More Advisors Would Have Custody Under New SEC Plan. Here's How.
“Most notably, discretionary authority over a client’s assets would give rise to custody, regardless of whether the assets are traded on a non-DVP basis,” Hanna explained, using an abbreviation for delivery versus payment. “This means that securities and non-securities assets alike would generally need to be maintained with a qualified custodian if an adviser has discretion over them, although there would be a narrow and condition-laden exception to this requirement for certain privately offered securities and physical assets.”
The exception for privately offered securities, Hanna continued, “is a holdover from the current Custody Rule, but it is clear that the SEC wants substantially more privately offered securities to be held with qualified custodians, and is imposing some new onerous conditions to the exception to get advisers to go along with that.”
Repapering and Other Headaches
The SEC’s new Rule 223-1 would apply to all assets over which an advisor has custody, “regardless of whether they are securities,” Hanna said.
“This is a clear response to the emergence of crypto and other digital assets that may or may not be securities, but we shouldn’t lose sight of the implications here for advisers providing advisory services in connection with other non-securities, such as insurance, real estate, bank loans, oil and gas assets, etc.,” Hanna noted.
The new rule also mandates “extensive new contractual relationships” between investment advisors and their clients’ custodians, adds McGrath.
If adopted, an advisor would be required to “enter into written agreements with each qualified custodian that maintains possession or control of a client’s assets and obtain reasonable assurances in writing that the custodian will take certain actions,” McGrath said.
Contracts between advisor and custodian “would be required even where clients engage their custodians directly and without regard to the terms in the client’s custodial arrangements,” McGrath explained. “The practical impediments to establishing or repapering contracts between substantial portions of the investment management industry and the banking industry will be enormous.”
An advisor “would need to enter into a written agreement with any qualified custodian holding client assets over which the adviser has custody, and the agreement would need to contain certain provisions specified in the Safeguarding Rule,” Hanna added.
One of these provisions “would require the qualified custodian to annually obtain and provide to the adviser an internal control report, regardless of whether the qualified custodian is a related person of the adviser,” Hanna said. Another would require an advisor “to define the scope of its authority with respect to the client’s assets and thereby avoid any so-called ‘inadvertent custody.’”
(Photo: Diego M. Radzinschi/ALM)
