RIA Compliance and Practice Management Blog

RIA Firms With Authorization to Transfer Client Funds May Have Custody

Posted by RIA in a Box

Jan 24, 2017 10:00:00 AM

Form ADV RIA custody disclosureIt has recently been reported that a growing number of registered investment adviser (“RIA”) firms are being deemed to have custody of client funds during regulatory audits conducted by the Securities and Exchange Commission (“SEC”). In these recent instances, the custody scenario is a bit unique and not directly related to traditional RIA custody problem areas such as bill-paying services, check writing authority, online login access to client accounts, trustee or power of attorney, or general partner of a pooled investment vehicle. However, this more recent issue still tie back to a similar root question: does the investment adviser have access to or the ability to obtain client funds while providing investment advisory services?

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Under Rule 206(4)-2 of the Advisers Act, the official definition of “custody” is:

“holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. You have custody if a related person holds, directly or indirectly, client funds or securities, or has any authority to obtain possession of them, in connection with advisory services you provide to clients.”

In a number of recent regulatory exam deficiency letters, SEC staff notes that “custody includes any arrangement where an adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian upon the adviser’s instructions to the custodian.” This is particularly relevant to a number of RIA firms given that many traditional client custodian agreements, asset movement authorizations, or standing letters of authorization (“SLOA”) have allowed an adviser to initiate bank wires to accounts held outside the custodian without direct instructions from the client as long the outside account was also titled in the client’s name. However, this issue is gaining more recent scrutiny given that custodians do not often have the ability to enforce such a restriction since the custodian is unable to always confirm that the receiving account is titled in the client’s name. Thus, in some such instances, SEC staff are deeming advisory firms with such authorization to have custody of client funds.

Unfortunately, an RIA firm registered with the SEC that has custody of client funds must meet a number of additional regulatory requirements including the need for an outside accounting firm to conduct an annual independent surprise audit. Rule 206(4)-2 further specifies that “the written agreement (with the independent public accountant) must provide for the first examination to occur within six months of becoming subject to this paragraph.” The independent public accountant must than file a Form ADV-E with the SEC within 120 days of the surprise audit.

Given the additional operational risks and regulatory expenses, the vast majority of RIA firms will likely want to avoid being deemed to have custody. The SEC staff and a number of the large industry custodians have confirmed that the Investment Adviser Association (“IAA”) is currently in active discussions with the SEC Division of Investment Management in order to gain more clarity and guidance on the issue. There is optimism that additional guidance will come from the SEC in the near future, however, in the interim, RIA firms should consider taking the following immediate steps:

  1. Review all current custodian agreements and SLOAs to determine if any potential custody issues may exist.
  2. Strongly consider canceling any SLOA instructions with clients that may be problematic.
  3. Communicate as needed with clients to inform them of these needed precautions until further guidance is issued.

As RIA compliance consultants, we strongly encourage all RIA firm principals to continue to actively monitor this developing regulatory issue.

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Topics: RIA Operations, RIA Compliance

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

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