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When Do Advisors Have Custody Relief?

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On Feb. 21, the Securities and Exchange Commission released guidance clarifying when advisors will be deemed to have custody with respect to standing letters of authorization (SLOA), and when they will be required to undergo annual surprise examinations as a result. The SEC guidance consisted of a No Action Letter directed to the Investment Adviser Association regarding third-party SLOAs and an amendment to an existing published FAQ regarding standing instructions for like-titled transfers.

FAQ Question II.4 states that advisors have custody if they have the authority to withdraw client assets from a qualified custodian. The SEC does not consider as a withdrawal the transfer of assets between the client’s accounts at qualified custodians “if the client has authorized the advisor in writing to make such transfers and a copy of that authorization is provided to the qualified custodians, specifying the client accounts maintained with qualified custodians.”

(Related: SEC’s Top 5 Advisor Compliance Failures)

As of Feb. 21, the response was amended to clarify that “specifying” means the written authorizations provided to the sending custodian should include the name and account numbers on both the sending and receiving accounts, including the ABA routing numbers or names of the receiving custodian. The SEC also added that the authorization does not need to be provided to the receiving custodian.

The amended response also states that an advisor’s authority to transfer client assets between the client’s accounts at the same or affiliated qualified custodians “that both have access to the sending and receiving account numbers and client account name (e.g., to make first-party journal entries) does not constitute custody and does not require further specification of client accounts in the authorization.”

Third-Party Transfers

The No Action Letter provided significant relief to advisors who are authorized to initiate third-party transfers for their clients. The SEC issued the letter in response to a request from the IAA, and it appears to be a reasonable compromise between the SEC and advisors.

The letter confirms the staff’s position that an advisor “with power to dispose of client funds or securities for any purpose other than authorized trading has access to the client’s assets.” Therefore, advisors whose clients execute SLOAs with custodians allowing the advisor to initiate third-party transfers will still be deemed to have custody. Starting with the first annual ADV amendment after Oct. 1, those advisors must indicate on Form ADV Part 1, Item 9 that they have custody of such client assets in connection with the advisory services they provide to clients. However, those advisors will not be required to undergo annual surprise examinations, as long as they satisfy the following conditions:

  1. The client provides instructions to the qualified custodian in writing that includes the client’s signature, the third party’s name, and the third party’s address or account number at a custodian to which the transfer should be directed.

  2. The client authorizes the advisor in writing, either on the qualified custodian’s form or separately, to direct transfers to the third party either on a specified schedule or from time to time.

  3. The client’s qualified custodian performs appropriate verification of the instruction, such as a signature review or other method, to verify the authorization, and provides a transfer of funds notice to the client promptly after each transfer.

  4. The client has the ability to terminate or change the instruction to the client’s qualified custodian.

  5. The advisor has no authority or ability to designate or change the identity of or any information about the third party contained in the client’s instruction.

  6. The advisor keeps records showing that the third party is not a related party of the advisor or located at the same address.

  7. The client’s qualified custodian sends the client in writing an initial notice confirming the instruction and an annual notice reconfirming the instruction.

We are aware of several custodians that are proactively helping advisors avail themselves of the No Action relief. While advisors can easily satisfy the sixth factor on their own, all remaining obligations can be reasonably assumed by custodians. We recommend that advisors review existing SLOAs and contact custodians as necessary to determine if any changes to the agreements or the custodian’s practices are required to avoid an annual surprise examination.

— Read Under Clayton’s SEC, Hefty Fines for Inadvertent Errors May Be Status Quo on ThinkAdvisor.