Market Compliance Corner: Investment Advisers With Standing Letters of Instruction May Have Custody
Do you have custody of your client's funds or securities? The answer is not always obvious. A registered investment adviser is considered to have custody if it "has authority to obtain possession of [client funds or securities]. in connection with [the] advisory services [it] provide[s] to clients.' This broad definition has captured many advisers who felt that their limited interaction with client assets did not grant them custody. In a recent no action letter the SEC clarified that RIAs may be considered to have custody even if the sole authority granted to them was to instruct the third-party custodian of the client assets to transfer those assets in accordance with the client’s prior express direction (so called standard letters of authority or SLOA).
The SEC believes that many but not all SLOA arrangements will result in an RIA having custody of the client's assets. The Staff noted that there is not a set format for SLOA arrangements and some may not trigger a custody obligation. For example, SLOA arrangements that are structured so that the adviser does not have discretion over the amount, payee, and timing of transfers should not mean that the adviser has custody.
RIAs who have custody of client assets must typically make sure they are held with a "qualified custodian", disclose that they have custody on Form ADV and (unless certain exemptions apply) subject themselves to surprise examinations by a Public Company Accounting Oversight Board member accountant, each year. Addressing these points, the SEC granted relief from the surprise audit requirement, under the following circumstances:
- 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.
- 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.
- 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.
- The client has the ability to terminate or change the instruction to the client’s qualified custodian.
- 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.
- 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.
- The client’s qualified custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.
The SEC also recognized that it may take some time for RIAs with these relationships to get the necessary compliance procedures in place. As a result, RIAs are allowed to update their response to Item 9 of Form ADV part 1 to include SLOA assets with their next updating amendment after October 1, 2017. Please let once of the attorneys below know if you have any questions about this Form ADV update or any other Investment Advisers Act matter.