SEC Proposes Broadening Custody Rule for Investment Advisers

On February 15, the SEC announced proposed rules to broaden the application of the current investment adviser custody rule beyond client funds and securities to include any client assets in an investment adviser’s possession or when an investment adviser has authority to obtain possession of client assets.

If adopted, the changes would amend and redesignate rule 206(4)-2, the Commission’s custody rule, under the Investment Advisers Act of 1940. According to the SEC’s Fact Sheet, the proposed amendments would:

• Expand the current custody rule to protect a broader array of client assets and advisory activities to the rule’s protections;
• Enhance the custodial protections that client assets receive under the rule; and
• Update related recordkeeping and reporting requirements for advisers.

In the SEC press release announcing the rules, Chairman Gary Gensler pointed out that the proposal would “help ensure that advisers don’t “inappropriately use, lose, or abuse investors’ assets.”

Notably, Gensler referred to crypto assets in his comments:

“In particular, Congress gave us authority to expand the advisers’ custody rule to apply to all assets, not just funds or securities,” Gensler said. “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.”

The SEC Fact Sheet points out that “Since the current custody rule was last amended in 2009, changes in technology, advisory services, and custodial practices have created new and different ways for client assets to be placed at risk of loss. In addition, in 2010, Congress gave the Commission more expansive and explicit authority to protect client assets. Thus, the proposal would scope in certain other assets that do not receive custodial protections under the current custody rule.”

According to the Fact Sheet, the proposed rule would:

• Require that an adviser enter into a written agreement with and obtain certain reasonable assurances from qualified custodians to ensure clients receive certain standard custodial protections when an adviser has custody of their assets. These protections are designed, among other things, to ensure client assets are properly segregated and held in accounts designed to protect the assets in the event of a qualified custodian bankruptcy or other insolvency;
• Modify the current custody rule’s exception from the obligation to maintain client assets with a qualified custodian for certain privately offered securities, including expanding the exception to include certain physical assets;
• Retain the current custody rule’s requirement for an adviser to undergo a surprise examination by an independent public accountant to verify client assets, but expand the availability of the current custody rule’s audit provision as a means of satisfying the surprise examination requirement;
• Amend the investment adviser recordkeeping rule to require advisers to keep additional, more detailed records of trade and transaction activity and position information for each client account of which it has custody; and
• Amend Form ADV to align advisers’ reporting obligations with the proposed safeguarding rule’s requirements and to improve the accuracy of custody-related data available to the Commission, its staff, and the public.

The SEC will accept comments on the proposed rules for 60 days following publication in the Federal Register. For more information about the details of the proposed rule and the potential impact on investment advisers and their clients, contact us. We are here to help.

©2023