IAA Alert: February 21, 2017 - SEC Staff Provides Custody Rule Guidance on SLOAs and more...


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SEC Staff Provides Custody Rule Guidance on SLOAs, First-Person Transfers, and Inadvertent Custody

February 21, 2017: Today, the SEC staff provided guidance in three areas under the Custody Rule: standing letters of authorization under which a client instructs its qualified custodian to transfer assets to a designated third party (SLOAs); a client’s grant of authority to an adviser to move money between the client’s own accounts (first-person transfers); and provisions in a separate custodial agreement entered into between an advisory client and a qualified custodian that inadvertently impute advisers with custody they otherwise did not intend to have.

To assist IAA members in understanding and implementing the no-action letter relating to SLOAs and updated FAQ II.4 relating to first-person transfers, the IAA has put together a number of FAQs, which are available online here.

SLOAs. In a significant development that should bring much-needed clarity to the investment adviser industry, the SEC staff has responded to the IAA’s request for no-action relief under the Custody Rule. In the February 21 letter, the staff of the SEC’s Division of Investment Management stated that it would not recommend enforcement action against an investment adviser that does not obtain a surprise examination where it acts pursuant to an SLOA, as long as the following representations were met:

  • The client provides a written, signed instruction to the qualified custodian that includes the third party’s name and address or account number at a custodian;
  • The client authorizes the investment adviser in writing to direct transfers to the third party either on a specified schedule or from time to time;
  • The client’s qualified custodian verifies the client’s authorization (e.g., signature review) and provides a transfer of funds notice to the client promptly after each transfer;
  • The client can terminate or change the instruction;
  • 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;
  • The adviser maintains records showing that the third party is not a related party of the investment adviser or located at the same address as the investment adviser; and
  • The client’s qualified custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.

The status of SLOAs under the Custody Rule has caused a great deal of confusion in recent years. As we indicated in our request letter to the SEC, in our view, an adviser simply following a client’s instruction to transfer assets pursuant to an SLOA should not confer custody – a conclusion that many in the industry shared. Although the SEC staff disagreed, it did provide relief from the annual surprise exam requirement, as long as the representations outlined in the letter are met. Because many of those representations involve the qualified custodian’s operations, the IAA collaborated closely with four major custodians – Charles Schwab, Fidelity, TD Ameritrade and Pershing – to ensure that the representations would be able to be met.

The SEC staff acknowledged in the no-action letter that investment advisers, qualified custodians and their clients will require a “reasonable period of time” to implement the processes and procedures necessary to comply with the no-action letter’s relief. The adviser should make a good faith effort to comply with the representations in six months, with the understanding that the staff views this timeframe with some flexibility.

The IAA no-action request and the SEC staff’s response letter are available here and on the IAA’s website under Publications >> Comment Letters.

First-Person Transfers. The SEC staff has also updated one of its Custody Rule FAQs to address a separate issue involving transfers where a client grants an adviser the authority to move money between the client’s own accounts (“first-person transfers”). This situation is covered by 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 to make such transfers specifies the client accounts. Many in the industry, based on FAQ II.4 and other available guidance, concluded that they did not have custody as long as they had clear authority to initiate first-person transfers, even if account numbers were not specified in the initial authorization signed by the client. Through examinations, it became clear that the SEC staff disagreed, and a number of advisers received examination deficiencies where the SEC staff found that accounts were not sufficiently “specified.” The SEC staff clarifies in the updated FAQ that “specifying” in FAQ II.4 means that the written authorization signed by the client and provided to the sending custodian states 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. While not ideal, the clarification will enable investment advisers and their custodians to adapt their policies and procedures within a reasonable timeframe and avoid further findings of deficiencies by OCIE.

Although the FAQ does not specify a deadline, the SEC staff understands that investment advisers will require a “reasonable period of time” to implement the processes and procedures necessary to comply with the clarification. Our initial conversations with the staff suggested that six to 12 months may be necessary. Subsequently, the industry and the staff came to realize that it may take some firms (advisers and custodians) longer based upon their own facts and circumstances. As with SLOAs, the adviser should make a good faith effort to comply with updated FAQ II.4, with the understanding that the staff views implementation timing with some flexibility.

See updated FAQ II.4 in Staff Responses to Questions About the Custody Rule, available at https://www.sec.gov/divisions/investment/custody_faq_030510.htm.

Inadvertent Custody. Also today, the SEC’s Division of Investment Management released a Guidance Update addressing provisions in a separate custodial agreement entered into between an advisory client and a qualified custodian that inadvertently impute advisers with custody they otherwise did not intend to have. The guidance notes that one way for an adviser to avoid such inadvertent custody would be to draft a letter addressed to the custodian that limits the adviser’s authority to “delivery versus payment,” notwithstanding the wording of the custodial agreement, and to have the client and custodian provide written consent to acknowledge the new arrangement.

The Guidance Update, Inadvertent Custody: Advisory Contract Versus Custodial Contract Authority (No. 2017-01), is available at https://www.sec.gov/investment/im-guidance-2017-01.pdf.

IAA Members with questions should contact IAA Assistant General Counsel Laura Grossman at laura.grossman@investmentadviser.org or (202) 293-4222.

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