Summary
Advisors: If you think you do not have custody of client assets, you should read this.
In trying to help your clients, you may inadvertently violate SEC custody rules.
The SEC last month released guidance and clarification as to when advisors have custody issues. It’s not getting easier.
Custody of accounts should be a relatively simple issue. Custody is assigned by contract. Unfortunately, the SEC has recently issued new guidance on custody rules that may cause many advisors to be considered an inadvertent custodian.
What’s the big deal, you say? There are certain things you have to do, or not do, to avoid violating the SEC custody rules.
First, if the SEC determines that you have custody of client assets, even if you have actual assets held by a qualified custodian (like a bank of a mega-brokerage firm), you have to have (and pay for) an independent accountant to do a “surprise audit” every year. If you don’t know that you have custody, like in some of the examples below, you will probably violate the SEC rules on custody, and that means more fines (if you’re lucky). The enforcement arm of the SEC, OCIE, says that one-third of advisors examined violate the custody rule.
So, how can you be a custodian and not know it? If you:
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-Accept client investment checks made out to your firm, even if you turn around and deposit or send it to the qualified custodian.
-Are a trustee (as a “good guy” service to your client) of a client’s trust you have as an account.
-Are authorized to write or sign checks for your client.
-Are authorized to make withdrawals from your client’s account as part of a bill paying service.
-Make transfers of client assets to another account, even if authorized by the client, unless the client signs an authorization which states exactly to whom the transfer goes, when it occurs, -how much is transferred, has the exact account number and the ABA routing number.
-Commingle client assets.
-Lack a reasonable basis to believe that a qualified custodian is sending at least quarterly account statements to the client.
-Receive securities from a client without immediately sending them back to the client (NOTE: not to the custodian; to the client).
-If you have the name and password of the client’s web account access to rebalance, withdraw or transfer assets, even if pursuant to a Standing Letter of Authorization (“SLOA”).
-If you do anything here, even if you do not receive compensation.
-If you have the ability to debit the client’s account, and the client has not explicitly instructed the qualified custodian to do so. NOTE: This includes your ability to instruct the custodian to debit the account for your fees, or if you change the fees and instruct the custodian. The client has to authorize this in writing, like in a contract.
-Have your name on the client’s account also.
So, what do I do here? Like with most SEC Rules, you have to have policies and procedures to make sure you have a qualified custodian that meets these rules:
Accounts or assets are separate or segregated.
Custodian sends statements directly to the client at least quarterly.
Custodian has that surprise audit.
Here are some “Do nots” for advisors:
Do not send the qualified custodian a bill for your fees and do not calculate or change the contracted fee, or the party to whom it is paid.
Don’t have access to client funds in any way, no matter what service you think you’re providing.
Do not accept any discretion as to amount, timing or payee of any transfer the client wants to make.
Do not accept access to a client’s website investment account.
Don’t even think about accepting securities.
Do not accept anything from a stranger who asks you to take something aboard the airplane, please extinguish all smoking electronic devices, fasten your safety belts, and return your tray tables to their full and upright locked position for taxi, takeoff, and landing. (Sorry, I’m getting ready to board).
So to answer the next obvious question: Is there anything I (as an advisor) CAN do that does not make me a custodian under the new reading of the rules? Yes.
You can get your fee quarterly from the custodian, if they calculate it.
You can transfer client assets to another account in exactly the same name as the client, at the address of record. (i.e., first party journal entries).
You can change the client’s address of record (but not the name) if you have a reasonable belief that the custodian has it wrong (OK, so that doesn’t make sense, what with all these can’t or don’t dos, but that’s what the SEC says).
Seek help from people like us, if you need it.
If you’re an investor, do NOT give anyone access to your money unless you absolutely implicitly trust them (or they’re a qualified custodian – for real.)
Finally, after this brief foray into custody, if you think, “What?” Or, you say to yourself, “But my fact pattern is different?” maybe you’re an investor wondering if your advisor (or anybody) has the actual custody. You are not totally out of luck. Call or email me, and I’ll help you sort it out.
Regards,
John