As somebody once said, it's the little things in life that get you; you can sit on a mountain but you can't sit on a pin.
For financial advisers, one of those little things could take the form of a password or username for a client's online account.
Or it could even be a subtle change in the way a client's 401(k) plan or fund company requires an address change.
Just like that, an adviser might find himself or herself in what the Securities and Exchange Commission considers a custodial relationship with a client.
Once an adviser is deemed to have custody of a client's account, the advisory firm is required to contract with an outside accountant to perform an annual surprise audit of that account.
As
InvestmentNews reporter Liz Skinner
reported in last week's issue, those audits can cost between $15,000 and $50,000 a year.
Bernie Madoff
This is all part of the reality of the custody-rule provisions, which the SEC upgraded in 2009 in an effort to protect investors from the next Bernie Madoff. Those provisions are intended to ensure that advisers use legitimate custodians, that proper policies and procedures are followed, and that clients receive proper account statements.
The downside of the provisions is that they also make it all too easy for advisers to find themselves unwittingly defined as custodians of their clients' assets. Custodial status can be triggered by a number of things, including having access to a client's online account login details, being named a trustee over client assets, having the ability to write checks on behalf of clients, or even something as simple as changing a client's record of a home address.
Remember, it's up to the adviser to regularly monitor and ultimately identify whether he or she is acting as a custodian and if so, make sure the proper auditing procedures are being followed.
If that model of self-checking seems to put a lot of
trust and confidence in the knowledge and integrity of individual advisers, that's because it does. Earlier this year the SEC listed the custody rule among the
five most-frequent compliance violations.
And by way of showing how little has changed along those lines, in 2013 the National Examination Program of the SEC's Office of Compliance Inspections and Examinations reported that a third of advisers were in violation of the custody rule.
A cynic might suggest that the steady pattern of custody-rule violations is related to the fact that most advisers only face an SEC exam about every 10 years and might be playing the odds of not getting caught.
Just Plain confusing
Another way of looking at it is that the rule is fairly arcane and difficult to understand, particularly for firms without a dedicated compliance officer.
With a new president in the White House and a general sense of a lighter regulatory hand, it is always possible that the custody rule will be revised or at least clarified for easier compliance.
Karen Barr, president and CEO of the Investment Adviser Association, suggested as much in a
January blog post.
Ms. Barr described the amended version of the rule as "overly complex with interpretations of various provisions causing confusion and consternation for advisers who are doing their best to be compliant."
Considering all the potholes that lay before Washington's politicians and regulators, a near-term revision to the custody rule isn't anything on which advisers should be hanging their hats. A better strategy for advisers is to gain a solid understanding of what constitutes custody status, then review all client accounts at least annually, all the way through to the platforms and fund-company relationships.
