While separate from the SEC’s new Form ADV filing requirements which took effect on October 1, 2017, registered investment adviser (“RIA”) firms may also need to update Item 9 on their Form ADV Part 1 related to new guidance on complying with Rule 206(4)-2 (“Custody Rule”) as it relates to the use of standing letter of authorization (“SLOA”) for a client. In a recent no-action letter, The SEC staff notes “with the next annual updating amendment after October 1, 2017, an investment adviser should include client assets that are subject to a SLOA that result in custody in its response to Item 9 of Form ADV.”
New Form ADV Item 9 Custody Guidance Took Effect on October 1, 2017
While no structural changes have been made to Item 9 of the Form ADV, the newly issued SEC guidance likely means that a number of firms will soon be updating their Item 9.A.(1) response to be “Yes”:
In order to properly update Item 9 as part of the next annual updating amendment, advisory firms utilizing SLOAs will need to gather new information related to the use of SLOAs including the “approximate amount of client funds and securities and total number of clients for which you have custody.”
How to Prepare for Item 9 Form ADV Updates
RIA firms should review our prior blog post summarizing new Custody Rule updated guidance related to SLOAs. In preparation for determining whether to update the Item 9 response on the Form ADV, the SEC’s February 21, 2017 no-action letter offers specific guidance in regards to disclosing custody and the potential ability to avoid the surprise examination requirement in limited circumstances.
It’s also important to note that while other SEC’s Form ADV filing requirements took effect on October 1, 2017 and apply to any type of Form ADV amendment (e.g. annual or other-than-annual updating amendment) filed on or after October 1, 2017, this new Custody Rule guidance is applicable for when the firm files its next annual updating amendment. Thus, for the majority or RIA firms, this new guidance will need to be applied during the first quarter of 2018 when firms with a traditional December 31 fiscal year-end file their annual updating amendments.
RIA firms also need to ensure that portfolio management and reporting systems are modified to properly categorize client accounts for which the firm may now be deemed to have custody. With the next annual updating amendment filed on or after October 1, 2017, advisory firms will need access to the proper organized information in order to make any necessary updates to the Form ADV.
It’s also important to note that the SEC recently highlighted the Custody Rule as one of the most common areas for regulatory exam deficiencies. In particular, the SEC examination staff states that many RIA firms fail to “recognize that they may have custody as a result of certain authority over client accounts.” Thus, it’s critical that all advisory firm principals and Chief Compliance Officers carefully review the latest Custody Rule guidance to ensure proper compliance.