SEC Proposes New Rule for Safeguarding Client Assets
On February 15, 2023, the U.S. Securities and Exchange Commission (SEC) proposed a new rule for registered investment advisers that would replace the current “custody rule” under the Investment Advisers Act of 1940 (Advisers Act) with a new “safeguarding rule”[1] and make corresponding amendments to the Adviser Act’s recordkeeping rule and Form ADV.
Additional information is contained in a related press release, fact sheet and proposing release.
Among other things, the new “safeguarding” rule would:
- significantly expand the scope of the types of client assets covered under the rule from “funds and securities” to include any client assets of which an adviser has custody (including non-securities assets, such as real estate, that are considered to be within the scope of the investment advisory relationship);
- broadly revise the definition of “custody” to include any client assets over which an adviser exercises discretionary trading authority; and
- require registered investment advisers to enter into a written agreement with the qualified custodian that contains terms addressing recordkeeping, client account statements, internal control reports, and the adviser’s agreed-upon level of authority to effect transactions in the account.
Although the proposed rule would include a limited exception from the surprise examination requirement (retained from the current rule) for a registered investment adviser whose custody of client assets arises solely from discretionary authority, that exception is conditional. To rely on this exception:
- the client assets must be maintained with a qualified custodian (e.g., securities not kept with a custodian pursuant to the “privately offered securities” exception would be disqualified from this exception) and
- the adviser’s trading under discretionary authority is limited to client assets that settle exclusively on a “delivery-versus-payment” (DVP) basis.
Notably, by proposing to expand “custody” to include assets traded under discretionary trading authority, the proposed rule would require substantially all registered investment advisers to comply with the safeguarding rule, including its surprise examination requirement (or through delivery of annual audited financial statements in lieu of a surprise examination, as permitted under the rule).
Comments on the proposed rule are due on or before the date that is 60 days following publication in the Federal Register and may be made as described in the proposal.
Our in-depth analysis of the proposed rule will be available in the coming days.
[1] Under the proposal, the SEC would renumber the current custody rule (Rule 206(4)-2 under the Advisers Act) as new Rule 223-1 under the Advisers Act.
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