Custody Rule Concerns

There has been a lot of discussion the last month or so about whether an advisor has custody, and therefore required to have an annual surprise custody audit.

The SEC has in several exams stated that a custodian’s contract could open advisors up to a claim that they hold custody of client funds.  The issue seems to be with Fidelity’s contract and the type of “level” advisor that you are.  There are some levels that could allow an advisor to make transfers from the client’s account at the custodian to another account in the client’s name.

Also, there is an issue with Schwab’s contract that has given rise to the following language in a deficiency letter from the SEC “it appears that the registrant has custody of the funds held in those accounts due to registrant’s ability to initiate bank wires outside Schwab without direct instructions from the client.”

There are several concerns:

  1. The advisor may be allowed to make the transfer without a signed form from the client.
  2. The custodian presumes that the receiving custodian/bank is an account in the name of the client – they don’t confirm that the receiving account is in the name of the client.

There is some discussion between the SEC and Investment Adviser Association and others to clarify this issue.  But I don’t see it being resolved any time soon.

In the meantime, I recommend that you review your current agreement with your custodian to see what it is that you are allowed to do.  If you have the ability to make these transfers without a signature from the client, then you will want to change your Compliance Policies and Procedures Manual.  I suggest changing your Manual prohibiting any transfers from a client’s account without a signature from the client.

So far the SEC has gone easy on advisors.  I wouldn’t count on that continuing.


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