New amended custody rules implemented by the SEC in March mainly impact those in the investment arena but could have an impact on others as well. The amendments to the SEC’s Custody Rule under the Investment Advisors Act of 1940 were designed to provide additional investor safeguards by requiring financial advisers with custody of client funds to maintain those assets with broker-dealers, banks or other qualified custodians, says Brian Finnegan, a partner with Burr Pilger Mayer.
“This is a sign of things to come, with more SEC and other government regulations on the horizon,” says Finnegan. “SEC Chairman Mary Schapiro’s focus is on pursuing an aggressive investor-focused agenda, and there are items being considered in Congress that would give the commission more funding to protect investors and step up oversight of investment advisers.”
Smart Business spoke with Finnegan about how the landscape is changing and how the new amendments will affect both investors and investment advisers.
How have the rules changed over the years?
Since 1966, registered investment advisers and others paid to manage money had been required to undergo a surprise exam by an independent accountant each year. In 2003, the SEC decided that if a qualified custodian was maintaining clients’ assets, there was no need for surprise exams.
Following the Madoff scandal and other high-profile Ponzi schemes and theft of client assets, the SEC decided that wasn’t a good idea. So, in 2009, it proposed custody rule amendments, which became effective March 12, 2010.
What do the new amendments require?
- A qualified custodian must maintain client assets, and each client’s assets and securities must be held in a separate account (or in an account containing only client funds under the adviser’s name as agent).
- Qualified custodians must send out account statements, and the registered adviser, after due inquiry, must have a reasonable belief that those statements are being sent.
- An adviser must inform clients if he or she opens new accounts on their behalf.
- Advisers who have custody of client assets must undergo an annual surprise examination by an independent public accountant to verify the existence of client funds. If the adviser has no control over the assets beyond deducting advisory fees from the account, that adviser is exempt from the surprise examination requirement.
- Advisers of pooled investment vehicles are exempt from the surprise examination provided the underlying pooled fund undergoes an annual financial statement audit performed by a public accountant registered with and subject to inspection by the Public Company Accounting Oversight Board.
- Advisers or related persons serving as qualified custodian must also receive an internal control report from an independent accountant.
