A Registered Investment Adviser Needs to Ensure that Power of Attorney Over Client’s Account is Limited

May 08, 2013

In order to trade or otherwise access a client’s account held by a custodian, a registered investment adviser must be granted written authorization by the client. Such authorization is generally granted in the form of a power of attorney. Although a power of attorney over a client’s account is necessary for a registered investment adviser to manage the client’s account, it is important for an investment adviser to ensure that the power of attorney is limited to only the functions actually intended by the client and the investment adviser.

Typically, an investment adviser’s limited power of attorney will grant a registered investment adviser the ability to only (1) trade the client’s account; (2) receive statements, confirmations and other documents such as proxies related to the account; and (3) make withdrawals from the account solely for the purpose of deducting the agreed upon investment advisory fees. Any additional authority over a client’s account is generally not needed or wanted by an investment adviser and subjects the investment adviser to additional regulatory scrutiny.

Unfortunately, registered investment advisers are occasionally granted full power of attorney on client accounts, but do not realize the ramifications that results from a full power of attorney. In addition to trading and receiving account documents, full power of attorney allows the investment adviser to transfer money to third parties, change the registration of the account, and completely liquidate and close the account. Under a full power of attorney, this can be done without the client’s consent. A full power of attorney is generally not needed and not desired by an investment adviser. Regardless of whether such authorization is intended or not, the investment adviser with a full power of attorney over a client’s account will be required to comply with the additional regulatory requirements that may result from having such authority.  For example, an investment adviser with such authority is deemed to have custody by securities regulators.  When a state registered investment adviser is granted full power of attorney, the investment adviser must comply with its state securities regulator’s often onerous custody requirements, such as submitting audited financial statements to the state on an annual basis.  Most states also require higher net worth requirements for firms with custody. Investment advisers registered with the U.S. Securities and Exchange Commission (“SEC”) will be required to comply with the SEC’s surprise verification examination requirements under Rule 206(4)-2 of the Investment Advisers Act of 1940.  Investment advisers maintaining custody of client funds and securities beyond the ability to deduct advisory fees directly from client accounts must engage an independent accounting firm to verify the location and existence of client funds and securities by actual examination once each calendar year.  Some state securities regulators have adopted this requirement. Additionally, investment advisers having a full power of attorney may be required to comply with the SEC’s recently released Identity Theft Red Flags Rules, Regulation S-ID.

Investment advisers should review all powers of attorney closely to make sure they fully understand the authorizations granted by a client to ensure authorizations are limited to only those the investment adviser needs to perform its investment advisory functions. Investment advisers should make sure that any powers of attorney do not provide for authorization that the investment adviser does not want or use thus potentially subjecting the investment adviser to needless regulatory requirements and scrutiny.

On May 9, 2013, RIA Compliance Consultants will be presenting a webinar titled “Understanding the New Identity Theft Red Flags Rules and How SEC Registered Investment Advisers are Affected” during which we will discuss which SEC registered investment advisers will be affected by the recently released rules and we will discuss the new requirements for SEC registered investment advisers under these rules.

Posted by Bryan Hill
Labels: Compliance Program, Compliance Training, Identity Theft, SEC, Webinar