On March 4, 2013, the U.S. Securities and Exchange Commission (“SEC”), by the Office of Compliance Inspections and Examinations issued a risk alert that discusses deficiencies involving investment advisers and custody. As stated in the risk alert, “One of the most critical rules under the Investment Advisers Act of 1940 is the custody rule, which is designed to protect advisory clients from the misuse or misappropriation of their funds and securities. Yet, the SEC’s National Examination Program (“NEP”) has observed widespread and varied non-compliance with elements of the custody rule.”
One of the custody-related deficiencies identified is failure by the investment adviser to recognize that they have custody. An investment adviser is deemed to have custody if it or its related person holds, directly or indirectly, client funds or securities or has any authority to obtain possession of them. Investment advisers that have custody must adhere to the SEC’s requirements outlined under the custody rule.
The following are several examples of activities that constitute custody, which are often times not recognized by investment advisers as custody.
- Receiving client funds or securities from a third-party, unless such assets are received inadvertently and the investment adviser returns them to the third-party sender within three business days. However, this would not include possession of a check drawn by a client that is made payable to a third party.
- If an employee or supervised person of the investment adviser serves as a trustee to a firm client (which does not meet the SEC’s family/personal relationship exception), the investment adviser is deemed to have custody.
- If an investment adviser has online access to a client account, such as user name and password that allows the investment adviser to withdraw funds and securities from the client’s account, the investment adviser has custody.
- Providing bill paying services with check writing authority.
- Maintaining physical possession of securities.
As stated in the Risk Alert’s conclusion, “The [Investment] Advisers Act custody rule is designed to protect and safeguard client assets. Advisers may want to consider their policies and procedures and their compliance with the custody rule in light of the deficiencies noted in this Alert. Deficiencies in this area have resulted in actions ranging from immediate remediation to enforcement referrals and subsequent litigation.” Investment advisers should review the Risk Alert closely and use it as a checklist to assess their investment adviser’s compliance policies and procedures and supervisory controls regarding custody of client assets.
Custody of client assets is just one of the many areas that must be addressed as part of an investment adviser’s written compliance policies and procedures. Has your investment adviser fully customized its written compliance policies and procedures and will they meet the examiners scrutiny during a regulatory exam? The first step to preventing regulatory violations is developing customized written compliance policies and procedures. RIA Compliance Consultants has developed an online tool, RIA Express-Compliance Manual Drafter, to assist investment advisers with efficiently updating or developing their written policies and procedures, using this online tool, your investment adviser will complete a detailed questionnaire about your investment adviser’s personnel, business model, and changes in your procedures and practices. The answers to the online questionnaire will generate a customized written supervisory procedures and code of ethics manual, via our electronic compliance manual authoring wizard. By using this tool your investment adviser will be able to develop its initial written policies and procedures or an updated manual reflecting current regulations and revisions to your investment adviser’s existing policies and procedures. For just $695, an investment adviser can purchase a Self-Customized, Regulator Specific Manual that it will prepare using the RIA Express – Compliance Manual Drafter. To purchase this product or for more information about this product, please visit our online store here.
If your investment adviser has customized policies and procedures in place, it must periodically (at least annually for all SEC and many state registered investment advisers) review and evaluate the effectiveness of the investment adviser’s policies and procedures and their ability to prevent and detect violations of the Investment Advisers Act or similar state securities regulations. RIA Compliance Consultant has developed a cost-effective, online tool, RIA Express-Compliance Review, to help an investment adviser review its compliance program. RIA Express – Compliance Review is our online compliance tool that helps guide you through the process of reviewing the effectiveness of your investment adviser’s compliance program. To learn more about RIA Express – Compliance Review, click here to schedule a demonstration of this product.
To gain a better understanding of custody, RIA Compliance Consultants is hosting a webinar “Custody Implications for Investment Advisers.” During this webinar our consultants will discuss the SEC’s definition of custody and analyze what triggers the additional requirements for investment adviser firms with custody. The webinar will be presented on August 15, 2013, at 12:00 p.m. CDT. Click here to register for this webinar.