Advisers complain to SEC about inadvertent custody

Agency official promises to clear up questions created by 2017 guidance

Mar 15, 2018 @ 5:05 pm

By Mark Schoeff Jr.

A Securities and Exchange Commission official said Thursday that the agency is working to clear up confusion about how investment advisers may inadvertently be deemed as having custody of client funds.

The questions arise from a guidance update the SEC's Division of Investment Management released in February 2017. A footnote says advisers don't have custody if they instruct broker-dealers or custodians to withdraw money from clients' accounts to settle trades. The money is taken out and securities are delivered.

The footnote asserts that this "delivery versus payment" arrangement minimizes the chances an adviser will misappropriate money from a client's custodial account. But it goes on to imply that any other arrangement could trigger custody.

That raised a warning flag for the Investment Adviser Association and others about whether transactions that don't fit the "delivery versus payment" model, such as those involving bank loans, derivatives and private placements, could cause an adviser to take custody.

Paul Cellupica, SEC deputy director of Investment Management, told about 500 attendees at the IAA compliance conference in Washington that the agency would address the concerns advisers have raised.

"We want to come up with the right answer, and maybe it's not just a simple answer. Maybe it's a multiple answer," Mr. Cellupica said.

Generally, advisers try to avoid assuming custody of client funds because of the stringent related requirements. The SEC has stressed custody regulation in the wake of the multibillion-dollar Bernie Madoff fraud that revolved around Mr. Madoff's control of client funds.

The IAA has been in touch with the SEC nearly every week since last February regarding the custody guidance.

"We've been banging our head against the wall on this issue for a year," said Karen Barr, IAA president and chief executive. "It's helpful for the broader community to know they're thinking carefully about the business implications of the guidance update for investment advisers."

Regardless of how the SEC answers the question of inadvertent custody, Mr. Cellupica urged advisers to put thought into how they handle client funds.

"It's very important for all advisers to have appropriate controls to limit the risk of misappropriation," Mr. Cellupica said. "This is probably a good opportunity for all advisers to go back and revisit the controls they have, assess them, test them and satisfy themselves that these risks are managed appropriately."

There's general agreement that scrutinizing custody is a good thing. But Ms. Barr hopes the SEC will rethink its approach to custody oversight. She calls the current rule "overly complicated."

Dalia Blass, SEC director of Investment Management, acknowledged that the rule has caused some head-scratching.

"There are so many big questions in the custody space," Ms. Blass said at the IAA conference.


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