On the Form ADV, there are two sections where a firm must declare whether or not they have custody, and if so, how much custody the firm has. Specifically, this is a part of Item 9 of Form ADV Part 1 – the amount of assets and the number of clients for which they’re deemed to have custody.
While it’s generally clear when a firm has custody in many cases (including the situation where a firm has dually registered as a broker-dealer and has physical custody), what has not been so clear in the past is how custody is viewed by the SEC in situations where a firm has non-physical custody and an SLOA (Standing Letter of Authorization) is involved.
In fact, the lack of clarity around this issue has persisted for years, leading to a request by the IAA for clarity on the issue. This was part of the SEC’s response:
“An investment adviser with power to dispose of client funds or securities for any purpose other than authorized trading has access to the client’s assets.”
You can read more about the letter (and the SEC’s response) here. With the recent updates to Form ADV in October 2017, investment advisors now need to list client assets that are subject to SLOA agreements. Every situation is unique, and there are many variables involved in determining whether or not your firm has custody and how to report it. Seeking outside help from a compliance consultant is often recommended to analyze your firm’s specific situation.
While this blog will attempt to cover some of the ways that SLOAs may impact custody, it’s a complex topic. Even if your situation isn’t covered in this blog, you may still have custody to include on your Form ADV. If you’re unsure, we highly recommend seeking the help of a third party compliance consultant.
Standing Letters of Authorization (SLOAs) Can Result in Inadvertent Custody
The difficulty of discussing SLOAs and inadvertent custody is the inherent complexity of trying to determine custody in the first place — truly, it requires an examination of each situation individually to be able to say, one way or the other, if custody exists.
Why all the fuss about custody in the first place?
Besides the obvious dangers of regulatory sanctions being levied if the requirements of the Custody Rule are not being adhered to, many firms would like to avoid having custody entirely. This is because those firms would then find themselves under a significant burden — namely, firms with custody must implement onerous (and sometimes quite expensive) risk management controls.
The main encumbrance most firms want to avoid is the requirement to obtain independent annual surprise examinations, which not only take up a large amount of time and resources, but may also cost quite a bit of money.
These surprise examinations, as the name suggests, are completely random and must take place annually through third-party accounting firms. If you’ve ever had to utilize the services of these firms, they can be quite expensive, so it is certainly worth the time and cost of working with third party consultants. They can work with you in determining if custody exists and what can be done, if anything, to remove that risk.
Fortunately, there are risk mitigation protocols that firms can follow to alleviate the need for surprise audits when deemed with custody due to having SLOAs. The SEC has outlined the steps firms can take in their no-action letter. For more information, we encourage you to read our blog that discusses the no-action letter where the SEC outlined some of these steps, which also includes a link to the no-action letter itself.
Seek Experienced Advice to Avoid Issues
Ultimately, it is up to each advisory firm to ensure that they remain in compliance with applicable custody regulations and that their Form ADV is kept up to date.
With less than a month to go before most firms will need to file their Form ADV annual updating amendment, now is the time to review the Custody Rule, to speak with a compliance consultant about any potential custody or compliance issues, and to ensure that this year’s Form ADV filing is updated.
Contact Core Compliance today to discuss how we can help your firm file in a timely manner and navigate any potential custody issues.