One of the salient regulatory rules to emerge from the Dodd-Frank Wall Street Reform Act was the custody rule mandating that an investment adviser who has custody of a clients cash or securities must retain a qualified independent custodian for such properties or follow strict rules for adviser-custodians. Of particular interest to registered advisers is the rules asset-audit and client-reporting requirements for in-house custodians that must be closely adhered to in order to avoid harsh SEC enforcement consequences.
Fraud Cases Led to Rule
In 2009, a series of fraud cases occurred in which investment advisers misappropriated client assets or misrepresented the value of those assets in their reporting to investors. Calls for strengthening investor protection resulted in revisions to the custody rule to decrease the likelihood of customer assets being misappropriated or misused and to provide early detection in the event of fraudulent activity. The rule defines custody as holding, directly or indirectly, client cash or securities, or having any authority to obtain possession of them in connection with rendering advisory services.
What Custodians Must Do
A registered adviser who acts as custodian is subject to the following requirements:
- (a) The custodian must be prepared for an unannounced annual audit by an independent public auditor to verify client assets being held;
- (b) the custodian is required to send account statements directly to clients;
- and (c) the custodian must obtain a report on the internal controls governing the custody of customer assets from an independent public accountant.
The rule cautions that it is a fraudulent, deceptive, or manipulative act for a registered adviser to maintain custody of client assets unless the adviser meets the requirements of the custody rule.
120 Day Rule Violation
Late last month, the Securities and Exchange Commission (SEC) announced charges against an investment advisory firm for allegedly failing to provide audited financial statements to clients within 120 days of the end of the fiscal year as required by the rule. The charges alleged that the firm was repeatedly late in providing investors with the audited statements of its private funds. Specifically, the SEC found that the firm was at least 40 days late in distributing audited financial statements to investors in 10 private funds for fiscal year 2010; in 2011, audited financial statements for those same funds were anywhere from six to eight months late; and for fiscal year 2012, materials were distributed to investors approximately three months late.
Andrew M. Calamari, director of the SECs New York regional office reminded advisers:
The custody rule is not a technicality. It is a critical investor protection provision designed to help ensure that investor assets are safe.
David draws on 20+ years’ experience in both legal practice and in business services delivery since his own call to the Bar in 1989. With several years in the startup environment, including as a co-founder in the legal tech space specifically, he brings a unique and timely perspective on the role of data, automation and artificial intelligence in the modern and efficient delivery of services for legal consumers. Having been both a corporate buyer of legal services and a services provider, he identifies the greater efficiency and value that can be achieved in legal operations for corporate buyers especially.
An attorney, David worked for law firms Pinsent Masons and Linklaters in London before moving to New York to join Credit Suisse. As CAO, he helped negotiate & execute the relocation of Credit Suisse into its new NYC global HQ. Subsequently, David directed major global outsourcing, shared sourcing, HR operations & process efficiency initiatives including the digitization of records, the global roll-out of PeopleSoft HRMS & Y2K. David has worked extensively in the UK, US, Philippines, India and China markets in the areas of data management, human resources and business process outsourcing.
Most recently, David has been successfully investing in and serving as an advisory board member of several legal services start-ups including a cloud-based solution for legal process automation and e-filing; and a technology solution for large-scale capture of court and other public data used for litigation analysis, among others.
David graduated from the University of Manchester with Honors in Law and Bar School (College of Legal Education) in London, and has been a member of Middle Temple since 1989. He is the founder and former Chairman of The Global Sourcing Council.
Member: Bar of England & Wales, ABA, NYCBA, ACC, DRI
