Recent OCIE Examinations Highlight Importance of Adviser Adherence to Custody Rule
Investment Management Update
Date: March 25, 2013
On March 4, 2013 the Securities and Exchange Commission (SEC) issued an Investor Bulletin and a Risk Alert on compliance with the custody rule under the Investment Company Act of 1940.
The Investor Bulletin describes the requirements of the custody rule and reminds investors that while the custody rule is intended to provide additional protections to investors, an investor must remain proactive in ensuring the safety of his or her investment, as the custody rule is no substitute for an investor's own monitoring and oversight.
The Risk Alert provides an overview of "significant deficiencies" associated with custody-related issues identified by the SEC's Office of Compliance Inspections and Examinations (OCIE). These common deficiencies were identified in approximately one-third of its recent examinations of SEC-registered investment advisers, and include the situations described below.
- Failure to recognize that the adviser has custody. This may arise in situations where the adviser serves as trustee, is authorized to write or sign checks for a client 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 requirement. A violation of this nature may be found, for example, where an adviser comingles client, proprietary and employee assets in a single account, or where an adviser lacks a reasonable basis to believe that a qualified custodian is sending quarterly account statements to the client.
- Failure to meet requirements specific to advisers to audited pooled investment vehicles. For example, failure to engage an independent accountant and demonstrate that financial statements were distributed to all fund investors.
OCIE Director Carlo V. di Florio noted that the examination of adviser compliance with the custody rule "is a key component of [OCIE's] investment adviser examination program," and SEC Chairman Elisse Walter commented that "safeguarding of assets is central to investor protection." To that end, the resulting actions by OCIE against advisers in connection with the deficiencies identified in the Risk Alert ranged from remedial measures, such as amending or enhancing an adviser's existing business practices and compliance policies and procedures, to referral to the SEC's Division of Enforcement.
Advisers should review their practices, policies and procedures to safeguard against a finding in a future OCIE exam of the deficiencies noted in the Risk Alert. In light of the SEC's increased attention to the custody rule reflected in Chairman Walter and Director di Florio's comments, advisers should also regularly review their practices, policies and procedures to confirm continued adherence to the custody rule.
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