In a recent IM Guidance Update, the SEC’s Division of Investment Management said that it would not object if registered investment advisers to certain private funds do not maintain “private stock certificates” with a qualified custodian under certain circumstances.

The Guidance Update responds to inquiries about whether Rule 206(4)- 2 under the Investment Advisers Act (the “Custody Rule”) requires registered advisers to audited private funds to maintain privately issued, non-transferable stock certificates with a qualified custodian. The staff said that, although private stock certificates do not technically meet the definition of “privately offered securities” in the Custody Rule, they are similar in all material respects. Moreover, the staff said that maintaining private stock certificates at a qualified custodian does not provide additional protection to fund investors, because auditors perform substantive procedures to verify fund investments (including privately issued securities) regardless of whether the private stock certificates are held at a qualified custodian.

Under the new guidance, registered investment advisers to private funds will no longer be required to custody private stock certificates with a qualified custodian if:

  • the client is a pooled investment vehicle that is subject to an annual audit as set forth in Rule 206(4)- 2(b)(4);
  • the private stock certificate can only be used to effect a transfer, or to otherwise facilitate a change in beneficial ownership, of the security with the prior consent of the issuer or holders of the outstanding securities of the issuer;
  • ownership of the security is recorded on the books of the issuer or its transfer agent in the name of the client;
  • the private stock certificate contains a legend restricting transfer; and
  • the private stock certificate is appropriately safeguarded by the RIA and can be replaced upon loss or destruction.