SEC Division of Investment Management Updates to Custody Rule Frequently Asked Questions

July 12, 2018Newsletters

The SEC Division of Investment Management issued Information Update 2018-01 “Updates to Custody Rule Frequently Asked Questions” (June 2018) to provide additional guidance relating to custody arising out of IM Guidance Update 2017-01 “Inadvertent Custody: Advisory Contract Versus Custodial Contract Authority” (February 2017). As summarized in a previous DCS Alert, IM Guidance Update 2017-01 addressed instances where an adviser would be deemed to have custody due to the provisions contained in the custodial agreement between the advisory client and the advisory client’s custodian.

IM Guidance Update 2018-01 informs advisers of the newly added Question II.11 and Question II.12 to the “Definition of Custody; Scope of the Rule” section of the Custody Rule FAQs. The newly added Question II.11 encompasses the clarification made by the Division of Investment Management. Question II.11 provides: “[T]he Guidance Update described circumstances where a custodial agreement between a client and a qualified custodian, to which the client’s adviser is not a party, might permit the adviser to instruct the custodian to disburse, or transfer, funds or securities. We are an advisory firm that does not know whether any of our clients’ custodial agreements would give our firm inadvertent custody [under IM Guidance Update 2017-01]. Are we now required to comply with the custody rule for those client accounts?”

In the Answer to Question II.11. the Division of Investment Management provides that where an adviser does not have a copy of a client’s custodial agreement, and does not know, or have reason to know, whether the agreement would give the adviser inadvertent custody under IM Guidance Update 2017-01, the adviser does not have to comply with the custody rule with respect to such a client’s account if the inadvertent custody under IM Guidance Update 2017-01 is the only reason why the adviser has custody over that client’s account.  The Division of Investment Management goes on to provide that this relief is not available where the investment adviser recommended, requested, or required the client’s custodian.

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