|

    SEC’s Proposed Changes to Custody Rule

     
     

     

    TO:  FPA Members

    FROM:  Duane Thompson, FPA Washington Office

     

    s you are probably aware, the Securities and Exchange Commission recently proposed a controversial new requirement for federally registered investment advisers that would mandate an annual surprise audit of all discretionary accounts of an investment adviser by an independent public accountant.  The SEC considers automatic deduction of client fees from these discretionary accounts to be 'custody' of client assets, thereby requiring special attention in the wake of the Madoff scandal.  The SEC estimates the average cost of these audits at $8,100 per firm. 

    FPA is strongly opposed to this specific requirement in the rule, and will submit detailed comments to the SEC prior to the July 28th deadline for public comment.  FPA also encourages you to submit your own comments by email to rule-comments@sec.gov.  Please include 'File Number S7-09-09' in the subject line.

    Below is an executive summary of the rule and suggested talking points to review before submitting your comments.  Please keep in mind that your comments will be publicly posted on the SEC website at http://www.sec.gov/comments/s7-09-09/s70909.shtml.

     FPA Executive Summary 6/24/09

    SEC’s Proposed Changes to the Custody Rule

    Release No. IA-2876

     

    “Custody of Funds or Securities of Clients by Investment Advisers”

     

    Rule summary: Amendments to the SEC custody rule that would, among other things, require most advisory firms to undergo a surprise audit annually by an independent accounting firm.  It would not affect state-registered firms although many states would likely adopt a similar rule.
    Main elements of the Rule:
     
    • Surprise Audit. Require surprise audit for approximately 9,575 RIAs who automatically deduct fees from client accounts and are technically deemed by the SEC to hold custody. There are about 11,200 RIAs registered with the SEC.
    Pooled Investment Vehicles. Excepted from this requirement if audited annually and audited financials are distributed to the limited partners.
    • Internal Controls Report. Unless accounts are held at a third-party custodian, the adviser or related person must obtain an annual written internal controls report from an accounting firm registered with PCAOB.
    FPA staff comment: SEC estimates annual cost of report at $250,000. Most likely dually registered broker-dealers would be affected by this proposal. This requirement would be in addition to a surprise audit. Also, the public accountant making the surprise audit in this case would also have to be PCAOB-registered.
    • Notice to Clients. A notice would be required to be sent to clients if the adviser is opening an account on their behalf with a qualified custodian. The notice would include contact information for the custodian as well as a statement encouraging client to compare account statements of the custodian and adviser.
    • ‘Due Inquiry’ Requirement. The adviser must have a ‘reasonable basis’ for believing that the qualified custodian sends statements to clients at least quarterly.
    FPA staff comment: SEC suggests advisers can satisfy this requirement by having the custodian send a copy of the account statements delivered to the clients or, alternatively, fax or email to the adviser confirmation that the account statements were mailed.
    • Changes to Form ADV Part I and Schedule D. RIAs would be required to report additional data to the SEC on Part I of Form ADV and Schedule D for purposes of allowing the SEC to identify potential problems more easily. As an example, Item 7 of Part 1A would be changed to require the adviser to identify any affiliated BDs that hold custody over client funds and Item 9 to detail amount of those assets and the number of clients.

     Suggested Talking Points in your email to the SEC:

    • Identify yourself as an FPA member and SEC-registered investment adviser.
    • Clearly state upfront that you are opposed to the requirement in the proposed amendments to the custody rule that would subject investment advisers to a surprise audit by an accounting firm.  You may wish to include some or all of the following reasons (please use your own words):
    • The proposed surprise audit appears to be more of a political reaction to public criticism of the SEC and congressional pressure after the Madoff scandal than an effective regulatory response.
    • The SEC already resolved one of the major problems with the custody rule, which was eliminating a loophole from registration for certain accounting firms with the PCAOB that Madoff's accountant used to avoid detection of its phony auditing practices.
    • The Madoff and other Ponzi schemes resulted from a lack of aggressive enforcement by the SEC and FINRA of current rules and ignoring repeated warnings from the media and whistle blowers.  The SEC should hold FINRA accountable for its shared oversight of Bernie Madoff in conducting the Ponzi scheme for decades as a broker-dealer before registering two years ago as an investment adviser.
    • The Ponzi schemes uncovered by the SEC had nothing to do with fees deducted by investment advisers.  As far as we are aware, there have been no systemic problems in this area and are unnecessary, costly and burdensome, particularly for small, independent investment advisers.
    • The new surprise audit requirement will add additional costs to my business that will ultimately be passed on to my clients.  [Provide an example of how this will affect your business, including taking away time needed to assist clients during the ongoing financial crisis.]
    • In order to enhance consumer protection, I would support Congress appropriating additional resources to the SEC to hire and train additional examination staff to increase the regular audit cycle of investment advisers.

     

    Please also cc your Member of Congress and Senators at the bottom of your message, if possible.  You may look up your representatives by going to FPA's website at http://www.fpanet.org/GovernmentRelations/GrassrootsEfforts/ to send them a copy of your email.

    To review the SEC rule, please to go: http://www.sec.gov/rules/proposed/2009/ia-2876.pdf

    Thanks for your prompt response to this request! 
       

     

     
       

    © 2009 FPA of San Francisco

    The FPASF website is for professional use and informational purposes only. Do not rely on it for investment advice. Opinions expressed are solely those of the members and speakers and do not represent the views of the FPA or FPASF. 

     

    ATTENTION!
    Your login will expire in the next five minutes due to inactivity. Please click the link below to refresh your login.

    Refresh my login