The Securities and Exchange Commission (SEC) has sanctioned three investment advisory firms for violating the “custody rule” that requires them to meet certain standards when maintaining custody of client funds or securities.
The majority of investment advisers do not maintain custody of client assets, which are instead held by qualified third-party custodians like a bank or broker-dealer. Investment advisers must comply with the custody rule if they have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets.
The Commission amended the custody rule in 2010 to strengthen investor protections by requiring all advisers with custody to undergo an annual “surprise exam” to verify the existence of client assets. Advisers also must have a reasonable basis to believe that a qualified custodian is sending account statements to fund investors at least quarterly. Advisers with custody of hedge fund or other private fund assets may alternatively comply with the custody rule through fund audits by a PCAOB-registered auditor, after which financial statements must be delivered to investors.
SEC investigations following referrals by agency examiners found that New York-based Further Lane Asset Management, Massachusetts-based GW & Wade, and Minneapolis-based Knelman Asset Management Group failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct surprise exams. The firms also committed other violations of the federal securities laws. Each firm has agreed to settle the SEC’s charges.
“The heart of the relationship between advisers and their customers is the safety of client assets. Surprise exams or procedures associated with audited financial statements provide additional safeguards against assets being stolen or misused,” says Andrew Ceresney, co-director of the SEC’s division of enforcement. “These firms failed to comply with their custody rule obligations, and other firms who hold client assets should take notice that we will vigorously enforce such requirements.”