Is Your RIA Aware of the New Custody Rule's Implications for Affiliated Intro B-Ds, Qualified Custodians and Pooled Investment Vehicles?
Does your SEC registered investment adviser or its affiliate serve as an introducing broker-dealer or qualified custodian for investment advisory accounts? If so, are you aware of the new internal control report requirements of the U.S. Securities and Exchange Commission ("SEC")?
Our webinar, Impact of New Custody Rule on an RIA Operating a B-D, Qualified Custodian or Private Investment Fund, recorded on March 25, 2010, is a must for investment advisers using affiliated qualified custodians and affiliated introducing broker/dealers. Jarrod James and Tammy Emsick discuss custody rule guidance issued in March 2010 by the staff of the SEC’s Division of Investment Management. Our presenters give SEC registered investment advisers with introducing broker-dealers specific examples of how to avoid being deemed by the SEC as having custody under the new rule. Finally, specific attention is given to requirements affecting investment advisers that own or operate pooled investment vehicles such as hedge funds, private real estate deals and other private placement securities.
Take this opportunity to understand the implications of the SEC's new custody rule as relates to the activities of your affiliated introducing broker-dealer, qualified custodian and pooled investment vehicle. You can purchase your seat to this recorded webinar by clicking here.
Our webinar, Impact of New Custody Rule on an RIA Operating a B-D, Qualified Custodian or Private Investment Fund, recorded on March 25, 2010, is a must for investment advisers using affiliated qualified custodians and affiliated introducing broker/dealers. Jarrod James and Tammy Emsick discuss custody rule guidance issued in March 2010 by the staff of the SEC’s Division of Investment Management. Our presenters give SEC registered investment advisers with introducing broker-dealers specific examples of how to avoid being deemed by the SEC as having custody under the new rule. Finally, specific attention is given to requirements affecting investment advisers that own or operate pooled investment vehicles such as hedge funds, private real estate deals and other private placement securities.
Take this opportunity to understand the implications of the SEC's new custody rule as relates to the activities of your affiliated introducing broker-dealer, qualified custodian and pooled investment vehicle. You can purchase your seat to this recorded webinar by clicking here.
Labels: Custody, Pooled Investment Vehicle, Webinar
posted by bhill at 9:33 AM
Many Investment Advisers Are Not Prepared for SEC's New Custody Rule
Although the recent changes by the U.S. Securities and Exchange Commission ("SEC") to the custody rule for federally registered investment advisers went into effect on March 12, 2010, it appears that many investment advisers mistakenly assume they don’t have custody, misinterpret the definition of custody or believe they are somehow exempt from the custody rule requirements.
As a result, RIA Compliance Consultants is encouraging SEC registered investment advisers to listen to the recording of our February 25, 2010 webinar, Exploring the SEC's New Custody Rule . During this webinar Jarrod James and Bryan Hill of RIA Compliance Consultants explore common investment adviser practices that result in custody as defined by the SEC and answer questions about the new custody rule’s impact on investment advisers. Focus is given to the deduction of advisory fees, acceptance of third-party checks from clients, trustee relationships, withdrawal authorization from client accounts and other common custody situations.
All federally registered investment adviser firms are encouraged to listen to this important webinar to better understand the SEC new custody rule’s impact on their operations. Click here to purchase your seat to this recording.
As a result, RIA Compliance Consultants is encouraging SEC registered investment advisers to listen to the recording of our February 25, 2010 webinar, Exploring the SEC's New Custody Rule . During this webinar Jarrod James and Bryan Hill of RIA Compliance Consultants explore common investment adviser practices that result in custody as defined by the SEC and answer questions about the new custody rule’s impact on investment advisers. Focus is given to the deduction of advisory fees, acceptance of third-party checks from clients, trustee relationships, withdrawal authorization from client accounts and other common custody situations.
All federally registered investment adviser firms are encouraged to listen to this important webinar to better understand the SEC new custody rule’s impact on their operations. Click here to purchase your seat to this recording.
posted by bhill at 9:10 AM
Is Your Investment Adviser Aware of the Custody Implications of Accepting Client Securities
Accepting third-party checks and securities for forwarding to a client's qualified custodian seems to be a common practice at many investment advisory firms. Many investment advisers process the delivery of third-party checks and securities as a convenience to clients; however, it is important to understand the implication such processes have on the firm's custody policies and procedures.
According to SEC Rule 206(4)-2 under the Investment Advisers Act of 1940, "custody includes 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."
Even though the SEC has excluded the practice of accepting and forwarding third-party checks from the definition of custody, investment advisers must implement and memorialize sufficient compliance procedures designed to ensure third-party checks are delivered to the qualified custodian. A classic example of this situation is when a client wants to make a deposit to the client's brokerage account. The client prepares a check payable to the qualified custodian holding the account. The client will deliver the check to the investment adviser who will then forward the check to the qualified custodian. While this procedure is not deemed to be custody by the investment adviser there is still risk of losing the check or not delivering the check on time so it is important to implement sufficient procedures and controls. Such procedures could include proper oversight, use of check receipt logs and follow- up to memorialize delivery of the check to the qualified custodian. It must be understood that an investment adviser would have custody of client funds if it holds a check drawn by the client and made payable to the investment adviser with instructions to pass the funds through to a custodian or to a third party. Unless the investment adviser is a qualified custodian, this must never be allowed.
While the receipt of checks drawn by clients and made payable to third parties is not considered custody for purposes of Rule 206(4)-2, the acceptance of securities (i.e. stock certificates) is considered custody even when the stock power is endorsed to the qualified custodian. Recently, RIA Compliance Consultants has seen this issue raised during SEC examinations. During these recent examinations, the SEC has stated an investment adviser that accepts securities is in violation of the custody rule's requirement that all securities be maintained at a qualified custodian. The SEC's position is that when securities are held by the investment adviser, even for a very brief time period, the investment adviser has violated the custody rule if the investment adviser is not a qualified custodian. Therefore, investment advisers that are not also qualified custodians need to make sure they don't accept client securities. To the extent an investment adviser receives client securities inadvertently; the investment adviser needs to return the securities to the client within 3 days. It is acceptable for an investment adviser to meet with clients to prepare or compile documents, including stock certificates, for forwarding to the qualified custodian. However, the client must be responsible for delivering such documents to the qualified custodian.
Many investment adviser employees are also registered representatives of a broker/dealer. Often it is asked if the custody rule permits these employees to forward securities. The SEC has provided the following guidance, "[y]es, so long as (1) the employees are acting within the scope of their employment with the affiliated broker-dealer, and (2) the affiliated broker-dealer is a qualified custodian , has opened accounts for these clients, and sends them account statements at least quarterly. Under these circumstances, the employees would be acting in their capacity as registered representatives of the broker-dealer when they accept the securities." (See Staff Responses to Questions About Amended Custody Rule - http://www.sec.gov/divisions/investment/custody_faq.htm ). It should be noted that often the employee is a registered representative of an introducing broker/dealer and not the clearing broker/dealer (i.e. qualified custodian).
You can learn more about the SEC's custody rule, recent changes to the rule, and best practices designed to avoid custody, by purchasing our webinar recorded on February 25, 2010.
According to SEC Rule 206(4)-2 under the Investment Advisers Act of 1940, "custody includes 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."
Even though the SEC has excluded the practice of accepting and forwarding third-party checks from the definition of custody, investment advisers must implement and memorialize sufficient compliance procedures designed to ensure third-party checks are delivered to the qualified custodian. A classic example of this situation is when a client wants to make a deposit to the client's brokerage account. The client prepares a check payable to the qualified custodian holding the account. The client will deliver the check to the investment adviser who will then forward the check to the qualified custodian. While this procedure is not deemed to be custody by the investment adviser there is still risk of losing the check or not delivering the check on time so it is important to implement sufficient procedures and controls. Such procedures could include proper oversight, use of check receipt logs and follow- up to memorialize delivery of the check to the qualified custodian. It must be understood that an investment adviser would have custody of client funds if it holds a check drawn by the client and made payable to the investment adviser with instructions to pass the funds through to a custodian or to a third party. Unless the investment adviser is a qualified custodian, this must never be allowed.
While the receipt of checks drawn by clients and made payable to third parties is not considered custody for purposes of Rule 206(4)-2, the acceptance of securities (i.e. stock certificates) is considered custody even when the stock power is endorsed to the qualified custodian. Recently, RIA Compliance Consultants has seen this issue raised during SEC examinations. During these recent examinations, the SEC has stated an investment adviser that accepts securities is in violation of the custody rule's requirement that all securities be maintained at a qualified custodian. The SEC's position is that when securities are held by the investment adviser, even for a very brief time period, the investment adviser has violated the custody rule if the investment adviser is not a qualified custodian. Therefore, investment advisers that are not also qualified custodians need to make sure they don't accept client securities. To the extent an investment adviser receives client securities inadvertently; the investment adviser needs to return the securities to the client within 3 days. It is acceptable for an investment adviser to meet with clients to prepare or compile documents, including stock certificates, for forwarding to the qualified custodian. However, the client must be responsible for delivering such documents to the qualified custodian.
Many investment adviser employees are also registered representatives of a broker/dealer. Often it is asked if the custody rule permits these employees to forward securities. The SEC has provided the following guidance, "[y]es, so long as (1) the employees are acting within the scope of their employment with the affiliated broker-dealer, and (2) the affiliated broker-dealer is a qualified custodian , has opened accounts for these clients, and sends them account statements at least quarterly. Under these circumstances, the employees would be acting in their capacity as registered representatives of the broker-dealer when they accept the securities." (See Staff Responses to Questions About Amended Custody Rule - http://www.sec.gov/divisions/investment/custody_faq.htm ). It should be noted that often the employee is a registered representative of an introducing broker/dealer and not the clearing broker/dealer (i.e. qualified custodian).
You can learn more about the SEC's custody rule, recent changes to the rule, and best practices designed to avoid custody, by purchasing our webinar recorded on February 25, 2010.
Labels: Custody
posted by bhill at 9:35 PM
Is Your Pooled Investment Vehicle In Compliance with the SEC's New Custody Rule for Investment Advisers
The recent changes by the U.S. Securities and Exchange Commission ("SEC") to Rule 206(4)-2 under the Investment Advisers Act of 1940 include an important development for investment advisers that operate so called pooled investment vehicles. Pooled investment vehicle is an SEC term and includes private investments such as limited liability companies and limited partnerships not registered as investment companies. For example, unregistered hedge funds fall under this category.
Investment advisers that operate pooled investment vehicles are required to: use a qualified custodian (e.g. a registered broker/dealer or registered bank) to hold assets of the pooled investment vehicle; form a reasonable belief that the qualified custodian delivers account statements to all investors; and comply with the annual surprise verification examination. Many pooled investment vehicles own or hold assets, such as real estate, not held at a qualified custodian. Therefore, complying with the qualified custodian, account statements and surprise verification examination requirements will prove impossible. For this reason, the SEC has provided relief to these requirements so long as the pooled investment vehicle is subject to an annual financial statement audit performed by an independent accounting firm; the audit is performed within 120 days after the pooled investment vehicle’s fiscal year-end; and the results of the audit are delivered to all investors of the pooled investment vehicle.
Many pooled investment vehicles are already subject to annual financial statement audits and deliver the results to investors so the new rule will have little impact in this regard. However, the new rule requires pooled investment vehicles to hire and retain independent accounting firms that are registered with and inspected by the Public Company Accounting Oversight Board (PCAOB). Pooled investment vehicles that are not subject to an annual financial statement audit performed by a PCAOB registered and inspected accounting firm and/or do not deliver the results of such an audit to investors, must ensure assets are held with a qualified custodian, all investors receive statements directly from the qualified custodian(s), and ensure compliance with the annual surprise examination requirements.
This Thursday, March 25, we will be hosting our second webinar on the new SEC custody rule. The webinar will begin at 12:00 p.m. Central and will focus specifically on how the rule applies to pooled invest vehicles and investment advisers operating a qualified custodian and/or introducing broker-dealer. We discuss the annual audit requirements and many other pressing issues for pooled investment vehicles. Click here to enroll.
Investment advisers that operate pooled investment vehicles are required to: use a qualified custodian (e.g. a registered broker/dealer or registered bank) to hold assets of the pooled investment vehicle; form a reasonable belief that the qualified custodian delivers account statements to all investors; and comply with the annual surprise verification examination. Many pooled investment vehicles own or hold assets, such as real estate, not held at a qualified custodian. Therefore, complying with the qualified custodian, account statements and surprise verification examination requirements will prove impossible. For this reason, the SEC has provided relief to these requirements so long as the pooled investment vehicle is subject to an annual financial statement audit performed by an independent accounting firm; the audit is performed within 120 days after the pooled investment vehicle’s fiscal year-end; and the results of the audit are delivered to all investors of the pooled investment vehicle.
Many pooled investment vehicles are already subject to annual financial statement audits and deliver the results to investors so the new rule will have little impact in this regard. However, the new rule requires pooled investment vehicles to hire and retain independent accounting firms that are registered with and inspected by the Public Company Accounting Oversight Board (PCAOB). Pooled investment vehicles that are not subject to an annual financial statement audit performed by a PCAOB registered and inspected accounting firm and/or do not deliver the results of such an audit to investors, must ensure assets are held with a qualified custodian, all investors receive statements directly from the qualified custodian(s), and ensure compliance with the annual surprise examination requirements.
This Thursday, March 25, we will be hosting our second webinar on the new SEC custody rule. The webinar will begin at 12:00 p.m. Central and will focus specifically on how the rule applies to pooled invest vehicles and investment advisers operating a qualified custodian and/or introducing broker-dealer. We discuss the annual audit requirements and many other pressing issues for pooled investment vehicles. Click here to enroll.
Labels: Custody, Hedge Funds, Pooled Investment Vehicle, Webinar
posted by bhill at 11:31 AM
Does the SEC’s new Internal Control Report Requirement Impact your Investment Adviser Firm or Introducing Broker/Dealer?
Internal Control Report
Earlier this month, new requirements under SEC Rule 206(4)-2 of the Investment Advisers Act of 1940 went into effect. The most stringent (and expensive) of these requirements is the new internal control report rule. Investment advisers or their related persons that serve as qualified custodian for investment advisory client funds or securities must annually obtain, or receive from its related person, a written internal control report. The internal control report must include an opinion with respect to the investment adviser’s or the related person’s controls relating to custody of client assets. The internal control report must be issued by an independent public accountant who is registered with and subject to regular inspection by the Public Company Accounting Oversight Board (PCAOB). The investment adviser must maintain the internal control report in its records and make the report available to the SEC staff upon request. The independent public accountant preparing the internal control report must verify that the client funds and securities are reconciled to a custodian other than the adviser or its related person.
Operationally Independent
In addition to the internal control reports, investment advisers with custody of client funds and securities must attain an annual surprise examination verifying the location of client funds and securities. When an investment adviser uses a related person qualified custodian, the investment adviser can avoid the surprise verification examination if it can prove the investment adviser is operationally independent from the related person qualified custodian. However, proving operationally independent may prove difficult. According to the new SEC rule, a related person that holds or has authority to obtain possession of advisory client assets is presumed not to be operationally independent of the investment adviser unless the following conditions are met and no other circumstances can reasonably be expected to compromise the operational independence of the related person: (i) client assets in the custody of the related person are not subject to claims of the adviser’s creditors; (ii) advisory personnel do not have custody or possession of, or direct or indirect access to client assets of which the related person has custody, or the power to control the disposition of such client assets to third parties for the benefit of the adviser or its related persons, or otherwise have the opportunity to misappropriate such client assets; (iii) advisory personnel and personnel of the related person who have access to advisory client assets are not under common supervision; and (iv) advisory personnel do not hold any position with the related person or share premises with the related person. The SEC has specifically commented that it would not consider a related person that shares management persons with the investment adviser, including an owner that was actively involved in the management of the two firms, to be operationally independent.
Introducing Broker/Dealer
In light of the new SEC rule, many investment advisers are analyzing the new requirement’s impact in their operations as a dually registered introducing broker/dealer or their related person introducing broker/dealer. Based on our understanding of the procedures and functions performed by introducing broker/dealers, most introducing broker/dealers have custody of advisory client assets and securities thus they are subject to the surprise verification examination. In addition, introducing broker/dealers must analyze their operations to determine if they perform functions requiring an internal control report. Recently, the SEC provided guidance on the applicability of the new custody rule on introducing broker/dealers. The following questions and answers have been posted on the SEC’s Division of Investment Management website and should be examined by all introducing broker/dealers affiliated with or registered as investment advisers.
Question XIV.1
Q: An investment adviser may also act as an introducing broker or have a related person acting as an introducing broker for its clients. Introducing brokers may have a variety of different relationships with a carrying broker with respect to matters such as the handling of customer funds and securities and sending customer account statements. In some cases, an introducing broker may maintain some client funds or securities, on a temporary and/or on-going basis (e.g., introducing brokers subject to paragraph (a)(2)(iv) of Rule 15c3-1 under the Securities Exchange Act of 1934). Is the introducing broker subject to the internal control report requirement in these circumstances?
A: Yes. An internal control report is required whenever an adviser or its related person is acting as a qualified custodian for client assets. (Posted March 10, 2010)
Question XIV.2
Q: If an introducing broker that is also an adviser or an adviser's related person is not acting as a qualified custodian under the rule for funds or securities of the adviser's clients, is the introducing broker subject to the internal control report requirement?
A: No. We would not consider an introducing broker to be acting as a qualified custodian under the rule if all client funds and securities are maintained with a carrying broker (which is not a related person of the adviser). Such an introducing broker must not receive client funds or securities other than checks drawn by clients and made payable to third parties such as the carrying broker. (Posted March 10, 2010)
Question XIV.3
Q: Does an adviser that meets the conditions above in Question XIV. 2 have custody of client funds or securities?
A: It depends. An adviser or its related person may have custody of client funds and securities without maintaining those funds or securities as qualified custodian for purposes of paragraph (a)(6) of the rule. For example, if the adviser or its related person has authority to withdraw client funds or securities maintained by the carrying broker, the adviser has custody of those assets. In that case, the adviser would be subject to all the applicable requirements of the rule, including the surprise examination requirement under paragraph (a)(4) of the rule. (Posted March 10, 2010)
This Thursday, March 25, RIA Compliance Consultants will be hosting our second webinar on the new SEC custody rule for federally registered investment advisers. The webinar will begin at 12:00 p.m. Central and will focus specifically on how the SEC's rule applies to pooled invest vehicles and investment advisers operating a qualified custodian and/or introducing broker-dealer. Click here to register.
Earlier this month, new requirements under SEC Rule 206(4)-2 of the Investment Advisers Act of 1940 went into effect. The most stringent (and expensive) of these requirements is the new internal control report rule. Investment advisers or their related persons that serve as qualified custodian for investment advisory client funds or securities must annually obtain, or receive from its related person, a written internal control report. The internal control report must include an opinion with respect to the investment adviser’s or the related person’s controls relating to custody of client assets. The internal control report must be issued by an independent public accountant who is registered with and subject to regular inspection by the Public Company Accounting Oversight Board (PCAOB). The investment adviser must maintain the internal control report in its records and make the report available to the SEC staff upon request. The independent public accountant preparing the internal control report must verify that the client funds and securities are reconciled to a custodian other than the adviser or its related person.
Operationally Independent
In addition to the internal control reports, investment advisers with custody of client funds and securities must attain an annual surprise examination verifying the location of client funds and securities. When an investment adviser uses a related person qualified custodian, the investment adviser can avoid the surprise verification examination if it can prove the investment adviser is operationally independent from the related person qualified custodian. However, proving operationally independent may prove difficult. According to the new SEC rule, a related person that holds or has authority to obtain possession of advisory client assets is presumed not to be operationally independent of the investment adviser unless the following conditions are met and no other circumstances can reasonably be expected to compromise the operational independence of the related person: (i) client assets in the custody of the related person are not subject to claims of the adviser’s creditors; (ii) advisory personnel do not have custody or possession of, or direct or indirect access to client assets of which the related person has custody, or the power to control the disposition of such client assets to third parties for the benefit of the adviser or its related persons, or otherwise have the opportunity to misappropriate such client assets; (iii) advisory personnel and personnel of the related person who have access to advisory client assets are not under common supervision; and (iv) advisory personnel do not hold any position with the related person or share premises with the related person. The SEC has specifically commented that it would not consider a related person that shares management persons with the investment adviser, including an owner that was actively involved in the management of the two firms, to be operationally independent.
Introducing Broker/Dealer
In light of the new SEC rule, many investment advisers are analyzing the new requirement’s impact in their operations as a dually registered introducing broker/dealer or their related person introducing broker/dealer. Based on our understanding of the procedures and functions performed by introducing broker/dealers, most introducing broker/dealers have custody of advisory client assets and securities thus they are subject to the surprise verification examination. In addition, introducing broker/dealers must analyze their operations to determine if they perform functions requiring an internal control report. Recently, the SEC provided guidance on the applicability of the new custody rule on introducing broker/dealers. The following questions and answers have been posted on the SEC’s Division of Investment Management website and should be examined by all introducing broker/dealers affiliated with or registered as investment advisers.
Question XIV.1
Q: An investment adviser may also act as an introducing broker or have a related person acting as an introducing broker for its clients. Introducing brokers may have a variety of different relationships with a carrying broker with respect to matters such as the handling of customer funds and securities and sending customer account statements. In some cases, an introducing broker may maintain some client funds or securities, on a temporary and/or on-going basis (e.g., introducing brokers subject to paragraph (a)(2)(iv) of Rule 15c3-1 under the Securities Exchange Act of 1934). Is the introducing broker subject to the internal control report requirement in these circumstances?
A: Yes. An internal control report is required whenever an adviser or its related person is acting as a qualified custodian for client assets. (Posted March 10, 2010)
Question XIV.2
Q: If an introducing broker that is also an adviser or an adviser's related person is not acting as a qualified custodian under the rule for funds or securities of the adviser's clients, is the introducing broker subject to the internal control report requirement?
A: No. We would not consider an introducing broker to be acting as a qualified custodian under the rule if all client funds and securities are maintained with a carrying broker (which is not a related person of the adviser). Such an introducing broker must not receive client funds or securities other than checks drawn by clients and made payable to third parties such as the carrying broker. (Posted March 10, 2010)
Question XIV.3
Q: Does an adviser that meets the conditions above in Question XIV. 2 have custody of client funds or securities?
A: It depends. An adviser or its related person may have custody of client funds and securities without maintaining those funds or securities as qualified custodian for purposes of paragraph (a)(6) of the rule. For example, if the adviser or its related person has authority to withdraw client funds or securities maintained by the carrying broker, the adviser has custody of those assets. In that case, the adviser would be subject to all the applicable requirements of the rule, including the surprise examination requirement under paragraph (a)(4) of the rule. (Posted March 10, 2010)
This Thursday, March 25, RIA Compliance Consultants will be hosting our second webinar on the new SEC custody rule for federally registered investment advisers. The webinar will begin at 12:00 p.m. Central and will focus specifically on how the SEC's rule applies to pooled invest vehicles and investment advisers operating a qualified custodian and/or introducing broker-dealer. Click here to register.
posted by bhill at 11:08 AM
SEC Offers Guidance to Investment Advisers for Co-Trustee Arrangements Under the New Custody Rule
Yesterday, the Division of Investment Management of the U.S. Securities and Exchange Commission ("SEC") updated its Staff Responses to Questions About the Custody Rule. In the updated responses, the Division provided guidance for co-trustee arrangements. As a result of the new guidance, we have revised our Investment Adviser Compliance Alert published yesterday. For an updated version, please click here.
For your easy reference, the following are the specific changes that have been made to pages 3 and 4 of this Investment Adviser Compliance Alert:SEC Adopts to Custody Rule under Investment Advisers Act of 1940:
Serving as Trustee is Deemed to be Custody
If an investment adviser or its related persons serve as trustee, executor to an estate or conservator, that will cause the investment adviser to have custody. If a supervised person has any capacity that gives the supervised person legal ownership of, or access to, the client funds, then the investment adviser is deemed to have custody. The current rule provides no exception for the investment adviser or its related persons acting as a co-trustee. However, on March 10, 2010, the SEC's Division of Investment Management provided the following guidance regarding co-trustee arrangements.
Q: In some trusts, co-trustees are required either by law or the trust instrument in order to protect the trust beneficiaries from the actions of a single trustee acting alone. In these situations, no co-trustee is able to withdraw assets without the prior written consent of the other co-trustee(s). Would an adviser acting as trustee in this type of arrangement have custody of the trust's assets for purposes of the rule?
A: The Division would not consider an adviser to have custody in such circumstances, provided that (i) the trust has a co-trustee that is a bank or a trust company that meets the definition of a qualified custodian under rule 206(4)-2(d)(6) and is not a related person of the adviser, (ii) the qualified custodian delivers account statements directly to each co-trustee that is not itself the custodian, and (iii) under the trust instrument or by law the withdrawal of any assets of the trust by the adviser requires the prior written consent of all of its co-trustee(s). (Posted March 10, 2010.)
Q: For estate planning and other purposes, some people form revocable grantor trusts. With these trusts, the person who establishes and funds the trusts (the grantor) may revoke or modify the trust at will, including changing beneficiaries. If an adviser is co-trustee along with the grantor, would the adviser have custody of the trust's assets for purposes of the rule?
A: The Division would not consider an adviser to have custody under rule 206(4)-2 in such circumstances if (i) the adviser is prohibited by the trust instrument or by law from withdrawing any assets from the trust without the prior written consent of all of its co-trustees, (ii) each grantor who has contributed assets to the trust acts as co-trustee, and (iii) the qualified custodian delivers account statements directly to each co-trustee. (Posted March 10, 2010.)
See: http://www.sec.gov/divisions/investment/custody_faq_030510.htm
For your easy reference, the following are the specific changes that have been made to pages 3 and 4 of this Investment Adviser Compliance Alert:SEC Adopts to Custody Rule under Investment Advisers Act of 1940:
Serving as Trustee is Deemed to be Custody
If an investment adviser or its related persons serve as trustee, executor to an estate or conservator, that will cause the investment adviser to have custody. If a supervised person has any capacity that gives the supervised person legal ownership of, or access to, the client funds, then the investment adviser is deemed to have custody. The current rule provides no exception for the investment adviser or its related persons acting as a co-trustee. However, on March 10, 2010, the SEC's Division of Investment Management provided the following guidance regarding co-trustee arrangements.
Q: In some trusts, co-trustees are required either by law or the trust instrument in order to protect the trust beneficiaries from the actions of a single trustee acting alone. In these situations, no co-trustee is able to withdraw assets without the prior written consent of the other co-trustee(s). Would an adviser acting as trustee in this type of arrangement have custody of the trust's assets for purposes of the rule?
A: The Division would not consider an adviser to have custody in such circumstances, provided that (i) the trust has a co-trustee that is a bank or a trust company that meets the definition of a qualified custodian under rule 206(4)-2(d)(6) and is not a related person of the adviser, (ii) the qualified custodian delivers account statements directly to each co-trustee that is not itself the custodian, and (iii) under the trust instrument or by law the withdrawal of any assets of the trust by the adviser requires the prior written consent of all of its co-trustee(s). (Posted March 10, 2010.)
Q: For estate planning and other purposes, some people form revocable grantor trusts. With these trusts, the person who establishes and funds the trusts (the grantor) may revoke or modify the trust at will, including changing beneficiaries. If an adviser is co-trustee along with the grantor, would the adviser have custody of the trust's assets for purposes of the rule?
A: The Division would not consider an adviser to have custody under rule 206(4)-2 in such circumstances if (i) the adviser is prohibited by the trust instrument or by law from withdrawing any assets from the trust without the prior written consent of all of its co-trustees, (ii) each grantor who has contributed assets to the trust acts as co-trustee, and (iii) the qualified custodian delivers account statements directly to each co-trustee. (Posted March 10, 2010.)
See: http://www.sec.gov/divisions/investment/custody_faq_030510.htm
Labels: Custody
posted by bhill at 11:39 AM
Our Complimentary White Paper About the SEC's New Custody Rule for Investment Advisers Is Now Available
Due to overwhelming number of questions and apparent confusion among many federally registered investment advisers, we've prepared a complimentary white paper exploring the new custody rule of the United States Securities and Exchange Commission ("SEC"). This white paper provides details regarding the definition of custody, examples of custody and requirements under the new SEC rule. To obtain a copy of our white paper, please click here.
We are also encouraging chief compliance officers of investment adviser firms to review the SEC's recently updated set of frequently asked questions related to the SEC's new custody rule. Prior to the recent update on March 5, 2010, the SEC's Division of Investment Management last updated the FAQs in 2005. In order to review the updated FAQs, please click here.
Finally, you can learn more about the SEC's new custody rule, best practices for complying with the rule and ways to avoid being deemed to have custody by attending our webinar on Thursday, March 25 at 12:00 p.m. Central. This webinar will focus specifically on how the rule applies to pooled invest vehicles and investment advisers operating a qualified custodian or broker-dealer.
We are also encouraging chief compliance officers of investment adviser firms to review the SEC's recently updated set of frequently asked questions related to the SEC's new custody rule. Prior to the recent update on March 5, 2010, the SEC's Division of Investment Management last updated the FAQs in 2005. In order to review the updated FAQs, please click here.
Finally, you can learn more about the SEC's new custody rule, best practices for complying with the rule and ways to avoid being deemed to have custody by attending our webinar on Thursday, March 25 at 12:00 p.m. Central. This webinar will focus specifically on how the rule applies to pooled invest vehicles and investment advisers operating a qualified custodian or broker-dealer.
Labels: Custody
posted by bhill at 9:03 PM
Effective Date for SEC's New Custody Rule Is Less than 4 Weeks Away
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.
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.
Labels: Custody
posted by bhill at 11:03 AM
A Registered Investment Adviser Needs to Ensure that Power of Attorney Over Client's Account Is Limited
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 occassionally 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 deemed by most securities regulators as to have custody over the client account. When a state registered investment adviser is granted full power of attorney, the firm must comply with its state’s often onerous custody requirements. Under such circumstances, the SEC also performs greater scrutiny of custody situations during routine examinations.
Are you certain your firm’s power of attorney is limited to only the authorizations the firm needs to perform its investment advisory functions and does not provide for authorization that the firm does not want or use thus potentially subjecting the firm to needless regulatory requirements and scrutiny?
On October 8, 2009, RIA Compliance Consultants will be presenting its webcast titled “Auditing Investment Advisory Fee Calculations, Deductions and Refunds” during which some attention will be given to an investment adviser’s legal authority to withdraw advisory fees from client accounts and ensuring such authority is limited to only what is necessary. The webcast will also discuss custody ramifications relating to the deduction of advisory fees directly from client accounts.
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 occassionally 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 deemed by most securities regulators as to have custody over the client account. When a state registered investment adviser is granted full power of attorney, the firm must comply with its state’s often onerous custody requirements. Under such circumstances, the SEC also performs greater scrutiny of custody situations during routine examinations.
Are you certain your firm’s power of attorney is limited to only the authorizations the firm needs to perform its investment advisory functions and does not provide for authorization that the firm does not want or use thus potentially subjecting the firm to needless regulatory requirements and scrutiny?
On October 8, 2009, RIA Compliance Consultants will be presenting its webcast titled “Auditing Investment Advisory Fee Calculations, Deductions and Refunds” during which some attention will be given to an investment adviser’s legal authority to withdraw advisory fees from client accounts and ensuring such authority is limited to only what is necessary. The webcast will also discuss custody ramifications relating to the deduction of advisory fees directly from client accounts.
Labels: Custody, Power of Attorney
posted by bhill at 7:19 PM
Join Our Webinar - Auditing Investment Advisory Fee Calculations, Deductions & Refunds
Earlier this year, the U.S. Securities and Exchange Commission ("SEC") proposed new requirements for registered investment advisor firms that have custody of clients funds and securities. According to current SEC Rule 206(4)-2, Custody or Possession of Funds of Securities of Clients, custody is defined as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. Custody includes –
(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.
The SEC’s proposed changes to Rule 206(4)-2 do not change the definition of custody or change what is considered custody, but impose additional requirements such as hiring a public accounting firm to perform an annual surprise examination for purpose of verifying client assets. Not surprisingly the proposed rule changes prompted significant discussion and resistance. Most of the investment advisory industry’s resistance has been aimed at the applicability of the audit requirements for the most common form of custody, automatic fee deductions from client accounts. It is estimated by the SEC that a large majority of SEC registered investment advisors automatically deduct their advisory fees from client accounts. The SEC considers this practice to be a type of custody covered under item (ii) above.
Many within the investment advisory industry believe automatic fee deductions pose lower risk than other forms of custody. While this may be true, there are significant risks and potential conflicts associated with automatically deducting advisory fees from client accounts. The fact of the matter is that the SEC and state securities regulators have brought several enforcement actions alleging fraudulent conduct involving the misappropriation and/or misuse of client funds directly related to automatic fee deductions. Fee deduction activities continue to be a focal point during regulatory examinations. Investment advisor firms need to have strong checks and balances to ensure their fee deduction policies and procedures are sufficient. Testing mechanisms need to be reasonably designed and then implemented to prevent, detect and correct errors from occurring during the fee calculation and deduction process. More importantly, supervisory procedures need to protect against fraudulent activity. All registered investment advisor firms need to make sure their compliance procedures go beyond the minimum regulatory requirements of having written client authorization to deduct fees from accounts and ensuring fee calculations appear on client account statements. Procedures need to include ongoing monitoring and auditing of the process.
Some of the more common deficiencies we often note when conducting mock regulatory reviews and annual assessments for our clients include (1) investment advisory fees being deducting from the wrong account; (2) miscalculation of quarterly or monthly investment advisory fees; (3) the agreed upon investment advisory fee between the client and advisor incorrectly entered into the investment advisor’s client database system; (4) the misconception that the client’s qualified custodian is auditing the accuracy of the investment advisor’s investment advisory fee calculations; (5) the investment advisor intentionally or unintentionally overcharging client accounts; and (6) the investment advisor failing to develop procedures to supervise and monitor the investment advisory fee calculation and deduction process.
Does your registered investment advisor firm adequately monitor its fee deduction process? Do you have questions about this important compliance function? If so, join us on Thursday, October 8 at 12:00 p.m. CST for a live webcast titled “Auditing Investment Advisory Fee Calculations, Deductions & Refunds”. During this informative one-hour online event, we will discuss the implications of proposed changes to SEC Rule 206(4)-2, recent regulatory enforcement actions, and best practices with respect to fee calculations, deductions and refunds. The fee to sign up for the webcast is $59.95. You can register now by clicking the link below.
(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.
The SEC’s proposed changes to Rule 206(4)-2 do not change the definition of custody or change what is considered custody, but impose additional requirements such as hiring a public accounting firm to perform an annual surprise examination for purpose of verifying client assets. Not surprisingly the proposed rule changes prompted significant discussion and resistance. Most of the investment advisory industry’s resistance has been aimed at the applicability of the audit requirements for the most common form of custody, automatic fee deductions from client accounts. It is estimated by the SEC that a large majority of SEC registered investment advisors automatically deduct their advisory fees from client accounts. The SEC considers this practice to be a type of custody covered under item (ii) above.
Many within the investment advisory industry believe automatic fee deductions pose lower risk than other forms of custody. While this may be true, there are significant risks and potential conflicts associated with automatically deducting advisory fees from client accounts. The fact of the matter is that the SEC and state securities regulators have brought several enforcement actions alleging fraudulent conduct involving the misappropriation and/or misuse of client funds directly related to automatic fee deductions. Fee deduction activities continue to be a focal point during regulatory examinations. Investment advisor firms need to have strong checks and balances to ensure their fee deduction policies and procedures are sufficient. Testing mechanisms need to be reasonably designed and then implemented to prevent, detect and correct errors from occurring during the fee calculation and deduction process. More importantly, supervisory procedures need to protect against fraudulent activity. All registered investment advisor firms need to make sure their compliance procedures go beyond the minimum regulatory requirements of having written client authorization to deduct fees from accounts and ensuring fee calculations appear on client account statements. Procedures need to include ongoing monitoring and auditing of the process.
Some of the more common deficiencies we often note when conducting mock regulatory reviews and annual assessments for our clients include (1) investment advisory fees being deducting from the wrong account; (2) miscalculation of quarterly or monthly investment advisory fees; (3) the agreed upon investment advisory fee between the client and advisor incorrectly entered into the investment advisor’s client database system; (4) the misconception that the client’s qualified custodian is auditing the accuracy of the investment advisor’s investment advisory fee calculations; (5) the investment advisor intentionally or unintentionally overcharging client accounts; and (6) the investment advisor failing to develop procedures to supervise and monitor the investment advisory fee calculation and deduction process.
Does your registered investment advisor firm adequately monitor its fee deduction process? Do you have questions about this important compliance function? If so, join us on Thursday, October 8 at 12:00 p.m. CST for a live webcast titled “Auditing Investment Advisory Fee Calculations, Deductions & Refunds”. During this informative one-hour online event, we will discuss the implications of proposed changes to SEC Rule 206(4)-2, recent regulatory enforcement actions, and best practices with respect to fee calculations, deductions and refunds. The fee to sign up for the webcast is $59.95. You can register now by clicking the link below.
Labels: Custody, Fee Audit, Webinar
posted by bhill at 3:04 PM
NASAA President Calls for Raising AUM to $100 Million for SEC Registration of Investment Advisers
In a recent speech at the North American Securities Administrators Association ("NASAA") annual conference, Texas Securities Commissioner, Denise Voigt Crawford who is the incoming NASAA President, revealed that the SEC might raise the asset under management ("AUM") threshold for SEC registration of investment advisers from $25 million to $100 million, and NASAA supports such a change.
The NASAA President explained that "...the current dividing line between federal and state regulation of investment advisory firms is $25 million of assets under management. The SEC might increase this to $100 million of assets under management. Given the difficulty the SEC has in examining such a large number of investment advisory firms, I think this is a good idea. NASAA has endorsed such a change and will work closely with the SEC to make this happen."
For those smaller SEC registered investment advisers that have voiced concerned about the burden of the proposed SEC rule requiring an annual surprise audit by a public accounting firm, such a change is likely to be well received by many investment advisers, especially since NASAA has indicated that it doesn't believe the surprise audit requirement is necessary for investment advisers deemed to have custody solely due to automatic fee deduction.
The NASAA President explained that "...the current dividing line between federal and state regulation of investment advisory firms is $25 million of assets under management. The SEC might increase this to $100 million of assets under management. Given the difficulty the SEC has in examining such a large number of investment advisory firms, I think this is a good idea. NASAA has endorsed such a change and will work closely with the SEC to make this happen."
For those smaller SEC registered investment advisers that have voiced concerned about the burden of the proposed SEC rule requiring an annual surprise audit by a public accounting firm, such a change is likely to be well received by many investment advisers, especially since NASAA has indicated that it doesn't believe the surprise audit requirement is necessary for investment advisers deemed to have custody solely due to automatic fee deduction.
Labels: Custody, Registration
posted by bhill at 4:38 PM
NASAA Urges SEC to Exclude from Surprise Audit RIAs with Custody Solely Due to Automatic Deduction of Fees
In response to the proposal by the U.S. Securities and Exchange Commission ("SEC") to require federally registered investment advisers with custody of client funds or securities to undergo an annual surprise audit by an independent public accountant, the North American Securities Administrators Association ("NASAA") surprisingly weighed in favor of the investment advisory industry.
NASAA urged the SEC to exclude from its proposed surprise audit requirement those investment advisers that have custody of client assets solely due to the authority to withdraw investment advisory fee. NASAA explained that "we believe these accounts are less likely to be subject to abuse and could reasonably be excluded from a program of annual surprise examinations by an independent CPA."
Considering that NASAA is typically less receptive to the investment advisory industry's concerns as compared to the SEC, this position by NASAA definitely adds legitimacy to the argument of many registered investment advisers that the SEC's proposed independent CPA surprise audit requirement is too expensive and overly broad.
NASAA urged the SEC to exclude from its proposed surprise audit requirement those investment advisers that have custody of client assets solely due to the authority to withdraw investment advisory fee. NASAA explained that "we believe these accounts are less likely to be subject to abuse and could reasonably be excluded from a program of annual surprise examinations by an independent CPA."
Considering that NASAA is typically less receptive to the investment advisory industry's concerns as compared to the SEC, this position by NASAA definitely adds legitimacy to the argument of many registered investment advisers that the SEC's proposed independent CPA surprise audit requirement is too expensive and overly broad.
Labels: Custody
posted by bhill at 2:46 PM
Join RIA Compliance Consultants for its June 18, 2009 Webinar on the Proposed Changes to the SEC’s Custody Rule
Last month, the U.S. Securities and Exchange Commission ("SEC") proposed amendments to the custody rule under the Investment Advisers Act of 1940, which the SEC explained are designed to increase protections for investors who entrust their funds and securities to registered investment advisers. According to the proposed rule changes, all SEC registered investment advisers will be required to hire an accounting firm to perform an annual surprise audit. The SEC has stated that it believes the surprise accounting audits will impact approximately 9,600 of the approximately 11,000 SEC registered investment advisor firms. The surprise accounting audits would be far-reaching because they would apply to all investment advisory accounts of which the registered investment advisor has any form of custody, including the ability to deduct advisory fees.
As the registered investment adviser industry wrestles with the proposed SEC rule changes, numerous questions are being asked. What do the changes mean for registered investment advisers? What is the practical implication of the proposed SEC rule? What will the costs be to the registered investment adviser? What new procedures will a registered investment adviser need to implement? What is the definition of custody, and what does a surprise accounting audit mean?
During a June 18 webinar, our consulting team will be discussing the major changes proposed by the SEC and providing answers to the many questions being asked by registered investment advisers. During the webinar we’ll examine some of the following topics:
- SEC’s intent and basis for proposing the changes;
- Definition and examples of custody;
Fee deduction procedures; - Proposed annual surprise audits for all firm’s with custody and the more stringent proposal requiring PCAOB accounting firm audits;
- Form ADV and client disclosure requirements; and
- Guidance on what an investment advisor can do during the proposed rule’s comment period.
The webinar sponsored by RIA Compliance Consultants will take place on Thursday, June 18, 2009 from 12:00 -1:00 pm Central Standard Time. During the webinar you will have the ability to direct questions to our staff. The fee for the webinar is $59.95 and space is limited so sign up today!
Purchase now your webinar seat for $59.95: https://www2.gotomeeting.com/register/466750603
Labels: Custody, SAS 70 Audit Report
posted by bhill at 3:51 PM
SEC Backing Off Proposal to Require Third-Party Compliance Audits
According to a recent article in Investment News which quotes an official of the Financial Planning Association ("FPA"), the chairman of the U.S. Securities and Exchange Commission ("SEC"), Mary Schapiro, is backing off of her previously discussed, but never formerly considered by the SEC, proposal to require each federally registered investment adviser to engage a third-party to conduct an annual compliance audit of the investment adviser.
Based upon recent public comments by several other SEC commissioners during the past month, this report isn't surprising. The fact that the third-party compliance audit requirement was not included with the SEC's recently proposed surprise audit and SAS 70 Type II audit requirement was a telltale sign that there wasn't a consensus among SEC commissioners for this approach.
Of course, this leads to the question of what, if any, additional reform efforts will the SEC support with respect to registered investment advisers. As the SEC's position become clearer, RIA Compliance Consultants will keep its readers of these developments.
Based upon recent public comments by several other SEC commissioners during the past month, this report isn't surprising. The fact that the third-party compliance audit requirement was not included with the SEC's recently proposed surprise audit and SAS 70 Type II audit requirement was a telltale sign that there wasn't a consensus among SEC commissioners for this approach.
Of course, this leads to the question of what, if any, additional reform efforts will the SEC support with respect to registered investment advisers. As the SEC's position become clearer, RIA Compliance Consultants will keep its readers of these developments.
Labels: Custody, SEC, Third-Party Compliance Audit
posted by bhill at 2:00 PM
Background Information for RIAs Concerning SAS 70 Type II Audit Reports by PCAOB Accountants
In light of the recent proposal by the U.S. Securities and Exchange Commission ("SEC") to require federally registered investment advisers, whose client assets are not held or controlled by a qualified custodian independent of the investment adviser, to obtain annually a SAS 70 Type II audit report from a PCAOB registered and inspected accountant, RIA Compliance Consultants thought it might be helpful to share some background information about this type of audit report and the PCAOB.
1. What is a SAS 70 Type II audit report? The American Institute of Certified Public Accountants ("AICPA") has developed auditing standards for services organizations known as Statement on Auditing Standards No. 70: Service Organizations ("SAS 70"). The Type II SAS 70 audit report (also known as a "Report on Controls Placed in Operation and Tests of Operating Effectiveness"), which will report the internal controls in place and test the effectiveness of such internal controls for period of six to twelve months.
2. What will be the scope of a SAS 70 Type II audit report under the proposed SEC rule? Based upon SEC Chairman Schapiro's speech, it appears that the scope of this SAS 70 Type II audit report will focus upon the custody controls of the registered investment adviser.
3. What is the PCAOB? According to its website, "The Public Company Accounting Oversight Board ("PCAOB") is a private-sectior, non-profit corporation, created by Sarbanes-Oxley Act of 2002, to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports."
4. How can I find an accountant registered and inspected by the PCAOB? The PCAOB maintains a list of PCAOB registered public accounting firms. Click here for a list of such accounting firms.
Once the SEC posts the text of the proposed amendments to its custody rule for federally registered investment advisers along with its interpretative release, RIA Compliance Consultants will provide its readers with further guidance about the scope of the proposed SAS 70 Type II audit report for a registered investment adviser using an affiliated qualified custodian.
1. What is a SAS 70 Type II audit report? The American Institute of Certified Public Accountants ("AICPA") has developed auditing standards for services organizations known as Statement on Auditing Standards No. 70: Service Organizations ("SAS 70"). The Type II SAS 70 audit report (also known as a "Report on Controls Placed in Operation and Tests of Operating Effectiveness"), which will report the internal controls in place and test the effectiveness of such internal controls for period of six to twelve months.
2. What will be the scope of a SAS 70 Type II audit report under the proposed SEC rule? Based upon SEC Chairman Schapiro's speech, it appears that the scope of this SAS 70 Type II audit report will focus upon the custody controls of the registered investment adviser.
3. What is the PCAOB? According to its website, "The Public Company Accounting Oversight Board ("PCAOB") is a private-sectior, non-profit corporation, created by Sarbanes-Oxley Act of 2002, to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports."
4. How can I find an accountant registered and inspected by the PCAOB? The PCAOB maintains a list of PCAOB registered public accounting firms. Click here for a list of such accounting firms.
Once the SEC posts the text of the proposed amendments to its custody rule for federally registered investment advisers along with its interpretative release, RIA Compliance Consultants will provide its readers with further guidance about the scope of the proposed SAS 70 Type II audit report for a registered investment adviser using an affiliated qualified custodian.
Labels: Custody, SAS 70 Audit Report
posted by bhill at 9:33 AM
SEC Proposes New Custody Rule for RIAs Requiring Annual Surprise Audits
During an open meeting yesterday, the U.S. Securities and Exchange Commission ("SEC") proposed amendments to Rule 206(4)-2 which, according to the SEC, are designed to increase protections for investors who entrust their funds and securities to registered investment advisers.
The proposed changes would require all federally registered investment advisers that have custody, as defined under Rule 206(4)-2, to undergo annual surprise examinations. The surprise examinations would have to be conducted by independent accounting firms for the purpose of verifying the safety and location of client assets.
Under the proposed amendments to the custody rule, registered investment advisers that use an affiliated qualified custodian will need to undergo an additional custody control review, known as a Statement on Auditing Standards ("SAS") No. 70 Type II report, conducted by an accounting firm registered and inspected by the Public Company Accounting Oversight Board ("PCAOB"). By requiring a SAS 70 Type 2 report prepared by a PCAOB accounting firm for federally registered investment advisers that use affiliated qualified custodians, the SEC is attempting to encourage registered investment advisers to use independent qualified custodians.
Unfortunately, the SEC has yet to publish the proposed rule and interperative release, but it is expected to be available on the SEC website soon. Once it is available, the proposal will have a 60 day public comment period before the final rule is voted on by the SEC commissioners.
Based on comments by SEC commissioners during the open meeting, it does not appear that the SEC will change the definition of custody, which is defined under Rule 206(4)-2 as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. Custody includes the following:
Some of the more common types of investment adviser custody observed by RIA Compliance Consultants, Inc. include investment advisers or their associated persons serving as trustee to a client, having full power of attorney on an account, accepting stock certificates from a client to forward to the qualified custodian, providing bill paying services, and deducting fees directly from client accounts.
The surprise audit requirement appears to be far-reaching as it would apply to all investment advisory accounts of which the investment advisor has any form of custody, including the ability to deduct advisory fees directly from the accounts. What is not clear at this point is the applicability of the rule when a client of a federally registered investment adviser has a third-party deduct advisory fees on behalf of the investment adviser and client. This could include another investment advisor, a broker/dealer or other administrator. It is also not clear if the previous SEC no-action letters in place before the SEC made changes to Rule 206(4)-2 in 2004 will be reinstated. According to those SEC no-action letters, a registered investment adviser could avoid the surprise examination requirement by (1) receiving the client’s written authorization to deduct fees; (2) deliver a written invoice to the client prior to fees being deducted; and (3) confirming the actual fee deducted is listed on the client’s account statement delivered from the qualified custodian. Hopefully, the proposed rule release will clarify this issue further, but early indication is that all federally registered investment advisers that deduct advisory fees will be subject to the surprise audit requirement.
Another issue that is seems unclear is a federally registered investment adviser’s authority to disburse funds from a client’s account directly to a client or directly to another account owned by a client. While the ability to disburse funds from an account to a third-party is clearly a form of custody under SEC rules, the ability to disburse funds to the client is often not as clear. Hopefully, the SEC will comment on this issue in the proposed rule release.
The proposed changes to the custody rule would no longer allow a federally registered investment advisor to send client statements in lieu of account statements prepared by the qualified custodian. It appears that proposed rule will require the qualified custodian to send account statements directly to underlying clients. This raises a question for registered investment advisers that maintain client accounts in omnibus accounts. How will such registered investment advisers comply with the rule? Hopefully, the SEC rule release will comment on the logistical issues concerning the use of omnibus accounts.
As part of the proposed rule, federally registered investment advisers will be required to disclose their accounting firms on Form ADV Part 1. Materials findings from the audits will need to be reported to the SEC. Accounting firms will need to report the termination of their agreement with an investment advisor directly to the SEC and report, if applicable, any problems with the examination that led to the termination of its engagement.
Once the SEC releases the actual text of the proposed amendments to SEC Rule 206(4)-6, RIA Compliance Consultants will host a webinar on this topic. Please stay tuned for more developments concerning the proposed custody rule and the registration information for our webinar.
The proposed changes would require all federally registered investment advisers that have custody, as defined under Rule 206(4)-2, to undergo annual surprise examinations. The surprise examinations would have to be conducted by independent accounting firms for the purpose of verifying the safety and location of client assets.
Under the proposed amendments to the custody rule, registered investment advisers that use an affiliated qualified custodian will need to undergo an additional custody control review, known as a Statement on Auditing Standards ("SAS") No. 70 Type II report, conducted by an accounting firm registered and inspected by the Public Company Accounting Oversight Board ("PCAOB"). By requiring a SAS 70 Type 2 report prepared by a PCAOB accounting firm for federally registered investment advisers that use affiliated qualified custodians, the SEC is attempting to encourage registered investment advisers to use independent qualified custodians.
Unfortunately, the SEC has yet to publish the proposed rule and interperative release, but it is expected to be available on the SEC website soon. Once it is available, the proposal will have a 60 day public comment period before the final rule is voted on by the SEC commissioners.
Based on comments by SEC commissioners during the open meeting, it does not appear that the SEC will change the definition of custody, which is defined under Rule 206(4)-2 as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. 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.
Some of the more common types of investment adviser custody observed by RIA Compliance Consultants, Inc. include investment advisers or their associated persons serving as trustee to a client, having full power of attorney on an account, accepting stock certificates from a client to forward to the qualified custodian, providing bill paying services, and deducting fees directly from client accounts.
The surprise audit requirement appears to be far-reaching as it would apply to all investment advisory accounts of which the investment advisor has any form of custody, including the ability to deduct advisory fees directly from the accounts. What is not clear at this point is the applicability of the rule when a client of a federally registered investment adviser has a third-party deduct advisory fees on behalf of the investment adviser and client. This could include another investment advisor, a broker/dealer or other administrator. It is also not clear if the previous SEC no-action letters in place before the SEC made changes to Rule 206(4)-2 in 2004 will be reinstated. According to those SEC no-action letters, a registered investment adviser could avoid the surprise examination requirement by (1) receiving the client’s written authorization to deduct fees; (2) deliver a written invoice to the client prior to fees being deducted; and (3) confirming the actual fee deducted is listed on the client’s account statement delivered from the qualified custodian. Hopefully, the proposed rule release will clarify this issue further, but early indication is that all federally registered investment advisers that deduct advisory fees will be subject to the surprise audit requirement.
Another issue that is seems unclear is a federally registered investment adviser’s authority to disburse funds from a client’s account directly to a client or directly to another account owned by a client. While the ability to disburse funds from an account to a third-party is clearly a form of custody under SEC rules, the ability to disburse funds to the client is often not as clear. Hopefully, the SEC will comment on this issue in the proposed rule release.
The proposed changes to the custody rule would no longer allow a federally registered investment advisor to send client statements in lieu of account statements prepared by the qualified custodian. It appears that proposed rule will require the qualified custodian to send account statements directly to underlying clients. This raises a question for registered investment advisers that maintain client accounts in omnibus accounts. How will such registered investment advisers comply with the rule? Hopefully, the SEC rule release will comment on the logistical issues concerning the use of omnibus accounts.
As part of the proposed rule, federally registered investment advisers will be required to disclose their accounting firms on Form ADV Part 1. Materials findings from the audits will need to be reported to the SEC. Accounting firms will need to report the termination of their agreement with an investment advisor directly to the SEC and report, if applicable, any problems with the examination that led to the termination of its engagement.
Once the SEC releases the actual text of the proposed amendments to SEC Rule 206(4)-6, RIA Compliance Consultants will host a webinar on this topic. Please stay tuned for more developments concerning the proposed custody rule and the registration information for our webinar.
Labels: Custody, SAS 70 Audit Report
posted by bhill at 10:48 PM
SEC Will Consider at May 14 Meeting Whether to Propose Amendments to Rule 206(4)-2 Requiring Audits of Investment Advisers with Custody
The Securities and Exchange Commission ("SEC") has announced that the Commission will consider whether to propose amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 during its open meeting scheduled for Thursday, May 14, 2009.
The agenda posted for this SEC open meeting explains that "[t]he proposed amendments would enhance the protections provided advisory clients when they entrust their funds and securities to an investment adviser. If adopted, the amendments would require investment advisers having custody of client funds and securities to obtain a surprise examination by an independent public accountant, and, unless the client assets are maintained with an independent custodian, obtain a review of custodial controls from an independent public accountant."
There is no reference in the posted agenda to the previously discussed requirement of a third-party compliance audit of the registered investment adviser or a requirement that a registered investment adviser's senior executive certify annually the adequacy of the investment adviser's internal controls. Of particular interest to many registered investment advisers is whether any proposed audit requirement for registered investment advisers will apply to those registered investment advisers that have custody solely due to automatic fee-deduction.
Following the SEC's open meeting on May 14, 2009, RIA Compliance Consultants will provide readers with more details of any proposed amendments to the custody rules for registered investment advisers.
The agenda posted for this SEC open meeting explains that "[t]he proposed amendments would enhance the protections provided advisory clients when they entrust their funds and securities to an investment adviser. If adopted, the amendments would require investment advisers having custody of client funds and securities to obtain a surprise examination by an independent public accountant, and, unless the client assets are maintained with an independent custodian, obtain a review of custodial controls from an independent public accountant."
There is no reference in the posted agenda to the previously discussed requirement of a third-party compliance audit of the registered investment adviser or a requirement that a registered investment adviser's senior executive certify annually the adequacy of the investment adviser's internal controls. Of particular interest to many registered investment advisers is whether any proposed audit requirement for registered investment advisers will apply to those registered investment advisers that have custody solely due to automatic fee-deduction.
Following the SEC's open meeting on May 14, 2009, RIA Compliance Consultants will provide readers with more details of any proposed amendments to the custody rules for registered investment advisers.
Labels: Custody, SEC, Third-Party Compliance Audit
posted by bhill at 11:00 AM
SEC Will Consider This Week: New Controls for Registered Investment Advisers with Custody
In a speech to the Investment Company Institute last week, the Chairman of the U.S. Securities and Exchange Commission ("SEC"), Mary Schapiro, noted that "[n]ext week [the SEC] will consider rule proposals for significant enhancements to controls around investment adviser custody of customer assets, to reduce dramatically the possibility that frauds like Madoff might happen again at a registered broker-dealer or investment adviser."
Based upon this speech and other public comments by SEC Chairman Schapiro, RIA Compliance Consultants presumes that the SEC will be considering this week proposals to require registered investment advisers to undergo a surprise audit as to custody of client assets, to complete a third-party compliance audit, and to certify through a senior executive the adequacy of the registered investment adviser's internal controls.
Once the SEC announces these proposed investment adviser rules, RIA Compliance Consultants will provide a detailed analysis to its readers.
Based upon this speech and other public comments by SEC Chairman Schapiro, RIA Compliance Consultants presumes that the SEC will be considering this week proposals to require registered investment advisers to undergo a surprise audit as to custody of client assets, to complete a third-party compliance audit, and to certify through a senior executive the adequacy of the registered investment adviser's internal controls.
Once the SEC announces these proposed investment adviser rules, RIA Compliance Consultants will provide a detailed analysis to its readers.
Labels: Custody, SEC, Third-Party Compliance Audit
posted by bhill at 8:21 PM
FPA Questions SEC's Proposed Suprise Custody Audits, Third-Party Compliance Audits & Internal Controls for RIAs
In a recent letter to Mary Schapiro, Chairman of the U.S. Securities and Exchange Commission ("SEC"), the Financial Planning Association ("FPA") questions SEC Chairman Schapiro's potential changes to the custody rule for registered investment advisers, third-party compliance audits of registered investment advisers, and internal controls of registered investment advisers.
With respect to the SEC Chairman's proposed surprise audit of registered investment advisers with custody of client assets, the FPA noted that it is under the impression that the third-party surprise audit requirement proposed by the SEC Chairman would apply to registered investment advisers that custody assets with qualified custodians since a registered investment adviser is already subject to a surprise audit requirement under SEC Rule 206(4)-2 if the investment adviser has custody of client assets.
The FPA explained that if the SEC intends to apply the surprise audit requirement to registered investment advisers that custody client assets with a qualified custodians, the costs of such a surprise audits will be significant, especially for small investment advisers. Moreover, the FPA argued that a surprise audit will not offer any benefit to clients since the qualified custodian already possess the assets and sends a statement to the client.
With respect to the SEC Chairman's proposed surprise audit of registered investment advisers with custody of client assets, the FPA noted that it is under the impression that the third-party surprise audit requirement proposed by the SEC Chairman would apply to registered investment advisers that custody assets with qualified custodians since a registered investment adviser is already subject to a surprise audit requirement under SEC Rule 206(4)-2 if the investment adviser has custody of client assets.
The FPA explained that if the SEC intends to apply the surprise audit requirement to registered investment advisers that custody client assets with a qualified custodians, the costs of such a surprise audits will be significant, especially for small investment advisers. Moreover, the FPA argued that a surprise audit will not offer any benefit to clients since the qualified custodian already possess the assets and sends a statement to the client.
In response to SEC Chairman's proposed third-party compliance audits of registered investment advisers, the FPA asks whether such compliance audits will include only registered investment advisers with custody or a broader segment of investment advisers. The FPA is concerned that such a requirement would cause registered investment advisers to incur significant expense with no benefit to clients since the FPA believes that the problems of the financial marketplace are not due to registered investment advise failing to maintain effective compliance progra. As an alternative, the FPA supports increasing the resources of the SEC so its staff may evaluate registered investment advisers' compliance programs.
Concerning the proposed requirement that a senior officer of the registered investment adviser attest or certify to the sufficiency of the registered investment adviser's internal controls to protect client assets, the FPA asserts that the cost of such certification would not justify the protection afforded to clients. The FPA believes the senior officer will expend significant resources to reassure him or herself of the adequacy of the compliance controls, which will be especially burdensome for small registered investment advisers.
As more details emerge about the SEC's proposals for registered investment advisers, RIA Compliance Consultants will update its readers on these developments.
posted by bhill at 11:54 PM
SEC Considering Rules Requiring Surprise CPA Exams and Third-Party Compliance Audits for Registered Investment Advisers
In a speech today, Mary L. Schapiro, Chairman of the U.S. Securities and Exchange Commission (“SEC”), announced that in response to the recent investment scams, the SEC will consider, in short order, a new proposal for strengthening the controls over investment advisers with custody of client funds and securities.
Ms. Schapiro explained “that this proposal will include a consideration of ‘surprise’ examinations by a certified public accountant, and a requirement that investment advisers undergo third-party compliance audits.” Unfortunately, she did not clarify whether custody due solely to automatic fee deduction would trigger the requirement of a third-party compliance audit.
Additionally, Ms. Schapiro noted that she has requested that the SEC draft a rule requiring a senior officer of an investment advisor with custody to “certify that controls are in place to protect investor assets.”
Once the actual text of these proposed rules are released by the SEC, RIA Compliance Consultants will provide its readers with more details and analysis. Stay tuned.
Ms. Schapiro explained “that this proposal will include a consideration of ‘surprise’ examinations by a certified public accountant, and a requirement that investment advisers undergo third-party compliance audits.” Unfortunately, she did not clarify whether custody due solely to automatic fee deduction would trigger the requirement of a third-party compliance audit.
Additionally, Ms. Schapiro noted that she has requested that the SEC draft a rule requiring a senior officer of an investment advisor with custody to “certify that controls are in place to protect investor assets.”
Once the actual text of these proposed rules are released by the SEC, RIA Compliance Consultants will provide its readers with more details and analysis. Stay tuned.
posted by bhill at 5:23 PM
California Proposes Amendments to Rules under the Corporate Securities Law of 1968
Earlier this month, the California Department of Corporations announced proposed changes to rules regulating investment advisers registered in California. According to the release, the objective in proposing the amendments is to increase uniformity with the model rules suggested by the North American Securities Administrators Association (NASAA), rules already in effect in other states, and rules established by the Securities and Exchange Commission (SEC). California is giving the public an opportunity to comment on the proposed changes. The time period for comment ends on October 30, 2007.
The proposed rules will have an impact on registered investment advisors in California, and all registered investment advisor firms doing business in California should take time to read the various releases and the text of the proposed rules. We feel the following are some of the more important changes proposed.
RIA Compliance Consultants, Inc. can help your firm comply with these proposed changes. Contact us to find out more about our written compliance manual and code of ethics drafting and reviewing services.
The proposed rules will have an impact on registered investment advisors in California, and all registered investment advisor firms doing business in California should take time to read the various releases and the text of the proposed rules. We feel the following are some of the more important changes proposed.
- Requirement to establish and maintain written procedures designed to supervise employees and ensure their compliance with securities laws.
- Incorporation of the principles governing performance-based advertising set forth in the 1996 SEC No-Action letter involving Clover Capital Management.
- Requirement to provide all clients a written disclosure document containing the same information in Form ADV Part II. While we suggest all registered investment advisors provide a disclosure document to clients, apparently this has not been a requirement in California.
- Amendment to the definition of custody and the procedures regarding custody. This rule will mirror the NASAA Model Rule for custody.
- Rule requiring the implementation of codes of ethics. The rule will copy the same requirements set forth under the SEC’s codes of ethics rule (Rule 204A-1 under the Advisers Act).
- Changes to “largely mirror” Rule 206(4)-3 of the Advisers Act which sets forth requirements that must be followed when fees are paid to solicitors.
- The adoption and implementation of a business continuity plan.
RIA Compliance Consultants, Inc. can help your firm comply with these proposed changes. Contact us to find out more about our written compliance manual and code of ethics drafting and reviewing services.
Labels: Advertising, Code of Ethics, Custody, Form ADV, Solicitors
posted by bhill at 3:00 PM
Attention Investment Advisers Registered in Illinois
Recently the Illinois Securities Department has been requesting investment advisors registered with their office provide additional information regarding disclosures made in the firm’s Form ADV. Requests for additional information have been made not only during the initial registration process but also in response to updates submitted by registered investment advisors with active registration. Additional information required has included more thorough descriptions of the services and fee arrangements offered by firms, copies of agreements entered into with third-party investment advisors, copies of privacy policy notices, and copies of Schedule H brochures used by the firm even when the wrap-fee program is sponsored by another firm. Firms registered in Illinois should be prepared to provide the additional information and documentation promptly to the Department when requested. We support the Department’s decision to ensure firms are fully disclosing all pertinent information and can substantiate compliance with investment advisory rules and regulations.
Illinois is also providing guidance regarding its interpretation and rules concerning custody. The Department interrupts an investment adviser to have custody of client accounts when question 2.I.(1) of Form ADV Part 1B (deduction of fees directly from client accounts) is checked 'yes' even if it is indirect custody, meaning the client has given permission for a third-party investment advisor to deduct fees from the client’s account. When fees are deducted from client accounts, the registered investment advisor will need to also mark Item 9.A and B of Form ADV Part 1A. As long as the firm is marking and complying with Form ADV Part 1B, Items 2.I(1) a, b, and c, the firm does not need to comply with the additional financial requirements, i.e. audited balance sheet and additional net worth and/or bonding. However, firms that deduct advisory fees but do not comply with Items 2.I.(1) a, b, and c (i.e. send invoices to clients, receive client authorization, and ensure the fee deduction is listed on the client’s account statements) will need to comply with the additional financial requirements.
If your firm is registered with the state of Illinois and has questions concerning these requirements, please give us a call.
Illinois is also providing guidance regarding its interpretation and rules concerning custody. The Department interrupts an investment adviser to have custody of client accounts when question 2.I.(1) of Form ADV Part 1B (deduction of fees directly from client accounts) is checked 'yes' even if it is indirect custody, meaning the client has given permission for a third-party investment advisor to deduct fees from the client’s account. When fees are deducted from client accounts, the registered investment advisor will need to also mark Item 9.A and B of Form ADV Part 1A. As long as the firm is marking and complying with Form ADV Part 1B, Items 2.I(1) a, b, and c, the firm does not need to comply with the additional financial requirements, i.e. audited balance sheet and additional net worth and/or bonding. However, firms that deduct advisory fees but do not comply with Items 2.I.(1) a, b, and c (i.e. send invoices to clients, receive client authorization, and ensure the fee deduction is listed on the client’s account statements) will need to comply with the additional financial requirements.
If your firm is registered with the state of Illinois and has questions concerning these requirements, please give us a call.
posted by bhill at 1:13 PM
Implications of Deducting Advisory Fees for Nebraska Registered Advisors
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.
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.
Labels: Custody
posted by bhill at 1:52 PM
Kansas Securities Regulator Suspends IA Firm
Earlier this fall, the Office of the Kansas Securities Commissioner entered an order to summarily suspend the investment advisor registration of a state firm located in Overland Park, Kansas. According to the Commissioner’s Press Release, the “firm committed fraud by informing a client that his funds were maintained in an account at a brokerage firm when, in fact, the funds were pooled with the funds of other investors in a second account controlled” by the advisor firm’s president. The firm also apparently did not fully cooperate with the state examiners during their investigation. This enforcement action serves as example as to how Kansas securities regulator will respond when an investment advisor attempts to circumvent state securities laws.
The Kansas Securities Commissioner has also become more visible through a series of television and radio advertisements encouraging the investing public to conduct its own investigating before hiring a Kansas based financial professional. In conjunction with these efforts to educate the public, Kansas has initiated a proactive approach to regulatory examinations and has already conducted numerous audits. As a result, it’s imperative that investment advisors located in Kansas ensure that they are implementing effective compliance programs and controls.
If your firm is located in Kansas and wants to discuss how RIA Compliance Consultants can help your firm meets its regulatory requirements, please give us a call at 877-345-4034.
The Kansas Securities Commissioner has also become more visible through a series of television and radio advertisements encouraging the investing public to conduct its own investigating before hiring a Kansas based financial professional. In conjunction with these efforts to educate the public, Kansas has initiated a proactive approach to regulatory examinations and has already conducted numerous audits. As a result, it’s imperative that investment advisors located in Kansas ensure that they are implementing effective compliance programs and controls.
If your firm is located in Kansas and wants to discuss how RIA Compliance Consultants can help your firm meets its regulatory requirements, please give us a call at 877-345-4034.
Labels: Custody, Enforcement
posted by bhill at 1:29 PM
Custody Interpretations Can Be Confusing
According to a letter from the State of Washington dated January 3, 2006, Washington regulators now deem investment advisors to have custody when they have the ability to directly withdraw fees from client accounts. This is the case even when the advisor firm attains the client's authorization, provides a fee notice to the client, and ensures the fee disbursement is disclosed on the client's account statement. Therefore, state registered advisor firms that engage in this practice and are located in Washington must answer affirmatively to ADV Part 1A, Item 9 (Custody). However, the State of Washington also explained that if the firm is deemed to have custody for this reason alone, the firm does not need to meet the minimum net worth requirements for firms with custody or attain audited financial records. This is the case so long as the firm receives client authorization to debit advisory fees directly from the client account, provides a fee deduction notice to clients, and ensures the fee disbursement is disclosed on the client's account statement.
This is an example of the inconsistency in the way that "custody" is interpreted between regulators. For example, the SEC has determined that deducting investment advisory fees directly from client accounts is also a form of custody; however, it alone does not require the investment advisor firm to mark ADV Part 1A, Item 9 in the affirmative.
Do you have a full understanding of your regulator's approach to defining custody? If you have any questions on what is custody and what additional rules must be followed if your firm is deemed to have custody, please give us a call.
This is an example of the inconsistency in the way that "custody" is interpreted between regulators. For example, the SEC has determined that deducting investment advisory fees directly from client accounts is also a form of custody; however, it alone does not require the investment advisor firm to mark ADV Part 1A, Item 9 in the affirmative.
Do you have a full understanding of your regulator's approach to defining custody? If you have any questions on what is custody and what additional rules must be followed if your firm is deemed to have custody, please give us a call.
Labels: Custody
posted by bhill at 7:47 PM
Custody Requirements for Advisors to Hedge Funds
If you are an advisor to a private fund (i.e. hedge fund or pooled investment vehicle) do you know if you are deemed to have custody? If so, is your Form ADV Part I completed correctly?
According to SEC Rule 206(4)-2(c)(1)(iii), the definition of custody includes an investment advisor with “any capacity (such as a 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.” In other words, if your investment advisor firm is the general partner (or similar status) of a hedge fund that it also manages, the advisor firm is deemed to have custody.
Investment advisor firms that fall under the definition of custody must meet a number of additional requirements. Under SEC Rule 206(4)-2, “it is a fraudulent, deceptive, or manipulative act, practice or course of business . . . for you to have custody of client funds or securities unless" the following are satisfied:
1. A qualified custodian maintains those funds and securities in a separate account for each client or in accounts that contain your clients’ funds and securities, under your name as agent or trustee for the clients;
2. You notify your clients in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, when the account is opened and when any changes to this information occur;
3. You verify the delivery and accuracy of account statements prepared by the qualified custodian, or, if you send account statements to clients, an independent public accountant must conduct a surprise audit of those funds and securities at least once each calendar year (please keep in mind that account statements must be sent to each limited partner, member or other beneficial owner); and
4. A client may designate an independent representative to receive, on her behalf, notices and account statements.
The Rule 206(4)-2 does allow for some exceptions of “certain privately offered securities”. According to the Rule, advisors “are not required to comply with this section with respect to securities that are:
A. acquired from the issuer in a transaction or chain of transaction not involving any public offering;
B. uncertificated, and ownership thereof is recorded only on books of the issuer or its transfer agent in the name of the client; and
C. transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.
While these exceptions do provide some relief for advisors to hedge funds, they are only available if the advisor is audited at least annually and then distributes the audit findings to all limited partners, members, or beneficial owners. The audit findings must be distributed within 120 days (or 180 days in the case of an advisor to a fund of funds) of the advisor’s fiscal year end. In addition, an advisor may satisfy its obligation to deliver account information (as described under number three above) to investors by distributing the audited financial statements to investors.
Finally, advisors need to ensure their ADV Part I is completed correctly. Item 9.A. and 9.B. require advisors to disclose if they maintain custody of cash or bank accounts and securities.
For many newly registered advisor firms, the custody rules seem intimidating and overwhelming. However, the SEC views these rules as extremely important and are sure to be reviewed during a regulatory examination. If you have questions on how to meet these requirements or would like us to conduct a mock exam, please give us a call today.
According to SEC Rule 206(4)-2(c)(1)(iii), the definition of custody includes an investment advisor with “any capacity (such as a 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.” In other words, if your investment advisor firm is the general partner (or similar status) of a hedge fund that it also manages, the advisor firm is deemed to have custody.
Investment advisor firms that fall under the definition of custody must meet a number of additional requirements. Under SEC Rule 206(4)-2, “it is a fraudulent, deceptive, or manipulative act, practice or course of business . . . for you to have custody of client funds or securities unless" the following are satisfied:
1. A qualified custodian maintains those funds and securities in a separate account for each client or in accounts that contain your clients’ funds and securities, under your name as agent or trustee for the clients;
2. You notify your clients in writing of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, when the account is opened and when any changes to this information occur;
3. You verify the delivery and accuracy of account statements prepared by the qualified custodian, or, if you send account statements to clients, an independent public accountant must conduct a surprise audit of those funds and securities at least once each calendar year (please keep in mind that account statements must be sent to each limited partner, member or other beneficial owner); and
4. A client may designate an independent representative to receive, on her behalf, notices and account statements.
The Rule 206(4)-2 does allow for some exceptions of “certain privately offered securities”. According to the Rule, advisors “are not required to comply with this section with respect to securities that are:
A. acquired from the issuer in a transaction or chain of transaction not involving any public offering;
B. uncertificated, and ownership thereof is recorded only on books of the issuer or its transfer agent in the name of the client; and
C. transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.
While these exceptions do provide some relief for advisors to hedge funds, they are only available if the advisor is audited at least annually and then distributes the audit findings to all limited partners, members, or beneficial owners. The audit findings must be distributed within 120 days (or 180 days in the case of an advisor to a fund of funds) of the advisor’s fiscal year end. In addition, an advisor may satisfy its obligation to deliver account information (as described under number three above) to investors by distributing the audited financial statements to investors.
Finally, advisors need to ensure their ADV Part I is completed correctly. Item 9.A. and 9.B. require advisors to disclose if they maintain custody of cash or bank accounts and securities.
For many newly registered advisor firms, the custody rules seem intimidating and overwhelming. However, the SEC views these rules as extremely important and are sure to be reviewed during a regulatory examination. If you have questions on how to meet these requirements or would like us to conduct a mock exam, please give us a call today.
Labels: Custody, Hedge Funds
posted by bhill at 7:15 PM
