SEC Issues Risk Alert and Investor Bulletin on Investment Adviser Custody Rule; Summarizes Rule and Recent Violations (with Lofchie Comment)

The SEC issued (i) a Risk Alert for investment advisers as to compliance with its custody rule and (ii) a related Investor Bulletin designed to inform advisory clients how to monitor their assets and protect their accounts from theft or misuse of their funds and securities by their advisers.

According to the SEC, the alert was issued after a review of recent examinations by the SEC's Office of Compliance Inspections and Examinations ("OCIE") showed that, among firms that had significant deficiencies, one third had custody-related violations (oddly, the alert does not give a percentage of all firms inspected, only of those firms with significant issues).

The advisers' deficiencies identified by OCIE included:

• Failure to recognize that they had custody by control, such as in situations where the adviser:
  • served as trustee,
  • was authorized to write or sign checks for clients, or
  • was authorized to make withdrawals from a client's account as part of bill-paying services.
• Failure to meet the custody rule's surprise examination requirements.
• Failure to satisfy the custody rule's qualified custodian requirements.
• Failure of the adviser to a pooled investment vehicle to engage a properly qualified independent accountant and to demonstrate that financial statements were distributed to all fund investors.

Lofchie Comment:Custody is a hot regulatory issue, and appropriately so. Accordingly, investment advisers seeking to stay on the good side of their regulators are well served to review their custodial arrangements in light of the various deficiencies pointed out by the SEC. As a practical matter, this review is a good investment: there can be few things worse for an adviser's business than having to disclose to potential investors that the adviser was found by the SEC to be in material violation of the custody rule.

See: SEC's Risk Alert and Investor Bulletin.
See also: The Custody Rule (Advisers Act Rule 206(4)-2).