Tag Archives: custody

SEC Compliance – Custody Issue

Annual Update Guidance on Custody Issue

It is that time of year that registered investment advisers are focusing on the ADV annual updating process.  Occasionally the SEC will provide guidance to managers on common questions applicable to the application or updating process.  Below is a note the SEC sent out to all registered investment advisers regarding the custody issue.  If you have questions on the application of the custody rules to your particular situation, you should discuss with your law firm or compliance consultant.


To: SEC-Registered Investment Advisers,

This email is a reminder that all SEC-registered advisers that have custody of client assets should answer all questions in Item 9 of Part 1A of Form ADV. Each adviser’s answers will vary depending on facts and circumstances.

For example, advisers that have custody solely because they deduct fees from client accounts would respond “no” in Item 9.A. Additionally, these advisers would likely respond “no” in Items 9.B., and 9.D., and they likely would not need to provide information in Items 9.C. or 9.E. However, in Item 9.F., these advisers likely would need to indicate that there is at least one person acting as qualified custodian for their clients in connection with advisory services they provide to clients.

If you have questions, you may reply to this email.

U.S. Securities and Exchange Commission
Division of Investment Management
100 F Street, N.E.
Washington, DC 20549-8549
Phone | 202.551.6999


Cole-Frieman & Mallon is a boutique law firm which provides regulatory compliance and consulting services to the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

SEC Chairman Discusses Potential New IA Custody Rules

Hedge Fund Advisors May be Impacted

Yesterday SEC Chairman Mary Schapiro discussed many new SEC initiatives in a speech given to the Society of American Business Editors and Writers.  One of the new initiatives involves those advisors who have “custody” of client assets.  With respect to such advisors, Shapiro said:

I anticipate that this proposal will include a consideration of “surprise” examinations by a certified public accountant, and a requirement that investment advisers undergo third-party compliance audits.

The tone of the speech was that of a new gunslinger who has come into town to clean up – in addition to the new custody provisions, she discussed regulatory reform and giving SEC examiners more room to initiate investigations.  Many of the ideas expressed in the speech may be worrisome to investment advisors and investors because the initiatives are likely to add significantly to the operating costs of hedge fund managers who are registered as investment advisors.  Additionally, registered managers may face increase inquiries into their business by nosy SEC examiners which will not go over well within the industry.

Below I have reprinted what I thought were important or interesting parts of the speech; the full text can be found here.


Speech by SEC Chairman:
Address to the Society of American Business Editors and Writers


Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
SABEW Annual Conference 2009
Denver, Colorado
April 27, 2009


Enforcement has been the most visible program at the SEC in recent history. But the financial crisis teaches us that there are policy and regulatory gaps that the SEC must also address.

Again, if investors are to have confidence in the ratings assigned to securities, that corporate boards are working on behalf of stockholders, that investment advisers are not running Ponzi schemes, that money market funds won’t break the buck, then the SEC needs to be pushing forward a real agenda of reform.

Let me just highlight a few of these:


In response to major investment scams — such as Madoff — and a rash of Ponzi schemes, we will be considering two proposals as part of a package of initiatives designed to better assure the safekeeping of investor assets.

In short order, the Commission will consider a proposal to strengthen the controls applicable to investment advisers with custody of client funds and securities. I anticipate that this proposal will include a consideration of “surprise” examinations by a certified public accountant, and a requirement that investment advisers undergo third-party compliance audits.

Also, as part of this package, I have asked the staff to draft a Commission requirement that a senior officer from broker-dealers and investment advisers with custody certify that controls are in place to protect investor assets.


Reforming the Landscape:

As a result, there is significant debate about regulatory reform — not about whether it should happen, but about what form it will take. You might say the train has left the station, but no one quite knows for sure where it will come to stop.

Whatever form it takes, I support the view that there is a need for system-wide consideration of risks to the financial system and to create mechanisms to reduce and avert such systemic risks.

But, at the same time, I believe that any reform must not — and cannot — compromise the quality of our capital markets or the protection of investors.

If we cannot show investors that we are looking out for their interests as much as the interests of the financial institutions — then we will have little success in restoring confidence.

Investors need to see that we are going after those who engage in wrongdoing. They need to see that we are forcing companies to be truthful and transparent in their reporting. They need to see that we are limiting risk in areas where substantial risk is not what they’re buying. And, they need to see that we’re rooting out fraud.

In short, they need an agency that’s there for them — and primarily them. They need an independent agency that exists not just to protect Wall Street, but to protect Main Street.

By offering that to investors, we can help to restore confidence.


In addition, I have streamlined our enforcement procedures by no longer requiring full Commission approval to launch an investigation. And, I’ve eliminated the need for full Commission approval before negotiating a settlement with a corporate defendant.

Before these directives, enforcement attorneys will tell you that they worried about red lights at every turn — now they see green.

Additionally, I brought on a consulting firm to assess and revamp the way we handle the nearly 1 million tips and complaints we get each year. Because we do not have unlimited resources we cannot pursue every lead — we get about 2,000 every day. But we can do a better job ensuring that each tip lands on the right desk and that the person reviewing it has the necessary skills.

Further, we are looking at improving our training programs and hiring new skill sets — from financial analysis to experts in complex trading strategies. It’s all an effort to keep pace with the fraudsters and the ever-changing financial concoctions of the day.

For me, the progress cannot be fast enough.

When I review the pipeline of cases I see how much we are confronting.

  • We have approximately 150 active hedge fund investigations, some of which include possible Ponzi schemes, misappropriations, and performance smoothing.
  • We have about two dozen active municipal securities investigations possibly involving offering frauds; arbitrage-driven fraud; public corruption; and price transparency.
  • And, we have more than 50 current investigations involving Credit Default Swaps, Collateralized Debt Obligations and other derivatives-related investments.

… and that’s just a small slice.

Please contact us if you have a question on this issue or if you would like to start a hedge fund.  If you would like more information, please see our articles on starting a hedge fund.  Other related hedge fund law articles include: