SEC’s No-Action Letter Offers Critical Clarification on Custody Rule


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On February 21, 2017, the SEC issued a highly anticipated no-action letter regarding Rule 206(4)-2 of the Investment Advisers Act of 1940—also known as the Custody Rule. In the letter, the SEC affirmed that a standing letter of instruction (SLOA) or similar asset transfer authorization arrangement would result in an investment adviser having custody of client assets.

Additionally, the SEC stated that they “would not recommend enforcement action” if the investment adviser does not obtain a surprise examination under the following circumstances:

  1. The client provides an instruction to the qualified custodian, in writing, that includes the client’s signature, the third party’s name, and either the third party’s address or the third party’s account number at a custodian to which the transfer should be directed.
  2. The client authorizes the investment adviser, in writing, either on the qualified custodian’s form or separately, to direct transfers to the third party either on a specified schedule or from time to time.
  3. The client’s qualified custodian performs appropriate verification of the instruction, such as a signature review or other method to verify the client’s authorization, and provides a transfer of funds notice to the client promptly after each transfer.
  4. The client has the ability to terminate or change the instruction to the client’s qualified custodian.
  5. The investment adviser has no authority or ability to designate or change the identity of the third party, the address, or any other information about the third party contained in the client’s instruction.
  6. The investment adviser maintains records showing that the third party is not a related party of the investment adviser or located at the same address as the investment adviser.
  7. The client’s qualified custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.

In order to provide investment advisers, qualified custodians and clients with reasonable time to implement the necessary compliance procedures, the SEC has stated that advisers should include client assets that are subject to a SLOA in Item 9 of Form ADV after October 1, 2017.

First-Party Movement Authorizations

On the same day the SEC issued the no-action letter, it also updated the Custody FAQs to provide guidance on first-party money movement—the ongoing authority that allows advisers to move money between a client’s accounts at different financial institutions.

In the revised FAQ, the SEC made it clear that clients must provide a signed authorization form that lists the receiving account number(s) of outside financial institutions in order for an adviser to avoid triggering custody and the annual surprise examination requirement. This holds true regardless of whether or not the adviser acts upon the authority.

While the SEC did not specify a deadline by which advisers and custodians are required to implement changes, advisers should work with their custodian to ensure the firm is compliant within the next 6–12 months.

 

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