On April 25, 2016, the Securities and Exchange Commission’s (“SEC”) Division of Investment Management issued a no-action letter to the Investment Adviser Association (“IAA Letter”) giving relief to certain sub-advisers from surprise audits requirements under Rule 206(4)-2 under the Investment Advisers Act of 1940 (“Custody Rule”).
The IAA Letter focuses on sub-advisers to investment advisory programs that are required under the Custody Rule to obtain surprise audits when a related custodian is the adviser (“Primary Adviser”). Importantly, in these situations the sub-adviser also must obtain a written internal controls report annually from the Primary Adviser that was performed by an independent public accountant registered with and subject to regular inspection by the Public Company Accounting Oversight Board (“PCAOB”).
The SEC clarified that these sub-advisers are not required to obtain a surprise audit, so long as the following conditions are met:
- the only reason the sub-adviser is deemed to have custody of client assets is due to the affiliation with the Primary Adviser;
- the related Primary Adviser complies with the Custody Rule, including receiving a surprise audit performed by a PCAOB independent accountant;
- the sub-adviser does not have custody of the clients’ assets due to other circumstances, including having authority to obtain possession or deduct fees from the clients’ accounts; and
- the sub-adviser continues to receive a copy of the Primary Adviser’s written internal control report annually.
The Custody Rule remains a hot topic for SEC examiners. Chief Compliance Officers (“CCOs”) should have a good understanding of the Custody Rule requirements and ensure that robust safeguarding policies, procedures and internal controls are in place to protect client assets.
Core Compliance can help. Our consultants are well versed in the requirements of the Custody Rule and can assist CCOs with maneuvering through the complexities of the Custody Rule and ensuring policies, procedures and controls are adequately designed to help prevent violations. For more information on our services and how we can help you, please contact us at (619) 278-0020.