Alert – SEC Issues Guidance Update on Inadvertent Custody
The SEC’s Division of Investment Management issued a February 2017 Guidance Update regarding situations where an adviser might inadvertently have custody.
The key takeaway is that the definition of “custody” is to review agreements with qualified custodians to determine if they give an advisor the ability to withdraw or transfer client funds or securities. If such ability is permitted by the agreement between the client and the custodian, it is deemed to be custody even if the advisor does not have permission to do so and does not act on that ability. This is true regardless of other agreements between the client and the advisor.
The Guidance provided several examples of provisions in custodial agreement language which might constitute custody by the advisor. These include:
- the right of the advisor to receive and dispose of assets;
- the ability of the custodian to rely on all advisor instructions fully; and
- authorization for the advisor to instruct the custodian to disburse cash for any purpose.
While the Division is likely to take a “facts and circumstances” approach to enforcement, there is nothing to suggest they would be lenient about inadvertent custody. Although each advisor’s business is different, there are at least two points of control available to firms:
- An advisor who recommends and works with a limited number of custodians can ensure the custodial agreement does not contain any language which might give the advisor custody.
- In cases where the agreement contains such language, the advisor can draft a written document addressed to the custodian limiting the advisor’s authority to “delivery versus payment” and obtain signed written acknowledgements and consents from both the client and the custodian to this arrangement.
The Guidance reiterated that if an advisor has custody solely due its ability to withdraw fees, the exception from a surprise audit is still available, provided the advisor otherwise complies with the associated provisions of the Custody Rule. Likewise, if the conditions in the SEC’s February 21, 2017 No-Action Letter are met, the surprise audit is not necessary for firms using SLOA’s to provide bill-pay services for their clients. For more information on the No Action Letter, view our March 7, 2017 blog post “Standing Letters of Authorization Clarity Provided”.
In any case, it is important to take time to review your agreements and, if necessary, seek outside advice to determine the best path forward.
Our consultants have the experience and perspective gained from working with hundreds of clients to help you efficiently and effectively run your firm. They have sat in your seat and faced the same obstacles and regulatory scrutiny. We can also provide you with compliance automation through our Oyster Solutions platform by integrating risk assessments, policies and procedures and testing programs that are aligned to how you do business.
More about Lance Whittemore: As a Senior Consultant at Oyster, Lance has designed, implemented and maintained compliance programs for SEC- and State-registered investment advisors, and has served as CCO. He also works with broker-dealers and clearing firms, performing examinations, designing and testing controls, and responding to regulatory matters. Lance has over 20 years’ experience in financial services. You can reach him at (804) 521-6016. If you have further questions or concerns about this topic, please complete our contact form and one of our Relationship Managers will be happy to assist you.