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SEC’s Proposed Amendment to Its Custody Rule

September 26, 2012

On May 20, 2009, the Securities and Exchange Commission (SEC) proposed amendments to Rule 206(4)-2, relating to custody of client assets, under the Investment Advisers Act of 1940. The definition of custody would continue to include arrangements in which a registered adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian upon the adviser’s instruction to the custodian. CFP Board submitted comments to the SEC in a letter dated July 28, 2009 that focused on two of the proposed amendments.

One of the amendments would require that all registered investment advisers with “custody” of client funds and securities engage an independent public accountant to conduct an annual surprise examination to verify those client assets. In its letter, CFP Board recommended that the SEC exempt from the surprise examination proposal all advisers that use independent qualified custodians to hold all client assets, are deemed to have custody solely because they have the authority to withdraw fees from client accounts, and rely on the custodians to send account statements to clients. Additionally, the SEC should require such advisers to send a statement to clients listing their annual fee and itemizing the fees that they have deducted year-to-date. This will serve as an additional check on such advisers’ activities, and will provide clients with the ability to compare custodian statements with their advisers’ statements. CFP Board also suggested that the SEC require such advisers to include in the statement a written notice telling clients to compare account statements received from the custodian with those received from the adviser.

Another amendment would require any registered investment adviser or a “related person” of the adviser who maintains custody of client assets to obtain a written internal control report from an independent public accountant registered with the Public Company Accounting Oversight Board that includes an opinion regarding the controls relating to custody of client assets. A related person would be defined as any person, directly or indirectly, controlling or controlled by the adviser, and any person that is under common control with the adviser.

CFP Board expressed its support of the SEC’s internal control report proposal, recognizing that it is designed to address the type of fraud that was perpetrated by Bernard L. Madoff, and is reasonable to provide the needed protection where an adviser maintains custody of client assets directly or through a related person. While requiring that all advisers maintain custody of client assets with an independent custodian would be consistent with the general practice of the majority of CFP® professionals, CFP Board recognized that maintaining client assets with an independent custodian may not be feasible under all business models and circumstances. In its letter, CFP Board said the internal control report proposal would provide needed protection for investors when is not feasible or desirable for an adviser to use an independent custodian.

A press release regarding CFP Board’s comment letter is available here.