Did you know that you may have Custody?
In February of 2017, the SEC provided guidance on the Custody Rule regarding Standing Letters of Authorizations (“SLOAs”), First Person Transfers, and inadvertent custody.
While a client can provide a standing letter of authorization to move money between the client’s own accounts, for purposes of the SEC’s No-Action Guidance, we’re limiting the definition of SLOAs to a client’s grant of authority to an adviser to move money from the client’s account to a designated third party. Such disbursements can be made by any method, such as wires, checks, or electronic funds transfers.
In the past, the SEC’s guidance was unclear as to whether the SLOA would be “authority to obtain possession” of client funds as contemplated by the Custody Rule. The recent SEC guidance has made it clear however that these types of arrangements would be considered Custody and therefore, an adviser would be required to comply with the Custody Rule. Complying with the custody rule requires, at a minimum, reporting the assets and accounts over which the adviser has custody on the Form ADV Part 1A, and having a surprise exam of the assets over which the adviser has custody (in addition to the other safe-keeping requirements).
However, the SEC has provided relief from the surprise audit requirement as long as the following the seven items noted below are met:
- The client provides an instruction to the qualified custodian, in writing, that includes:
- the client’s signature,
- the third party’s name, and
- either the third party’s address or the third party’s account number at a custodian to which the transfer should be directed.
- The client authorizes the adviser, 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.
- The client’s qualified custodian performs appropriate verification of the instruction, such as a signature review or other method to verify the client’s authorization, and provides a transfer of funds notice to the client promptly after each transfer.
- The client has the ability to terminate or change the instruction to the client’s qualified custodian.
- The adviser has no authority or ability to designate or change the identity of the third party, the address, or any other information about the third party contained in the client’s instruction.
- The adviser maintains records showing that the third party is not a related party of the firm or located at the same address as the investment adviser.
- The client’s qualified custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.
Many custodians, including TD Ameritrade, Fidelity and Charles Schwab, are working with their advisers’ to provide solutions that will assist the adviser in meeting these seven requirements. We strongly suggest that you contact your current custodian for assistance.
Assuming that the seven requirements are met, the adviser must also report custody on the Form ADV Part 1, Item 9. The requirement to report is the first ADV amendment filed after October 1, 2017. The Form ADV Part 2A Item 15 should also be amended accordingly.
In light of the custody requirements, investment advisers should update their Policies and Procedures Manual, if applicable. Additionally, investment advisors should be prepared to report custody on the Form ADV on their next Other Than Annual Amendment or its next required Annual Updating Amendment, whichever comes first.
First Person Transfers
First person transfers occur when a client grants an adviser the authority to move money between the client’s own accounts (generally limited to “like titled accounts”). This situation is covered in the SEC FAQ II.4 under the Custody Rule, which, among other things, indicates that the adviser does not have custody if the client’s authorization provides sufficient specificity. The staff of the Commission clarified that this means that the written authorization signed by the client and provided to the sending custodian must state with particularity the name and account numbers on sending and receiving accounts (including the ABA routing number(s) or name(s) of the receiving custodian) such that the sending custodian has a record that the client has identified the accounts for which the transfer is being effected as belonging to the client.
Certain questions have come up with respect to whether transferring assets from an individual account to a joint account with a spouse is considered like-titled. At this time the SEC has not clarified these types of account transfers and therefore NCS Regulatory Compliance is taking the conservative approach with respect to these transfers. We recommend that they be considered as an SLOA and therefore an adviser should comply with the guidance provided above regarding SLOAs.
What this means to an adviser is that documents of first person transfers may have to be re-papered in order to include the required account information and account numbers. You should review the paperwork on file with the custodian to ensure that the proper information is noted.
The SEC’s guidance also addressed provisions in separate custodial agreements entered into between the advisory client and a qualified custodian that inadvertently imputes advisers with custody they did not intend to have. The SEC suggests that one way to avoid such inadvertent custody would be to draft a letter to the custodian that limits the adviser’s authority to “delivery versus payment” notwithstanding the custodial agreement. They also suggest that the adviser should receive written consent from the client and the custodian acknowledging the new arrangement.
In conclusion, advisers should carefully consider the SEC’s guidance and evaluate their client accounts for possible SLOAs, First Person Transfers, and/or inadvertent custody.
*Many states have adopted the SEC’s custody rule thereby making this guidance applicable to state registered investment advisers. Please contact your NCS Regulatory Compliance consultant to determine if this applies to your firm.