In early June, SEC staff provided the industry with clarity and potential relief regarding one of 2017’s more controversial and debated regulatory updates.
In February 2017, the SEC’s Division of Investment Management issued IM Guidance Update 2017-01 “Inadvertent Custody: Advisory Contract Versus Custodial Contract Authority” (the “Guidance”). The Guidance caused some confusion and concern by cautioning investment advisers that they may inadvertently be deemed to have custody of their client assets due to certain provisions included in client custodial agreements. The industry was concerned due to, among other things, the fact that advisers were not privy to such agreements as they are generally entered into directly between a client and their custodian(s).
In the Guidance, SEC staff referenced their concern that custodial agreements may contain provisions that allow a client’s investment adviser to instruct the disbursement or transfer of the client’s funds or securities, even if the agreement between the adviser and the client restricted such activity. The Guidance stated that the adviser would be deemed to have custody of such client’s assets and therefore would be subject to, among other things, the Custody Rule’s surprise audit requirement.
Clarifications to the Guidance
On June 5, 2018, the SEC staff clarified the Guidance by adding Questions II.11 and II.12 to the Custody Rule FAQ. Specifically, SEC staff stated that an investment adviser neither has to comply with the Custody Rule nor report in its Form ADV that it has custody over client assets to the extent the adviser:
- does not have a copy of a client’s custodial agreement;
- does not know, or have reason to know, whether the agreement would inadvertently give the adviser custody of the client’s assets under the Guidance; and
- if the inadvertent custody would be the sole basis for custody.
SEC staff cautioned that investment advisers cannot rely on the relief provided by the Custody Rule FAQ if the adviser’s client executes an agreement with a custodian that is recommended, requested, or required by the adviser.
For More Information
If you have questions about the Custody Rule or need assistance with reviewing your custodial policies and procedures, please contact Jack Rader at firstname.lastname@example.org, Charlie Stout at email@example.com, or your ACA consultant.