The SEC Proposes New Rule to Safeguard Client Assets

The SEC proposed a new rule under the Investment Advisers Act of 1940 to address how registered investment advisers safeguard client assets.

As part of this proposal, the SEC intends to amend certain provisions of the current custody rule for enhanced investor protections. The SEC also proposed corresponding amendments to the recordkeeping rule under the Advisers Act and to Form ADV for investment adviser registration under the Advisers Act.

About the Amendments

The proposed amendments are designed to modernize the scope of assets and activities that would trigger application of the rule. Specifically, the safeguarding rule would specify the types of assets subject to the safeguarding requirements of the rule by defining assets as funds, securities, or other positions held in a client’s account, as opposed to the custody rule’s use of funds and securities.

The proposed rule also would explicitly include discretionary authority to trade within the definition of custody.

Under the proposal, the written agreement would require two provisions that aren’t explicitly addressed by the current rule.

The first provision would require the qualified custodian to provide promptly upon request records relating to clients’ assets held in the account at the qualified custodian to the SEC or to an independent public accountant engaged for purposes of complying with the safeguarding rule. The second provision specified the adviser’s agreed upon level of authority to effect transactions in the account.

The proposed rule’s written agreement requirement would also incorporate, and expand, two components of the current rule: account statements and internal control reports.

Under the account statement rule, the written agreement must contain a provision requiring the qualified custodian to deliver account statements to clients and to the adviser, as currently advisers must have only a reasonable basis for believing account statements are provided.

The internal control report provision would require the qualified custodian to obtain a written internal control report that includes an opinion of an independent public accountant regarding the adequacy of the qualified custodian’s controls.

Finally, the SEC proposed amendments to Form ADV to align reporting obligations with the proposal and improve the accuracy of custody-related data available to the SEC, its staff, and the public.

As part of these proposed amendments, the SEC also proposed changes to the Surprise Examination requirements.

Under the proposed amendments, the SEC is expanding availability of audit provision from limited partnerships, limited liability companies, and other pooled investment vehicles to include any advisory clients whose financial statements can be audited.

The proposed amendments would require privately offered securities or physical assets not maintained with a qualified custodian to also be verified—a change from the current custody rule. The SEC has also recently published a final rule for private fund advisers, which amongst other requirements, requires private funds to obtain an annual audit.

Transition Period and Compliance Date

The proposal, if finalized, would provide a one-year transition period following the rules’ effective date, which would be sixty days after the date of publication of the final rules in the Federal Register for advisers with more than $1 billion in regulatory assets under management (RAUM).

For advisers with up to $1 billion in RAUM, the compliance date of any adoption of this proposal would be 18 months following the rules’ effective dates, which would be sixty days after the date of publication of the final rules in the Federal Register.

We’re Here to Help

To learn more about the proposed amendments, or the potential impacts on your business, contact your Moss Adams professional.

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