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SEC Issues Risk Alert and Investor Bulletin on Investment Adviser Custody Rule

OCIE issued a risk alert and investor bulletin in March regarding compliance with the SEC custody rule for investment advisers, which is designed to protect advisory clients from theft or misuse of their funds and securities. The alert comes after a review of recent examinations that suggest widespread noncompliance with the custody rule. Examiners found that approximately one third of investment advisers subject to examination had custody-related deficiencies.

One common deficiency noted by the SEC is that advisers often fail to recognize they have custody, such as where:

  • the adviser or a related person serves as trustee or has power of attorney for the client accounts;
  • the adviser provides bill-paying services for clients and is therefore authorized to withdraw funds from the client's account;
  • the adviser manages portfolios by directly accessing online accounts using a client's personal username and password;
  • the adviser acts as a general partner of a limited partnership;
  • the adviser is authorized to write or sign checks for clients; or
  • the adviser receives checks made out to clients and fails to return them promptly to the sender.

Examiners also noted problems with adherence to the custody rule's surprise exam requirement. Specifically, Form ADV-E was often not filed within 120 days after the exam by the accountant, and exams were often not conducted on a surprise basis but were instead conducted at the same time each year.

Advisers also routinely failed to comply with the custody rule's qualified custodian requirements. Client assets were often held in the adviser's name, but not in an account that was under the adviser's name as agent or trustee for the client and that held only client assets. Instead, advisers often commingled client, proprietary and employee assets in one account. Furthermore, advisers often had no reasonable basis to believe the custodian was sending quarterly account statements to the client. In instances where the adviser opened a custodial account on behalf of a client and sent account statements to the client, the statements often failed to include notification urging clients to compare the account statements from the custodian with those from the adviser.

In addition, for advisers that relied on the audit approach with respect to pooled investment vehicles, the examinations found various deficiencies. Accountants that conducted audits were often not independent, and the audited financial statements were often not prepared in accordance with GAAP. Additionally, advisers failed to demonstrate that:

  • the financial statements were distributed to all fund investors and were sent within the required timeframe;
  • the auditors used were PCAOB-registered; and
  • a final audit was performed on liquidated pooled investment vehicles.

Advisers are encouraged to review their compliance with the custody rule in light of the deficiencies noted in the risk alert. Deficiencies noted in the risk alert have resulted in actions ranging from immediate remediation to litigation.

Sources: SEC Issues Risk Alert and Investor Bulletin on Investment Adviser Custody Rule, SEC Release No. 2013-33, March 4, 2013; Significant Deficiencies Involving Adviser Custody and Safety of Client Assets, National Exam Program Risk Alert Volume III, Issue 1, March 4, 2013.

Copyright © 2020 Godfrey & Kahn S.C.National Law Review, Volume III, Number 103


About this Author

Godfrey & Kahn has one of the Midwest's largest investment management practices, with a team of attorneys dedicated solely to investment management clients. Our team offers a wide range of experience and includes attorneys who have worked at the SEC, held senior executive positions at national and international mutual fund groups and served as in-house counsel to companies within the investment management industry. This broad experience gives us the insight and understanding necessary to advise clients in the United States and abroad on the complex issues faced by investment management...