funds or securities, or has any authority to obtain possession of them, in connection with advisory services you provide to clients. As defined under the rule, custody includes the following:

(i) Possession of client funds or securities (but not of checks drawn by clients and made payable to third parties) unless you receive them inadvertently and you return them to the sender promptly but in any case within three business days of receiving them;

(ii) Any arrangement (including a general power of attorney) under which you are authorized or permitted to withdraw client funds or securities maintained with a custodian upon your instruction to the custodian; and

(iii) Any capacity (such as general partner of a limited partnership, managing member of a limited liability company or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives you or your supervised person legal ownership of or access to client funds or securities.

Investment advisers with custody must continue to make sure that all client funds and securities are held with a qualified custodian and make sure clients are given notice of the qualified custodian’s name, address, and manner in which the funds and securities are maintained. The new rule requires that client’s receive an account statement directly from the qualified custodian at least quarterly. Investment advisers must establish a reasonably believe, after due inquiry, that all clients are receiving account statements directly from the qualified custodian. Investment advisers may continue to send their own statements to clients so long as the statements include a legend in the statement urging clients to compare the statements they receive from the qualified custodian with those they receive from the investment adviser.

In addition to these requirements, investment advisers must hire an independent accounting firm to perform an annual surprise examination verifying the location of client funds and securities. To the relief of many investment advisers, the SEC was persuaded that the surprise verification examination will not provide materially greater protection to advisory clients when the investment adviser has custody of client assets solely because of its authority to deduct advisory fees from client accounts. Therefore, while fee deduction authority is custody, it has been exempted from the surprise examination requirement.

Investments advisers that act as the qualified custodian and investment advisers that use a related person qualified custodian will be subject to an annual internal control report. The internal control report must include an opinion of an independent public accountant as to whether controls have been placed in operation as of a specific date, and are suitably designed and are operating effectively to meet control objectives relating to custodial services, including the safeguarding of funds and securities held by either the investment adviser or the related person on behalf of clients, during the year. The independent public accountant must verify that the funds and securities are reconciled to a custodian other than the investment adviser or related person. Finally, the independent public accountant must be registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by, the Public Company Accounting Oversight Board in accordance with its rules.

To hear more about the new custody rule, best practices for complying with the rule and ways to avoid being deemed to have custody, join us for our February 25th and March 25th webinars.

Posted by Bryan Hill
Labels: Custody