The SEC issued guidance on inadvertent custody issues with respect to the custody rule, Rule 206(4)-2 under the Advisers Act. The SEC staff noted that an investment adviser may inadvertently have custody of client funds or securities because of provisions in a separate custodial agreement entered into between its advisory client and a qualified custodian. This guidance updated the circumstances the staff has encountered where such inadvertent custody could arise.
The SEC stated that, in some cases, the terms of an agreement between a client and qualified custodian might permit the client’s adviser to instruct the custodian to disburse, or transfer, funds or securities. The SEC stated that it believes that an adviser would have custody where the custodial agreement enables the adviser to withdraw, or transfer, client funds or securities upon instruction to the custodian. An adviser could also have custody, according to the SEC, when provisions in a custodial agreement and advisory agreement conflict as to an adviser’s authority to withdraw, or transfer, client funds or securities upon instruction to the custodian.
The SEC gave the following examples of custody:
• if the custodial agreement authorizes the adviser to withdraw client funds or securities, notwithstanding a provision in the advisory agreement to the contrary; and
• a separate bilateral restriction between the adviser and the client where the custodial agreement enables the adviser to withdraw or transfer client funds or securities upon instruction to the custodian.
The SEC noted that one way for an adviser to avoid such inadvertent custody would be to draft a letter addressed to the custodian that limits the adviser’s authority to “delivery versus payment,” notwithstanding the wording of the custodial agreement, and to have the client and custodian provide written consent to acknowledge the new arrangement.
Two SEC Documents Result from this Work:
1. SEC Guidance: https://www.sec.gov/investment/im-guidance-2017-01.pdf
2. Updated SEC Custody Q&A: https://www.sec.gov/divisions/investment/custody_faq_030510.htm