In this month’s article, Lexington Compliance discusses the latest SEC guidance pertaining to RIA Standing Letter of Authorization (SLOA) custody.
On February 21, 2017, the Securities and Exchange Commission (SEC) Division of Investment Management issued a no-action letter in response to a letter from the Investment Adviser Association (IAA) asking for clarification and assurances related to Rule 206(4)-2 (“Custody Rule”) under the Investment Advisers Act of 1940 (“Advisers Act”). The IAA sought to 1) confirm that a registered investment advisor (RIA) firm “utilizing a standing letter of instruction (SLOA) or other similar asset transfer authorization arrangement established by a client with a qualified custodian would not be deemed to have custody and 2) confirm that the SEC staff would not recommend enforcement action under Section 206(4) of the Advisers Act and the Custody Rule against an RIA firm if it acts pursuant to a SLOA, as described in the IAA’s letter, without the advisory firm obtaining a surprise independent verification* (“surprise examination”) as required by Rule 206(4)-2(a)(4).”
While the SEC Division of Investment Management does state in its response that an RIA firm that enters into an SLOA arrangement with its clients “would therefore have custody of client assets and would be required to comply with the Custody Rule,” the SEC staff more importantly further notes that “notwithstanding this view, staff of the Division of Investment Management would not recommend enforcement action to the Commission under Section 206(4) of, and Rule 206(4)-2 under, the Advisers Act against an investment advisor if that advisor does not obtain a surprise examination where it acts pursuant to such an arrangement under the following circumstances:
- The client provides an instruction to the qualified custodian, in writing, that includes the client’s signature, the third party’s name, and either the third party’s address or the third party’s account number at a custodian to which the transfer should be directed.
- The client authorizes the investment advisor, in writing, either on the qualified custodian’s form or separately, to direct transfers to the third party either on a specified schedule or from time to time.
- The client’s qualified custodian performs appropriate verification of the instruction, such as a signature review or other method to verify the client’s authorization, and provides a transfer of funds notice to the client promptly after each transfer.
- The client has the ability to terminate or change the instruction to the client’s qualified custodian.
- The investment advisor has no authority or ability to designate or change the identity of the third party, the address, or any other information about the third party contained in the client’s instruction.
- The investment advisor maintains records showing that the third party is not a related party of the investment advisor or located at the same address as the investment advisor.
- The client’s qualified custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.”
However, it is important to note that the staff does also clarify that an RIA firm filing an annual updating amendment after October 1, 2017, “should include client assets that are subject to a SLOA that result in custody in its response to Item 9 of Form ADV.” Thus, while under specific circumstances the SEC staff is granting relief to firms complying with the surprise examination requirement, firms will still need to be mindful to ensure that all proper Form ADV disclosures are made.
In addition, on February 21, 2017, to coincide with the release of this no-action letter, the SEC staff also updated its Custody Rule FAQ page to include an updated response to Question II.4:
Q. Does an advisor have custody if it has authority to transfer client funds or securities between two or more of a client’s accounts maintained with the same qualified custodian or different qualified custodian?
A. Under Rule 206(4)-2(d)(2)(ii), an advisor has custody if it has the authority to withdraw client assets maintained with a qualified custodian upon the advisor’s instruction to the custodian. We do not interpret the authority to withdraw assets to include the limited authority to transfer a client’s assets between the client’s accounts maintained at one or more qualified custodians if the client has authorized the advisor in writing to make such transfers and a copy of that authorization is provided to the qualified custodians, specifying the client accounts maintained with qualified custodians. In the staff’s view, “specifying” would mean that the written authorization signed by the client and provided to the sending custodian states with particularity the name and account numbers on sending and receiving accounts (including the ABA routing number(s) or name(s) of the receiving custodian) such that the sending custodian has a record that the client has identified the accounts for which the transfer is being effected as belonging to the client. That authorization does not need to be provided to the receiving custodian. Moreover, in the staff’s view, an advisor’s authority to transfer client assets between the client’s accounts at the same qualified custodian or between affiliated qualified custodians that both have access to the sending and receiving account numbers and client account name (e.g., to make first-party journal entries) does not constitute custody and does not require further specification of client accounts in the authorization. (Modified February 21, 2017.)
As RIA compliance consultants, we recommend that all RIA firm principals and chief compliance officers review the latest SEC no-action letter and related Custody Rule FAQs. In general, it’s also important to remember that like all SEC no-action letters, the staff highlights that “This conclusion is based on all of the facts and representations set forth in your letter. You should note that any different facts or representations might require a different conclusion. Further, this response expresses our position only with respect to enforcement action, and does not express any legal conclusion on the issues presented.”
This is an evolving topic that we have previously discussed* and we expect this particular custody issue to continue to receive more focus in the coming months and years.
Here are additional IAA reference materials for RIA firms to review:
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