Amendments to Custody Rule for SEC Registered Investment Advisers

Some highlights of the Amended Custody Rule:

• Annual surprise examination required of all advisers deemed to have custody; exceptions apply
• No surprise examination requirement for private fund advisers whose funds are audited annually
• Fund audits must be conducted by independent accountants registered with the Public Company Accounting Oversight Board (“PCAOB”)
• Fund audit is required upon fund’s liquidation
• Fund advisers managing separate accounts are subject to surprise examinations with respect to separate account assets
• No surprise examination requirement for advisers that have custody solely for deducting advisory fees from client accounts
• Advisers that do not have custody but whose affiliates do will be subject to the surprise examination requirements unless they can establish “operational independence” from the affiliate that has custody
• Advisers that do not maintain custody with an independent qualified custodian must obtain from their affiliated custodian an annual internal control report (SAS 70) prepared by a PCAOB-registered accountant
• Advisers with custody must make “due inquiry” to ascertain the custodian delivers quarterly reports, regardless whether the adviser is subject to surprise examinations or sends quarterly reports
• Privately offered securities must be covered by the surprise examination

The Current Custody Rule
The current Custody Rule requires SEC registered investment advisers (“advisers”) that have custody of client funds or securities to maintain those assets (with some exceptions) with a “qualified custodian”¹ which, in the adviser’s reasonable belief, sends quarterly account statements to each client. In addition to having physical custody of cash or securities, an adviser that maintains custody of client assets with a qualified custodian is nevertheless deemed to have “custody” of those client assets if it has authority to (i) obtain possession of client funds or securities (such as advisers operating pursuant to a general power of attorney and/or as the general partner of an investment limited partnership) or (ii) deduct advisory fees from a client’s account.

1. “Qualified custodian” generally includes banks, certain broker-dealers, futures commission merchants and certain foreign financial institutions.

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