Update of Custody Rules for Investment Advisors

Changes to Custody Rules for Investment Advisors
Investment Advisors with custody of client assets are subject to new custody rules and regulations. The following outline highlights certain aspects of the new Custody Rules for Investment Advisors; however, it should not be used as a comprehensive summary or to make decisions as to whether these rules apply to your firm. ACI does not perform the newly required custody examinations, however, recognizes that this information is highly relevant for the investment advisor community for which we perform other bookkeeping and compliance outsourcings services.


FULL SEC RULE

Surprise Custody Examinations
An independent public accountant must conduct a surprise examination to verify assets in custody of the Investment Advisor. The examination should include: 

• A review of client accounts for which the firm has custody (on a sample basis per client account)
• Confirmation of the clients funds and securities with both the qualified custodian and the client
• Confirmation of contributions and withdrawals with clients
• The auditor must notify the SEC within 1 business day of finding any material discrepancy during the exam as required by the regulation.
• The audit must be performed by December 31, 2010.

Custody Examination Report

• Following the examination, the service provider should provide an examination report with an informed opinion as to whether the adviser is in compliance with the rule.

 Custody Examination Exemptions and Exemption Memorandum

• If the firm is exempt from the surprise examination, it will need to development and submit a memorandum that describes the relationship between the related person and adviser to explain the exemption for operational independence is satisfied.
• Exemptions may apply for

o Advisors with custody of the assets solely as a consequence of their authority to deduct advisory fees from client accounts

o Advisors to pooled investment vehicles that distribute annual audited financial statements to the pool's investors prepared by a PCAOB registered independent public accountant according to GAAP standards

o Advisors deemed to have custody solely because a related person who is ‘operationally independent' of the advisor holds the assets or has any authority to obtain possession of them in connection with services provided by the advisor.  

Internal Control Report -

• Annual written control report (SAS 70) if a related custodian maintains client assets. In addition to the report the PCAOB registered firm must verify that the client funds and securities are reconciled to a custodian other than the adviser or its related person.
• The Internal Control Report must be developed by September 12, 2010
• This report must be created by PCAOB registered firm

Recommended Update of Compliance Policies and Procedures

• Update of compliance manual to include policies and procedures for conducting and responding to custody audit, internal controls report, and disclosure requirements. ACI can assist in updating compliance policies and procedures accordingly.

Update of Disclosures

• Amend Form ADV / ADV-E as relevant to include additional disclosures regarding custodial practices during first annual Form ADV amendment post January 1, 2011 (within 120 days of the examination).