Industry Requests More Time to Review SEC's Proposed Expansion of the IA Custody Rule

Thirteen financial services trade associations called for a 60-day comment period extension on an SEC proposal to expand the requirements of IAA Rule 206(4)-2 ("Custody of Funds or Securities of Clients by Investment Advisers"). The associations represent banks of all sizes, global custodians, broker-dealers, investment funds, fund managers, alternative investments and registered investment advisers ("RIAs").

In the letter to the SEC, the associations said that more time is needed because the proposal is "broad based, complex, and technical" and because the changes would "drastically and permanently alter the custody business model and the prevailing market for custody services." The associations explained that because the proposal will alter the various relationships between RIAs, qualified custodians, RIA clients and third parties, market participants require additional time to evaluate the extent of the impact on these parties.

As previously covered, the proposal would require the safekeeping of virtually all client assets by "qualified custodians" at all times, including during the trade settlement process. If adopted, the rule would apply to (i) customer assets that are not funds or securities and (ii) digital assets that the SEC has said are generally securities but that it generally does not permit to be held by a broker-dealer. The proposal would cover all "positions held in a client account" - thereby bringing in previously excluded assets such as real estate and other physical assets - to the extent that the adviser has control over the account. Additionally, the authorities that constitute custody will explicitly include any discretionary trading. Further, the proposed rule would require any adviser that has custody of a client's assets to enter into an agreement with the client's custodians, among other changes.

The associations also cautioned that some banks and savings associations may be materially impacted due to the revised definition of "qualified custodian" causing such entities to fall outside this definition. The associations characterized the proposal as "yet another of a flurry of regulatory changes aimed at RIAs" that will have a impact on RIAs in terms of costs and regulatory burdens. Referencing a 2022 letter to SEC Chair Gary Gensler (see prior coverage), the associations stressed that "aside from the sheer volume of rulemaking items," the SEC's pursuit of issues that may result in extensive shifts in industry operations and practices is cause for generally longer comment periods.

The letter was signed by ABA Securities Association, Alternative Credit Council, Alternative Investment Management Association, American Bankers Association, American Investment Council, Association of Global Custodians, Independent Community Bankers of America, Investment Adviser Association, Investment Company Institute, LSTA, Managed Funds Association, Securities Industry and Financial Markets Association, SIFMA Asset Management Group.

For more analysis on the SEC proposal, click here for Fried Frank's Client Memorandum.