In early 2023, the SEC proposed amendments that would redesignate the current custody rule — 206(4)-2 — as a new rule, 223-1, or the “safeguarding rule,” under the Investment Advisers Act of 1940. The extended comment period expired at the end of October 2023. As we wait to see if the changes are adopted, it’s important for RIAs to be ready. Those with over $1 billion in regulatory assets under management (AUM) will have 12 months to comply with the new rule, while those with less than $1 billion will have 18 months.
There is quite a bit of uncertainty where the SEC will ultimately land. However, the proposed amendments are substantial. Regardless of the composition of the final rule, it’s a safe bet that in situations where RIAs maintain custody, they will need to be working more with their independent public accountants. Below are three key takeaways from the proposed rule:
The safeguarding rule increases the scope of custody from client “funds and securities” to any client “funds, securities, or other positions held in a client’s account.” Discretionary trading authority is deemed to meet the definition of “custody” per the proposal. The amended custody definition would include any arrangement, including a general power of attorney or discretionary authority under which the adviser is authorized to withdraw or transfer beneficial ownership of client assets upon the adviser’s instruction.
Under the proposed changes, advisers that have discretionary authority will now need a surprise examination unless they meet the following two criteria verbatim:
The increase in scope of what constitutes custody combined with limited relief from surprise custody exams mean a large number of RIAs will need surprise custody examinations that haven’t historically.
The SEC received 90 comment letters on the safeguarding rule. Many touched on the proposed changes aiming to reduce the number of privately offered securities and physical assets — such as real estate, precious metals, physical commodities — not held at qualified custodians. This change would likely be costly to implement.
As it stands, the proposal would require all client assets to be held at a qualified custodian, eliminate custody by the RIA or retain the current exception with several new modifications. If privately offered securities or physical assets cannot be held at a qualified custodian, the proposed rule includes a requirement for an independent accountant to verify any purchase, sale or other transfer of beneficial ownership promptly after receiving notice from the adviser, within one business day of such transaction.
Once the final rule is published, the 12- to 18-month window to comply will pass quickly. As such, it’s important that RIAs digest these final rules soon, with the help of legal counsel, to ensure they have an independent public accountant engaged and are performing the necessary services to comply with this redesignated rule.
Contact Mike Meckstroth at mmeckstroth@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.