Are You in Compliance with SEC Custody Rules?

After the barrage of investment frauds several years ago, the SEC came under intense pressure to update its rules protecting investors. The SEC responded by issuing what is commonly referred to as the “custody rules.”

The custody rules indicate that if an investment manager has custody of client funds, they fall under the scope of the rules and must follow the rules’ requirements, which generally include that an investment manager (among other requirements):

  • Inquire that qualified custodians send account statements directly to clients and provide notification of this to its clients.
  • Meet audit requirements for any investment funds it manages.
  • Engage an accounting firm to perform a surprise custody examination, which results in an opinion filed with the SEC regarding the investment manager’s compliance with the custody rules.
  • Obtain SSAE 16 (formerly SAS70) reports in certain circumstances.

The rules are lengthy and can at times be a bit complex.  As such, it was no surprise when the SEC’s Office of Compliance and Examinations (OCIE) issued an alert that identified several significant deficiencies relating to custody issues. These investment manager deficiencies included:

  • Failure to recognize a manager has custody, such as situations in which the manager serves as trustee, is authorized to write or sign checks for clients, or is authorized to make withdrawals from a client’s account as part of bill-paying services.
  • Failure to meet the custody rule’s surprise examination requirements.
  • Failure to satisfy the custody rule’s qualified custodian requirements; for instance, by commingling client, proprietary, and employee assets in a single account, or by lacking a reasonable basis to believe that a qualified custodian is sending quarterly account statements to the client.

In addition, OCIE discovered that some investment managers that manage investment funds failed to meet the requirements to provide audited financial statements to all fund investors in a timely manner.

What Does This Mean for Investment Managers?

The SEC takes the custody rules seriously and OCIE has made these rules a focus of its ongoing process of examining investment managers. Investment managers should take steps to ensure they understand the rules and dedicate resources to comply with them. This may mean consulting with legal and accounting firms to get up to speed.

What Does This Mean for Investors?

The bulletin issued by the SEC’s Office of Investor Education and Advocacy (OIEA) describes the requirements of the custody rule, including the requirement for custodians to send account statements to investment advisory clients at least every quarter. The bulletin notes that even though the custody rule provides enhanced protections to investors, it is not a substitute for an investor’s own oversight and monitoring of their investments. As OIEA Director Lori Schock noted, “asking questions and monitoring investments are key ways to protect yourself from investment fraud.”

Thomas A. Peters, Director, Audit & Accounting can be reached at tpeters@kmco.com or 215.441.4600.

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