SEC Custody Rules Include Surprise Exams

Surprise Exam. The advisor is now required to engage an independent public accountant to conduct an annual “surprise exam” to verify that client assets exist. Such a surprise examination would provide another set of eyes on the client’s assets, and provide additional protection against theft or misuse. The accountants would have to contact the SEC if they discovered client assets were missing.

Custody Controls Review. When the advisor or an affiliate serves as custodian of client assets, the advisor is now required to obtain a written report–prepared by an accountant that is registered with and subject to regular inspection by the PCAOB–that, among other things, describes the controls in place at the custodian, tests the operating effectiveness of those controls and provides the results of those tests. These reports are commonly known as SAS-70 reports. Requiring that the accountant be registered with and subject to inspection by the Public Company Accounting Oversight Board–the PCAOB–will provide greater confidence regarding the quality of these reports, the SEC says.

A new control will be imposed on advisors to hedge funds and other private funds that comply with the custody rule by obtaining an audit of the fund and delivering the fund’s financial statements to fund investors. The rule, the SEC says, “will require that the auditor of such a private fund be registered with and subject to regular inspection by the PCAOB.”

The new rules also require “that the advisor reasonably believe that the client’s custodian delivers the account statements directly to the client, to provide greater assurance of the integrity of these account statements,” the SEC says. “It also will enable clients to compare the account statement they receive from their advisor to determine that the account transactions are proper.”