Private Funds Balk at Proposed Changes to Custody Rule

The Investment Adviser Section of the North American Securities Administrators Association (NASAA) recently released proposed changes to the NASAA model investment adviser custody rule. The most controversial aspect of the model rule, as originally proposed, was the requirement that advisers to private funds provide investors with detailed quarterly account statements including the requirement to list all transactions during the quarter with specificity as to the specific securities, trade dates, and execution prices. Widespread opposition to this requirement focused on the fact that disclosing such information would jeopardize the proprietary nature of a private fund’s trading strategy and potentially lead to the use of such strategies to the detriment of investors.

The proposed revisions to the model custody rule attempt to address some of these concerns but likely do not go far enough to protect the trading strategies of private funds. The requirement for advisers to private funds to send quarterly statements to investors remains, and these statements must include: opening and closing cash balances, the total amount of additions and withdrawals for each investor and the fund as a whole, and a listing of all portfolio holdings as of the end of the quarter. Rather than requiring a detailed list of all transactions during the quarter, advisers would be required to disclose an aggregate listing of transactions with a breakdown by type of security.

While the absence of trade dates, specific securities, and execution prices from the quarterly statements will reduce some concern over the identification of trading strategies, the information required by the revisions is still quite extensive and may nevertheless give rise to significant objection in the industry over the potential for mandating disclosure of proprietary trading strategies.

The NASAA is soliciting comments on the proposed revisions until May 19, 2011. Details on how to submit comments are available here. For additional information on the impact of the proposed revisions, please contact Zac Rosenberg, Compliance Consultant by email at zachary.rosenberg@corecls.com or by phone at (619) 278-0020.