Safeguarding Clients’ Assets: Are You In Compliance?– June 24, 2015

The SEC continues to make safeguarding clients’ assets a top priority, as demonstrated by its publicized 2014 examination initiatives and recent enforcement actions. The amendments to the Custody Rule (the Rule) have been effective since early 2010, and yet there are still misconceptions of what actually constitutes custody.  The SEC has published numerous risk alerts to clarify the Rule and to provide examples of common violations, with the intent of educating advisers and curbing future violations. The results seem to be mixed. Although the alerts have provided some insight, advisers continue to question if they have custody of clients’ assets, and violations continue to persist.

Do You Have Custody?

Advisers should have policies and procedures in place to help identify whether new and ongoing client relationships deem the adviser to have custody over clients’ assets. Advisers, newly registered with the SEC, should consider talking with their legal counsel and independent accountants early in the registration process to understand the impact the Rule will have on their firm. Some common examples of what constitutes custody under the Rule include:

  • The adviser’s personnel serve as trustee or have been granted power of attorney for client accounts;
  • The adviser has check-writing or bill-pay authority for client accounts;
  • A client has granted the adviser online access to client accounts;
  • The adviser has physical possession of client assets or receipt of checks made to clients; and
  • The adviser manages a pooled investment vehicle.

If a relationship creates custody for the adviser, the adviser is required to ensure that:  1) all client assets are in the custody of a qualified custodian, and 2) the client receives statements directly from the qualified custodian on no less than a quarterly basis. The adviser also must undergo a surprise examination performed by an independent accountant registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board.

The Pooled Investment Vehicle Dilemma

Whether you are a newly registered adviser or have operated as a registered investment adviser for many years, pooled investment vehicles (PIVs) continue to be problematic. If an adviser manages a PIV, e.g., a hedge fund or a private equity fund, the adviser is deemed to have custody of the clients’ assets within the PIV. Perhaps less apparent, custody is also imputed to the adviser if an employee of the adviser operates in a managing capacity of a fund — such as acting as the General Partner of a limited partnership or as Managing Member of a limited liability company — and thereby has control of the fund’s assets. 

In both instances, the Rule requires one of two approaches:

  1. Assets of the PIV must be in the custody of a qualified custodian that sends quarterly account statements detailing the PIV’s assets, and the adviser must undergo a surprise custody examination performed by an independent accountant; or
  2. The financial statements of the PIV must be prepared in accordance with accounting principles generally accepted in the United States (GAAP), audited by an independent accountant and distributed to each investor of the PIV within 120 days from year-end (180 days for Fund of Funds), known as the Audit Exception.  In this approach, the assets are not required to be in the custody of a qualified custodian.

Complications accompany either approach. If the adviser chooses the Audit Exception and the PIV has private investments in its portfolio, GAAP requires the adviser to mark the investments to fair value for reporting purposes. This creates an additional burden on the adviser and poses complexities for the audit, likely leading to higher costs. On the other hand, placing alternative assets in the custody of a qualified custodian may prove to be difficult and potentially costly as well. Advisers should spend the time to conduct a cost-benefit analysis of both approaches to determine which provides the most effective approach.

What’s Ahead

The complex Rule will continue to be a hot topic for the SEC, who will likely continue to penalize advisers that do not comply. The SEC’s risk alerts and frequently asked questions may not be enough for advisers to understand how the Rule impacts them and their client relationships, especially regarding PIVs. It is imperative that advisers address these issues and communicate with legal counsel and their independent accountants to resolve uncertainties and address lingering questions. By being proactive, advisers can remain in compliance while properly safeguarding clients’ assets.


Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.