SEC Issues Guidance Update on RIA Custody Rule

Understanding Custody Rule SEC Guidance

The SEC’s Division of Investment Management issued a February 2017 Guidance Update to Rule 206(4)-2 (the Custody Rule) under the Investment Advisers Act of 1940 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.

Examples of Custodial Agreement Provisions that May Constitute Custody

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.

Enforcement Approach: Facts and Circumstances

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 Rule 206(4)-2 (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 Standard Letters of Authorization (SLOAs) to provide bill-pay services for their clients.

RIA Custody Compliance Support

It is important to take time to review your agreements and, if necessary, seek outside advice to determine the best path forward. Oyster Consulting’s regulatory compliance experts have the experience and perspective registered investment advisors need to comply with the SEC’s custody requirements. From Books and Records to Form ADV disclosures, our consultants ensure that your program will meet regulatory expectations.