More On Legal & Compliancefrom The Advisor's Professional Library
- Whistleblowers A whistleblower is any individual providing the SEC with original information related to a possible violation of federal securities law. The Dodd-Frank Act established a whistleblower program that enables the SEC to reward individuals who voluntarily provide such information.
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
Sweeping amendments to the Securities and Exchange Commission's custody rule 206(4)-2 became effective March 12, 2010, and will substantively impact significantly more advisors than imagined who do not have "physical" custody of client assets. If you have "custody" (see examples below) subsequent to March 12, 2010, you are deemed to have it for 2010 and are required to comply with the amended rule regardless of whether or not you ceased such practices prior to December 31, 2010.
In addition, those having custody will be required to reflect that fact on the recently amended Form ADV format (which will be the topic of November's column). The amended rule requires an advisor to engage an independent CPA to commence an initial annual surprise examination no later than December 31, 2010, and for that CPA to then file the corresponding initial Form ADV-E no later than April 30, 2011. However, if the CPA starts the surprise exam prior to December 31, 2010, the exam must be completed and the ADV-E filing made no later than 120 days thereafter.
Unfortunately, many issues pertaining to the amended rule continue to remain unclear and subject to interpretation.
All the instances below would require an advisor to engage an independent auditor and file Form ADV-E.
Ability to Sign Checks or Withdraw Funds. The authority to sign checks on a client's behalf, to withdraw funds or securities from a client's account (except for the debiting of its advisory fee, so long as the assets are held by a qualified custodian that sends a periodic statement at least quarterly and directly to the client), or to dispose of client funds for any purpose other than authorized trading.
Possession of Bank Account or Credit Card Information. The possession of client bank account or credit card information for the purpose of the advisor debiting/charging said accounts to pay the advisor's fee.
Possession of Stock Certificates. The amended rule specifically excludes inadvertent receipt by the advisor so long as the advisor returns them to the sender within three business days. An advisor may continue to meet with clients to prepare or compile documents, including stock certificates, for forwarding by the client to a custodian or third party, without the advisor having custody. However, if the client were to leave the stock certificate in the possession of the advisor thereafter, such possession would most likely not be inadvertent, and would result in custody of client assets.
Trustee Service. The advisor would be deemed to have custody when he (or a related person as defined under the Adviser Act, including any access person) acts as both trustee and investment advisor of a trust (excluding accounts that are family relationships of the related person). If the advisor or its related person is a co-trustee, the advisor shall be relieved of the surprise examination requirement if the co-trustee is a qualified custodian or the trust grantor (which will not be applicable for irrevocable trusts).
Advisor's 401(k) Plan. If any member of the advisor serves as a trustee to the firm's qualified retirement plan, and the advisor also serves as the investment advisor to the plan, the advisor would be deemed to have custody and be subject to the annual CPA surprise examination. This adverse custody determination also currently applies if the qualified plan is self-directed but the advisor manages certain asset allocation models from which the participants may choose.
Possession of Client 401(k) Passwords. An advisor who maintains possession of client 401(k) passwords for the purpose of allocating the client's retirement account among the investment options provided under the plan shall be deemed to have custody and correspondingly be subject to the annual CPA surprise examination if the plan website permits the advisor (regardless of whether the advisor has any intention to do so) to electronically (via the website) compromise the integrity for the underlying assets or beneficiaries (i.e., the ability to make account distributions or change account beneficiaries).
Thomas D. Giachetti is chairman of the Securities Practice Group of Stark & Stark, a law firm with offices in Princeton, New York, and Philadelphia that represents investment advisors, financial planners, broker-dealers, CPA firms, registered reps, and investment companies, and a regular contributor to Investment Advisor. He can be reached at email@example.com.