Even after SEC's additional guidance, custody remains complicated rule for investment advisers

Compliance experts want agency to revisit regulation whose FAQs now run to 17 pages

Jul 6, 2018 @ 12:48 pm

By Mark Schoeff Jr.

Recent guidance from the Securities and Exchange Commission about investment advisers' custody of client funds cleared up one aspect of the regulation but didn't go far enough to illuminate the complicated rule, according to compliance experts.

In June, the SEC added two new questions to a list of frequently asked questions that now totals 68. The queries, which were in response to February 2017 SEC guidance on inadvertent custody, center on advisers who acquire clients who bring with them custodial agreements that allow advisers to tell the custodian to disburse, or transfer, funds or securities.

The SEC clarified that the adviser doesn't have custody if the adviser does not have a copy of the custody agreement and doesn't know about it.

"It was quite helpful," said Amy Lynch, president of FrontLine Compliance. "It definitely gives [advisers] more comfort for their clients who have their own custodial relationships."

But the Investment Adviser Association continues to have concerns about situations in which advisers can inadvertently gain custody through conducting transactions for clients involving bank loans, derivatives and private placements.

"The FAQs are definitely a step in the right direction, but there's still more work to be done through guidance," said Laura Grossman, IAA associate general counsel. "It's a very complex rule, which makes a very challenging compliance area."

The custody rule — which was updated in 2009 in wake of the multi-billion-dollar Bernie Madoff Ponzi scheme that revolved around his control of client funds — is one of the top compliance headaches for investment advisers. If advisers are deemed to have custody, which can occur in a variety of situations, it triggers often expensive audit requirements.

"There are always ways to cross the line," Ms. Lynch said.

Now that the FAQs have reached several dozen, there's a longing for fundamental change.

"Ideally, we would like to see [the SEC] revisit the current rule from the ground up," Ms. Grossman said.

Todd Cipperman, principal at Cipperman Compliance Services, goes a step farther on a regulation that he said has been "overwrought."

"It's a rule that needs to be rewritten," he said.

The SEC has put action on amending the custody rule on its long-term agenda. There's no specific timeline for getting it done.

"The SEC recognizes this is an area of significant uncertainty," Mr. Cipperman said. "There is a decent chance it will happen in the [SEC Chairman] Jay Clayton administration."

Mr. Clayton's term ends in 2021.

While advisers wait for SEC action, they'll continue to worry about custody.

"It's at the top of the list because it requires very strong oversight, especially for retail advisers," Ms. Lynch said.


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