On February 15th, 2023, the Securities and Exchange Commission (SEC) announced its proposed rule changes to enhance protections for customer assets managed by registered investment advisers. If adopted, the changes would amend and redesignate rule 206(4)-2, the Commission’s custody rule, under the Investment Advisers Act of 1940, and amend certain related recordkeeping and reporting obligations.
In a statement, SEC Chair Gary Gensler voiced his support for the proposal, citing the importance of using authorities granted to the SEC by Congress after the financial crisis to prevent inappropriate use, loss, or abuse of investors’ assets. The proposed changes to the custody rule would broaden its application beyond client funds and securities to include any client assets in an investment adviser’s possession or when an investment adviser has the authority to obtain possession of client assets.
The proposed rules exercise Commission authority under section 411 of the Dodd-Frank Act and entrust the safekeeping of client assets to qualified custodians, such as certain banks or broker-dealers. The proposed changes are intended to ensure that qualified custodians provide certain standard custodial protections when maintaining an advisory client’s assets. This would include proper segregation and holding of client assets in accounts to protect them in case of a qualified custodian bankruptcy or other insolvency.
The proposal would also enhance protections for certain securities and physical assets that cannot be maintained by a qualified custodian. Additionally, the proposed rule retains the current requirement for an adviser with custody of client assets to obtain a surprise examination from an independent public accountant to verify client assets but modifies the audit provision to expand the availability of its use, enhance investor protection, and facilitate compliance.
Finally, the proposal updates and enhances related recordkeeping requirements for advisers and amends Form ADV to align reporting obligations with the proposed rule and to improve the accuracy of custody-related data available to the Commission, its staff, and the public.
The proposed changes, if implemented, would provide investors working with advisers with time-tested protections for all of their assets, including crypto assets, consistent with what Congress envisioned. The comment period on the proposal will remain open for 60 days following the publication of the proposing release in the Federal Register.
In conclusion, the proposed rule changes by the SEC represent an important step towards safeguarding investor assets against inappropriate use, loss, or abuse by registered investment advisers. The proposed changes would broaden the application of the current custody rule, enhance protections for certain securities and physical assets, and improve reporting obligations and data accuracy. The proposed rule changes align with Congress’s vision of providing time-tested protections for all of an investor’s assets, including crypto assets.
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Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.
He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.