Securities Law & Corporate Counsel Blog

Recently, the Securities and Exchange Commission (“SEC”) issued a Risk Alert(the “Alert”) concerning rule 206(4)-2 of the Investment Advisers Act of 1940 (the “Rule”), commonly referred to as “The Custody Rule” for investment advisers.  The Alert was issued as a response to recent examinations conducted by the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) who found significant deficiencies in this area in nearly one-third of firms that were examined.  The following items were provided by OCIE as some of the more common deficiencies discovered:

1. Failure [of the adviser] to recognize that they have custody, such as situations where the adviser serves as trustee, is authorized to write or sign checks for clients, or is authorized to make withdrawals from a client’s account as part of bill-paying services;
2. Failure to satisfy the Rule’s qualified custodian requirements, for instance, by commingling client, proprietary, and employee assets in a single account, or by lacking a reasonable basis to believe that a qualified custodian is sending quarterly account statements to the client;
3. Failure to meet the Rule’s surprise examination requirements; and
4. In instances where the adviser oversees an audited pooled investment vehicle, the examinations found some failed to meet requirements to engage an independent accountant and demonstrate that financial statements were distributed to all fund investors.

The alert goes on to state that these deficiencies have resulted in enforcement actions ranging from remedial measures (such as requiring the adviser to draft, amend, or enhance written compliance procedures, policies or processes), to referrals made to the SEC’s Division of Enforcement with the recommendation for more serious sanctions.This area will continue to be a focus of SEC examinations according to OCIE Director Carlo V. di Florio.  As such, it is critical that advisers understand and follow these regulations when they maintain custody of client funds.  For further information about this, or other related topics, please contact us at [email protected] or (619) 298-2880.