Synopsis: On December 30, 2009, the SEC issued final amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 relating to the custody of client funds and securities by registered investment advisers, many of which became effective as of March 12, 2010 (see "Status" below). The most significant requirements relating to the new Rule are as follows:
(a) Advisers must undergo a mandatory annual surprise examination by an independent public accountant to verify client assets. Exceptions are provided for: (i) investment advisers to pooled investment vehicles subject to an annual audit by an independent public accountant that is registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board (the "PCAOB"), provided that the audited financial statements are delivered to the vehicle's investors within the specified time frame (180 days after fiscal year end for fund of funds; 120 days for other pooled investment vehicles); (ii) investment advisers that have custody solely because of their authority to deduct advisory fees from client accounts; and (iii) investment advisers that have custody solely as a result of "related persons" holding client assets, provided that such investment advisers are "operationally independent" from such related persons). (Note that investment advisers to pooled investment vehicles must still obtain a surprise examination for any non-pooled investment vehicle assets unless a separate exemption from such requirement applies.)
(b) With the exception of investment advisers to pooled investment vehicles subject to an annual audit by a PCAOB registered independent public accountant, investment advisers must have a reasonable belief, formed after "due inquiry," that account statements are sent by a qualified custodian directly to advisory clients.
(c) Where an adviser, or a related person of an adviser, maintains client funds and securities as a qualified custodian, in addition to the requirement that the annual surprise examination be conducted by a PCAOB registered public accountant, the investment adviser must also obtain an internal control report from a PCAOB registered independent public accountant assessing the quality of the adviser's (or related person's) custody controls.
On March 5, 2010, the SEC issued new FAQs to clarify several of the new requirements under the Rule, including the definition of "custody," the surprise examination process, the timing and standards to be used for audits of pooled investment vehicles, and responsibilities of introducing brokers and transfer agents. The FAQs can be found here. The Lowenstein Sandler Investment Management Group Client Alert analyzing the final rule is available here.
Status: The general compliance date for the final Rule was March 12, 2010. Advisers required to obtain a surprise examination must enter into a written agreement with an independent public accountant that provides that the first examination will take place by December 31, 2010. Advisers required to obtain an internal control report must obtain the report within six months of becoming subject to the requirement. The final Rule also revises Form ADV, effective for annual amendments to Form ADV after January 1, 2011. The final Rule is available here.