SEC Sees Deficiencies in “Custody Rule”: Warns Clients to be Vigilant.

Simon Riveles Custody Rule, Investment Advisers, SEC

The Securities and Exchange Commission (the “Commission”) recently issued an Investor Bulletin with guidelines on compliance with its “custody rule” for investment advisers. While the rule is designed to enhance safeguards over client assets, clients still need to be aware of the specific steps taken by their advisers to comply with the rule.

Custody relates to the holding of client funds or securities, directly or indirectly, or having the authority to obtain possession of them. Advisers have custody over a client’s funds when they have the power to withdraw funds or securities from the client’s account for some purpose other than authorized trading.

The custody rule itself imposes a number of requirements on SEC-registered investment advisers in order to protect the assets over which the adviser has custody. First, advisers must use “qualified custodians” to hold client assets. Qualified custodians can include “banks, registered broker-dealers, futures commission merchants, or certain foreign entities.” Additionally, advisers must send detailed notices to clients regarding the custody over their funds and they must advise clients to compare account statements sent by the adviser with the statements sent by the custodian. Thirdly, advisers must have a “reasonable basis” to believe that the custodian has sent account statements directly to the adviser’s clients, and on at least a quarterly basis. Fourth, the investment adviser must enter into a written agreement with an independent public accountant to examine those assets on a surprise basis every year. The examiner will contact clients to discuss the details of their holdings. Moreover, the adviser must obtain a written report from an independent public accountant regarding the effectiveness of the custodian’s procedures for safeguarding client funds and securities each year.

Despite these requirements, the Commission is aware of significant deficiencies with regard to advisers’ diligence and care over client assets, and they warn clients to be aware of the measures taken by advisers. Clients are advised to keep the following in mind:

• If a client already has a bank or other custodian looking after their assets, and it is not clear whether the adviser will also have custody over assets, the client should ask the adviser to identify any custodian and provide the custodian’s contact information.

• Check whether the account is under the client’s own name or under the investment adviser’s name as agent for the client.

• The client should be sure that they are getting at least quarterly statements directly from a qualified custodian regarding his or her account. Any discrepancies should be reported to the adviser and custodian right away. If any issue is not resolved, contact the SEC.

• Always ask about adviser fees, as they can have a material effect on a client’s return.

The custody rule works to provide guidelines for the exercise of adviser judgment, but clients are advisesd to continue to remain informed of the policies and procedures taken by advisers, so as to ensure the safety of their assets.


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