By Scott Hoffmann, CPA, Business Assurance & Advisory Services Senior Manager | Financial Services Industry Team
SEC Custody Rule’s No-Action Letter Provides Some Relief to Registered Investment Advisors (RIAs)
The SEC has issued a no-action letter providing relief from some investment advisors’ requirement to receive a surprise annual examination if their custody arrangement satisfies certain criteria. Since the passage of the Dodd-Frank Act in 2009, which required investment advisors who are determined to have custody of their clients’ accounts to undergo annual surprise examinations by independent accountants, there has been a lot of confusion and divergence in interpretation on what constitutes “custody.” In February 2017, the SEC issued a no-action letter that clarifies the definition of custody for the purpose of the examination.
SEC Custody Definition
The SEC defines “custody” as:
“[W]here it (the investment advisor) or its related person “holds, directly or indirectly, client funds or securities, or has any authority to obtain possession of them, in connection with advisory services [it] provide[s] to clients . . . .” Moreover, “custody” includes “[a]ny arrangement . . . under which [an investment adviser is] authorized or permitted to withdraw client funds or securities maintained with a custodian upon [its] instruction to the custodian . . . .”
What Is a Signed Letter of Authorization (SLOA)?
Some investment advisors had previously interpreted this definition to exclude from “custody” arrangements where the client would sign a “Signed Letter of Authorization” (SLOA), allowing the investment advisor to disburse funds only to pre-authorized third parties, and would therefore not receive the annual surprise examination.
Who is exempt from a surprise custody examination of client funds and securities?
The SEC disagreed with this interpretation, but instead allowed client accounts to be excluded from the surprise examination if the following conditions exists:
- The client provides an instruction to the qualified custodian, in writing, that includes the client’s signature, the third party’s name, and either the third party’s address or the third party’s account number at a custodian to which the transfer should be directed.
- The client authorizes the investment adviser, in writing, either on the qualified custodian’s form or separately, to direct transfers to the third party either on a specified schedule or from time to time.
- The client’s qualified custodian performs appropriate verification of the instruction, such as a signature review or other method to verify the client’s authorization, and provides a transfer of funds notice to the client promptly after each transfer.
- The client has the ability to terminate or change the instruction to the client’s qualified custodian.
- The investment adviser has no authority or ability to designate or change the identity of the third party, the address, or any other information about the third party contained in the client’s instruction.
- The investment adviser maintains records showing that the third party is not a related party of the investment adviser or located at the same address as the investment adviser.
- The client’s qualified custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.
Several large commonly used custodians such as TDAmeritrade and Charles Schwab have provided documentation to their advisor clients that certain of the accounts they custody satisfy the conditions related to the custodian’s policies. Investment advisors should check with their custodians directly to ensure their accounts satisfies the conditions above that relate to custodian practices.
Additionally, the SEC noted that even though accounts that satisfied the conditions noted above could be excluded from the surprise examination, they should still be listed as custodied funds on the advisor’s Form ADV. This no action letter may allow investment advisors to either reduce the number of accounts that are subject to the annual examination, or remove the examination requirement altogether.
Additional Resources for Financial Services companies
- SEC Evaluating Scaled Approach for Broker-Dealer Reporting and Audit Requirements
- Investor Relations – Important Changes Coming to your 2019 Partnership K-1
- IRS Issues New Guidance for Cryptocurrency Transactions
- Senators Introduce the Small Business Audit Correction Act
- Updates on Regulation Best Interest (Reg BI)
- Senior Investor Protection: What Broker-Dealers and Investment Advisors Need to Know
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.