As a result of widespread confusion and uncertainty among investment advisers and other members of the financial industry, the Investment Adviser Association (IAA) sent a letter to the SEC’s Division of Investment Management requesting clarification and no-action relief pertaining to the written Standing Letter of Authorization (SLOA) arrangements that allow investment advisers to give custodians instruction to send money from clients’ accounts to third parties. Specifically, the IAA letter asked for clarification on whether these arrangements would cause an investment adviser to be deemed to have custody, in addition to seeking no-action assurance from the SEC that if they did invoke custody then advisers would not be required to obtain independent annual surprise examinations otherwise required under Rule 206(4)-2 of the Investment Advisers Act of 1940 (“Custody Rule”).
The IAA’s outlined position was that an SLOA arrangement, where an investment adviser is only acting on a client’s instructions to transfer assets to a third party, does not result in an investment adviser having the ability to hold, obtain possession of, or withdraw client funds. In their response letter, the SEC disagreed and stated that “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.” They went on to say that this includes letters of instruction or other asset transfer authorization arrangements that enable an investment adviser to withdraw client funds or securities from their accounts. The SEC believes that entering into such an arrangement does constitute custody and the investment adviser is therefore required to comply with the Custody Rule.
Despite the polite disagreement with IAA’s stance, the SEC staff of the Division of Investment Management stated in their no-action letter that they would not recommend enforcement action to the Commission under Section 206(4) and Rule 206(4)-2 of the Advisers Act if an investment adviser with one or more these SLOA arrangements in place does not obtain an annual surprise examination, so long as the adviser adheres to all the requirements outlined in their letter. In addition, the SEC staff said that starting October 1, 2017, investment advisers will be required to include client assets that are subject to these SLOA arrangements in their response to Item 9 of Form ADV Part 1.
In addition to the no-action letter, the SEC updated their answer to question II.4 in their FAQs covering the Custody Rule pertaining to transfers between client accounts with the same registration. They also issued guidance on inadvertent custody due to certain language in custodial agreements that clients sign.
Custody is a very complex subject that depends on specific facts and circumstances. Therefore, Chief Compliance Officers should review the information issued from the SEC in detail and determine whether additional controls and procedures need to be implemented.
If you have questions or need assistance with or guidance on implementing the processes and procedures necessary to comply with this no-action relief, please contact us at (619) 278-0020 to schedule a consultation.