5.14.2009 The SEC proposed rule amendments to increase protections for investors who entrust money to investment advisers. Spurred by recent enforcement actions where firms and principals have been charged with misusing clients’ money and covering up their illicit activities by distributing false account statements showing non-existent funds, the proposed safeguards promote independent custody and enable independent public accountants to act as third-party monitors. Included in the proposed amendments are a yearly “surprise exam” performed by an independent public accountant and, when an adviser or an affiliate directly holds client assets, a custody control review would have to be conducted by a PCAOB-registered and inspected accountant. The proposed measures also include reporting requirements.
Click http://www.sec.gov/rules/proposed/2009/ia-2876.pdf to access the proposing release.
Click http://www.sutherland.com/files/News/7f5141fd-fc3f-4e80-8d79-f27d9773fb7f/Presentation/NewsAttachment/b431e6e5-1a99-4330-bc72-4b892c223f68/FINSERVAlert5.27.09.pdf to access a Sutherland legal alert about the rule proposal.
At the SEC Open Meeting, SEC Chairman Mary L. Schapiro and Commissioners Kathleen L. Casey and Troy A. Paredes remarked on the proposal to amend Rule 206(4)-2—the rule designed to address concerns about the custodial practices of advisers and the safety of client assets.
Chairman Schapiro opened the meeting by sharing that approximately 9,600 SEC-registered investment advisers have custody of client assets, in one form or another, which means that they either physically control the assets directly or through an affiliate or have the authority to withdraw their clients’ funds. The Chairman advocated the proposal as seeking to: (1) protect investors by promoting independent custody; (2) enhance reliance on independent public accountants, including those that are PCAOB-registered and inspected, as a third-party check on custody controls and client assets; and (3) effectively require that client assets be maintained with a qualified custodian that is independent of the adviser and require a PCAOB-registered and inspected public accountant to perform an annual custody control examination. The Chairman touted the proposal as being aimed to address the “shortfalls of the current custody control regulations highlighted by the [Bernard] Madoff case, as well as the series of recent allegations involving frauds that relate to Ponzi schemes and misappropriation of client assets” and, at the same time, “to decrease the likelihood that an investment adviser could misappropriate client assets and go undetected—because an independent public accountant will be looking over their shoulder on at least an annual basis.”
Click http://www.sec.gov/news/speech/2009/spch051409mls.htm to access Chairman Schapiro’s full remarks.
Commissioner Kathleen L. Casey noted that due to significant declines that have led to the implosion of a number of Ponzi schemes and revelations of other kinds of misconduct, a logical area for the SEC to focus on is whether the rule is operating effectively or could be strengthened and improved. Because the proposal makes certain significant departures from the judgments made in 2003 about the efficacy and operation of the custody rule, the Commissioner addressed whether the proposal makes the right recommendations to improve custodial practices. The Commissioner stated that she believes the 2003 rule is a good one for those law-abiding, regulation-observing entities and the SEC should, therefore, “improve the rule by way of surgery instead of wholesale reengineering.” The Commissioner next addressed the proposed scope of the rule, the cost-benefit analysis that should be done, and the impact of the proposed amendments on legitimate small and mid-sized firms.
Click http://www.sec.gov/news/speech/2009/spch051409klc.htm to access Commissioner Casey’s full remarks.
Commissioner Troy A. Paredes agreed with Commissioner Casey that safeguarding client assets is a critical function of investment advisers and that investors must feel safe knowing that the funds and securities they own on paper exist in reality. Commissioner Paredes stated that he supports the proposal and it goes to great lengths to ensure that client assets are safeguarded through measures such as surprise examinations and internal control reports. Despite the Commissioner’s support, he raised several questions about the proposal: “(1) whether the surprise examination requirement should cover investment advisers with an independent qualified custodian or be targeted to instances where the investment adviser or a related person is the qualified custodian, given that non-affiliated custodians already serve as an important safeguard of client assets; (2) whether the rules should cover investment advisers who have custody only because they withdraw fees from client accounts; (3) the extent to which the new requirements could adversely impact competition if they are disproportionately costly and burdensome for smaller entities; and (4) the extent to which the new rules could foster moral hazard by promoting an undue sense of security that dissuades investors from doing their own diligence. It is worth considering the circumstances under which active investor diligence may do more to deter and detect misconduct than certain regulatory demands.”
Click http://www.sec.gov/news/speech/2009/spch051409tap.htm to access Commissioner Paredes’ full remarks.