SEC Proposed “Safeguarding Rule” May Impact RIAs

Potential increase in number of registered investment advisors subject to “Custody Rule”

In February 2023, the Security and Exchange Commission (SEC) proposed significant rule changes for registered investment advisors (RIAs) to enhance protections of customer assets due to changes in technology, advisory services, and custodial practices. Building on my colleague Andrew Sledd‘s article, “Potential Changes Coming to the SEC’s Custody Rules in 2023,” I aim to provide more specifics regarding the SEC’s proposed “Safeguarding Rule.”

If adopted, the Safeguarding Rule would expand the scope of assets included in the definition of custody, which obligates RIAs to comply with the rule, and would remove the custody exception for advisers with authorized trading authority. Data drawn by Form ADV Part 1A filings and released by the Investment Adviser Association indicates that over 5,000 RIAs would be deemed to have custody over client assets and would be subject to the new rule requirements.

Expansion of the scope of assets

The current custody rule defines assets as “client funds and securities”. The proposed rule would expand the definition to “funds, securities, or other positions held in a client’s account”. The SEC believes the change in definition will allow the proposed rule to remain relevant throughout the evolution of new types of investments and would include crypto assets, physical assets, short positions, and more.

Removal of exception for discretionary authority

Many RIAs have been granted discretionary authority to effect trades on behalf of their clients without obtaining consent every time. In 2003, the SEC released guidance that specifically stated that an adviser’s ability to issue instructions to a broker-dealer or custodian to authorize trading does not constitute custody under the rule. The proposed Safeguarding Rule would explicitly include a RIA’s discretionary authority to trade client assets within the definition of custody in most cases.

What’s next?

The proposed Safeguarding Rule went through two comment periods, the last ending in October of last year. The status of the proposal is unknown at this time. In the meantime, RIAs should familiarize themselves with the proposed Safeguarding Rule and determine whether custody would be triggered based on the proposed changes. While the Safeguarding Rule would increase custody rule requirements for many RIAs if adopted, the requirements do not need to be burdensome.

Reach out to your Keiter Opportunity Advisor to learn how we can help you fulfill the surprise custody examination requirements without added stress to you or your clients.