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August 26, 2002 at 08:00 PM
Two proposed rule changes by the Securities and Exchange Commission are catching the attention of the investment advisor community. The first amendment–proposed a few weeks ago–is a new custody rule dealing with Rule 206(4)-2 under the Investment Advisers Act of 1940, which governs the custody of client funds or securities. And the second rule, which the Financial Planning Association (FPA) has been battling for years, would ease disclosure requirements for broker/dealers.
David Tittsworth, president of the Investment Counsel Association of America (ICAA) in Washington, D.C., says that very few investment advisors actually have custody of client funds or securities, “but if you have an arrangement where you can deduct advisory fees in advance–which a lot of advisors do–you are deemed to have custody. Therefore you have to produce an audit balance sheet every year, and you are subject to a surprise inspection by the SEC every year.” While the new proposal doesn’t change the broad definition of custody, Tittsworth explains, it states that “so long as the funds and securities are custodied at a qualified custodian, which is someone who is regulated and sends monthly account statements to the client, then you don’t have to” produce an audit or be inspected by the SEC. “In the world of custody, that’s a fairly major change.”
John Baker, a securities lawyer with Stradley, Ronan, Stevens & Young in Washington, says “the proposed rule would not apply these custody requirements to the accounts of hedge funds or other pooled investment vehicles that provide audited financial statements annually to investors.” This isn’t such a good thing, he says, considering the number of “high-profile frauds committed in recent years against hedge funds with audited financial statements.” Baker says “a rigorous custody requirement would provide assurance to private fund investors substantially greater than that given by an audit and should reduce the number of fraud cases.”
Comments on the custody proposal are due by September 25.
The FPA recently sent a letter to the SEC opposing, once again, the regulator’s proposed changes to its rule called “Certain Broker-Dealers Deemed Not to be Investment Advisors.” The FPA says the rule “helps move broker/dealers toward asset-based compensation, while allowing representatives to bypass the higher standard of the Investment Adviser Act of 1940.”
