There has been a problem floating around for custody for investment advisers. Custody agreement between the client and qualified custodian may permit the adviser to do things with the assets in the account that create a custody problem. The Securities and Exchange Commission had been noticing this problem and last February issued a Guidance Update that flagged it.
The SEC has issued new guidance to address the problem. And the new standard is:
The SEC has updated its Frequently Asked Questions About the Custody.
Back to the substance, it’as all about the adviser not knowing about the inadvertent custody.
“An adviser that 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, need not comply with the custody rule with respect to that client’s account if Inadvertent Custody would be the sole basis for custody.”
It seems best for an adviser to stick its head in the sand or act like Sergeant Schultz and see nothing. The adviser is not a party to the custodial agreement so the powers granted to the adviser may be outside the scope of its knowledge. This new guidance seems like an adviser can purposefully not get a copy of the agreement and shield itself from the custody rule.
With inadvertent custody, the client could force a custody violation on the adviser without its knowledge.
Now, ignorance is a defense.
The other item that caught my attention is that this was released through a new thing called an Information Update.
IM Information Updates are recurring notices regarding the activities of the Division.
The Division generally issues IM Information Updates to alert the public—including
investors and industry participants—to key developments, such as updates to Frequently
Asked Questions, technical improvements to SEC forms, and certain other staff actions.
IM Information Updates may also explain administrative and procedural matters, such as
how to most effectively communicate with the staff.
This IM Information Update does not constitute staff legal guidance and is not a rule,
regulation, or statement of the Securities and Exchange Commission. The Commission
has neither approved nor disapproved its content.
This is somehow different than the Guidance Updates that we have seen from the Division of Investment Management.
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