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Press Statement on IAA Comment Letter on SEC’s Proposal on Safeguarding Advisory Client Assets

May 9, 2023

IAA VP of Communications & Marketing Janay Rickwalder.

Attribution to Gail Bernstein, IAA General Counsel

Yesterday, the Investment Adviser Association (IAA) submitted a comment letter urging the SEC to make substantial changes to its proposed new rule on safeguarding advisory client assets.

The IAA strongly supports the SEC’s efforts to protect advisory client assets from misuse, misappropriation, or losses resulting from an investment adviser’s insolvency or bankruptcy. However, we have serious concerns with several of the central features of the proposed rule that we believe will be ineffective to achieve our shared investor protection goal. These features will prove impractical, if not infeasible in many respects, and impose significant costs on investment advisers and both direct and indirect impacts on investors that far exceed any perceived benefits.

The proposal goes well beyond its core purpose of protecting client assets from misappropriation by, or losses of, the adviser. In particular, the IAA is deeply concerned by the dramatic expansion of the concept of custody to include discretionary authority and the virtually boundless scope of assets transacted in myriad different markets that the proposed rule seeks to cover, unrealistic requirements to enter into written agreements with custodians with specific terms that custodians likely wouldn’t agree to, and the attempt to use the Investment Advisers Act to indirectly regulate custodians, which are already subject to their own regulatory regimes, and many of which the SEC has no authority to regulate directly.

The SEC has not demonstrated any meaningful analysis that an investment adviser’s discretionary trading authority presents risks that are in any way proportionate to the vast new burdens that the proposed rule would impose on investment advisers. Similarly, the SEC has not provided a sufficient rationale to justify abandoning the existing Custody Rule framework for privately offered securities and upending the market practices and regulatory regimes of other asset classes that have traded for years without evidence of meaningful risk of misappropriation or loss.

The IAA also objects to the proposed requirements for written contracts with, and specific assurances from, custodians. These requirements would mandate that investment advisers enter into multiple separate contracts with each and every custodian its clients use, which is unrealistic for all advisers and would be especially burdensome for smaller investment advisers that have little negotiating leverage over custodians.

The IAA believes that the proposal would compel the investment adviser to police commercial terms between custodians and their customers on matters unrelated to the investment advice provided by the adviser, including custodians not regulated by the SEC. This type of “backdoor” regulation is inappropriate, turns on its head the regulatory purpose of the Custody Rule, imposes regulatory burdens unfairly, and is unlikely to be effective in achieving the SEC’s investor protection goal. Risk is not binary, as the proposed rule suggests. Risk exists on a spectrum and safeguarding protections should be calibrated to the spectrum of risk.

The IAA believes that focusing the adviser’s role in safeguarding client assets on implementing principles-based and risk-based internal controls reasonably designed to mitigate the risk of loss, misuse, and misappropriation would more effectively address the spectrum of risks across different assets and markets and achieve the Commission’s goal of protecting advisory client assets more broadly. The internal controls approach that the IAA recommends would avoid the impracticalities, weaknesses, and flaws in the proposed rule and would be proportionate to the actual risks presented by different asset classes, advisory practices, and business models.

While we appreciate that the SEC recognizes that smaller advisers will face unique challenges in implementing a final safeguarding rule by proposing a staggered compliance date based on an adviser’s assets under management, the IAA believes the time proposed for all advisers is unreasonably short. The IAA urges the SEC to take into account the practicalities of implementing any new rule and provide more realistic deadlines and compliance periods that do not place undue burden on advisers of all sizes.

The IAA is compelled to highlight that the proposed safeguarding rule is the latest in a series of rulemaking proposals that are unprecedented in their scope and speed. The SEC has not considered how these proposals interrelate or their cumulative effect on investment advisers, especially smaller investment advisers, despite our many calls for the SEC to do so.

The IAA is committed to working constructively with the SEC to achieve our shared goal of safeguarding advisory client assets. We will continue to engage with the SEC as it considers this proposal and the feedback it receives, and will continue to advocate for all advisers, and in particular for smaller advisers, to ensure that any final rule recognizes the extent of the burdens being placed on them and considers less burdensome ways to achieve the SEC’s goals.

Please contact Janay Rickwalder with any questions or to set up an interview.

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