The SEC’s Custody Rule continues to be a common source of confusion and a landmine for noncompliance. Custodial paperwork has caused huge headaches for investment advisers, who are not a party to the agreement and may not even have a copy of the custodial new account paperwork. The issue with existing guidance is that it really doesn’t provide any good suggestion for how to resolve the matter. The Securities and Exchange Commission (SEC) has repeatedly indicated that getting clients and custodians to sign a letter has been their interpretation since 2003.
The Investment Adviser Association has had several meetings with the SEC to discuss this issue in hopes of finding another remedy, IAA Assistant General Counsel Laura Grossman said in a panel discussion with Charles Schwab & Co.’s Kimberly Davis and Ascendant’s Jackie Hallihan during Ascendant’s recent compliance conference. Many custodians do not want to sign the letters suggested by the SEC because they are fearful of any additional liability this may cause.
Grossman indicated during the panel that the SEC may have proposed a solution. It would like to see the following:
- The adviser sends one letter to the custodian stating, “We do not know if we have custody based on paperwork, but we don’t need it and will not act on it.” The letter doesn’t need to be signed by the Custodian; thus, it’s a one-way letter.
The adviser could also send a letter to the client stating that they don’t know if there is custody due to custodial paperwork but that they will not act on it. (The SEC hasn’t yet indicated whether this letter would need to be signed). Additionally, the SEC wants to see strong controls in place to ensure no distributions can be made.
It therefore may come down to notice plus controls: notice to the custodians and the internal controls to ensure protection of client assets.
The IAA hopes to get the SEC to opine on this as soon as possible since it will impact the ADV filings coming up for AUA filings.