In March, the SEC issued a Risk Alert and an Investor Bulletin related to compliance with its custody rules for investment advisers. The Risk Alert was issued following recent examinations of investment advisers which revealed various deficiencies related to compliance with the SEC’s custody rules.
Custody by an investment adviser means holding client funds or securities, directly or indirectly, or having the authority to obtain possession of them. For example, an investment adviser has custody of its clients’ assets when an investment adviser has the power to withdraw funds or securities from its client’s accounts, including fees. SEC-registered investment advisers who have custody of client assets must, subject to certain exceptions, (i) use qualified custodians to hold client assets, (ii) provide notice to their clients in writing of the qualified custodian’s name, address, and the manner in which the client’s funds or securities are maintained, (iii) have a reasonable basis to believe that the qualified custodian that maintains its clients’ funds and securities sends account statements at least quarterly to the adviser’s clients directly, (iv) must enter into a written agreement with an independent public accountant to examine client funds and securities on a surprise basis every year to verify such funds and securities, and (v) comply with certain additional rules when the adviser uses a related qualified custodian.
The deficiencies identified in recent exams of investment advisers included:
- failure of advisers to recognize that they had custody;
- failure of advisers to comply with the custody rule’s surprise examination requirements;
- failure of advisers to comply with the custody rule’s qualified custodian requirement; and
- failure of advisers to comply with the audited fund exception to the surprise audit requirement for pooled investment vehicles.
As a result of recent examinations, the SEC staff has required advisers with custodial deficiencies to take various actions, including remedial measures, such as drafting, amending or enhancing their written compliance procedures, policies, or processes; changing their business practices; or devoting more resources or attention to the area of custody. In addition, in certain cases, the staff has made referrals to the SEC’s Division of Enforcement. In connection with the annual review of their policies and procedures, investment advisers should pay particular attention to their custodial policies, procedures and actual business practices in light of this recently issued Risk Alert.