On Feb. 15, 2023, the Securities and Exchange Commission (SEC) published for comment amendments to the custody rule and related recordkeeping and Form ADV changes. The proposal would redesignate current custody rule 206(4)-2 as new rule 223-1 under the Advisers Act, to be called the Safeguarding Client Assets Rule.
“I support this proposal because, in using important authorities Congress granted us after the financial crisis, it would help ensure that advisers don’t inappropriately use, lose, or abuse investors’ assets,” said SEC Chair Gary Gensler. “In particular, Congress gave us authority to expand the advisers’ custody rule to apply to all assets, not just funds or securities. Further, investors would benefit from the proposal’s changes to enhance the protections that qualified custodians provide. Thus, through this expanded custody rule, investors working with advisers would receive the time-tested protections that they deserve for all of their assets, including crypto assets, consistent with what Congress envisioned.”
Among other provisions, the proposed rule:
- Defines assets as funds, securities or other positions held in a client’s account, including but not limited to all crypto assets, financial contracts and physical assets.
- Explicitly includes discretionary authority to trade within the definition of custody.
- Modifies the definition of qualified custodian to require having possession or control of advisory client assets (e.g. custodians would not be allowed to report on accommodation assets or assets they don’t control).
- Requires an adviser to enter into a written agreement with and receive certain assurances from the qualified custodian to make sure the qualified custodian provides certain standard custodial protections when maintaining client assets.
- Requires advisers to receive copies of statements sent by qualified custodians to clients.
- Allows an adviser to rely on an exception only if it reasonably determines that ownership of privately offered securities cannot be recorded and maintained by a qualified custodian, the adviser reasonably safeguards the assets, the adviser notifies the independent public accountant performing the verification of such an asset.
- Provides exceptions to the surprise examination requirement when the adviser’s sole reason(s) for having custody is because it has discretionary authority, because the adviser is acting according to a standing letter of authorization, or adviser directly debits advisory fees, each subject to certain conditions. Assets must be held with a qualified custodian and be subject to DVP transactions only to qualify for the exception.
- SLOA written instruction and authorization must be delivered by the client to both adviser and the qualified custodian.
- Amends Form ADV to require the disclosure of additional information, including the basis for custody, amount of client assets, and number of clients in nine separate categories.
The proposal includes a staggered compliance date which gives larger advisers (more than $1 billion in RAUM) one year to comply, while smaller advisers (up to $1 billion in RAUM) will have 18 months to comply. Comments on the proposal can be submitted for 60 days after the proposal has been published in the Federal Register.
About the Author
Max Mejiborsky
Max joined NRS in 2007 as a Consultant in the Investment Adviser Services Department and is based in our Massachusetts branch office. Max delivers comprehensive compliance solutions to all types of investment management firms, with special emphasis on private fund advisers, including hedge funds, funds of funds, private equity and debt funds, venture capital funds, real estate funds and other pooled investment vehicles.
Max earned his Juris Doctor degree Cum Laude from Boston College Law School in 2002. He is a member of the State Bar of Massachusetts.
After graduating from law school, Max accepted a corporate associate position with Choate Hall & Stewart LLP. During his tenure at Choate Hall, Max specialized in secured financing transactions, mergers and acquisitions, and bankruptcy litigation.
Max received his Bachelor of Arts degree Summa Cum Laude, graduating Phi Beta Kappa from Tufts University with majors in International Relations and Eastern European Studies.