New SEC Custody Rule Would Scare Away Qualified Custodians: Lawyer

That alone will cause qualified custodians to rethink their custodian services from a business perspective, as will the additional potential requirement of a custodian-adviser contractual relationship with set terms under the rule.

I have also seen anecdotally through my practice that not all custodians can or seek to serve all investment advisers — there are minimum asset requirements with certain custodians. I would not be surprised to see qualified custodians taking even further steps along those lines in approaching their business.

Smaller advisers will be affected the most in terms of lack of range of choices, which is never productive from a commercial perspective. A lack of choices can also mean rising costs, which could ultimately be passed onto clients, including retail clients.

Furthermore, this proposal includes client assets beyond cash and securities — while this is driven by the proposal’s focus on cryptocurrency, the expansion of covered client assets also concerns me. Outside the realm of crypto, this expansion will have a disproportionate impact on smaller advisers. And, it is important to remember that 90% of SEC-registered advisers have fewer than 50 employees.

Finally, the 60-day comment period is too short for a proposal of this scale — the Custody Rule is one of the more complex rules under the Advisers Act, and this proposal would wholly replace the existing rule. This is not a proposal amending components — this is a proposed rewrite of the rule.

Both the comment period and the implementation timelines should be longer than they are now.

What’s ahead for Regulation Best Interest exams and enforcement? Do you see the SEC taking any more policy actions regarding Reg BI, that is, defining ‘best interest’?

Reg BI is squarely in the realm of exams and enforcement at this point — we might see another Reg BI risk alert in the next year, but this latest one (published Jan. 30, 2023) really struck me as setting expectations for what the exam staff expects to see in terms of policies, procedures and practices for Reg BI compliance.

Risk Alerts are vital in understanding the staff’s expectations and point of view. Broker-dealers should review their current Reg BI compliance framework with the Risk Alert in mind.

Any updates on firms’ compliance with the SEC’s new Marketing Rule, which had a Nov. 4 compliance date? 

I was pleased that firms had a robust 18-month transition period to the compliance date, which gave them time to implement the rule. The publication of an FAQ just over two months after the Nov. 4 compliance date was unexpected and did cause some course correction among the industry. However, in light of the 18-month transition period leading up to Nov. 4, 2022, I do believe firms are well prepared going into 2023 examinations.

Because of the FAQ’s approach to gross versus net, some advisers further sharpened disclosure and presentation of gross versus net. The practical impact was reproducing materials for 4Q 2022 that had already been finalized. None of this impacted investors and clients as the materials were updated prior to dissemination, but there was an impact on industry resources.