California’s Commissioner of Business Oversight (the “Commissioner”) recently issued new rules and regulations affecting investment advisers and broker dealers licensed by the California Department of Business Oversight (the “DBO”), formerly the California Department of Corporations.
Amendments to the Investment Adviser Custody Rule
On January 9, 2014, the Commissioner adopted amendments to the state’s custody rule, Section of Title 10 of the California Code of Regulations.1 The new rule incorporates provisions from Rule 206(4)-2, promulgated by the Securities and Exchange Commission under the Investment Advisers Act of 1940, and the North American Securities Administrators Association Model Rule.
Subject to certain limitations, the California amendments require advisers with custody of client assets to maintain those assets with a qualified custodian. The new rule also specifies that certain audits and independent reviews must be conducted by accountants registered with the Public Company Accounting Oversight Board. In addition, the rule requires advisers that are licensed or required to be licensed in California to:
- Notify the Commissioner on Form ADV that the adviser “has or may have” custody of client assets;
- Notify clients of the identity and location of the qualified custodian;
- Have a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each client for which it maintains funds or securities, identifying the amount of funds and of each security in the account at the end of the period and stating all transactions in the account during the period, including adviser fees; and
- Retain an independent certified public accountant to conduct a surprise examination of client assets.
Exceptions to the custody rule are provided for advisers that (i) only have custody of certain privately held securities, (ii) have custody solely because they directly deduct advisory fees from client accounts, or (iii) advise limited partnerships subject to an annual audit.
The amended custody rule becomes effective on April 1, 2014.
Order Regarding Electronic Communications
In an order issued on November 22, 2013 (the “Order”),2 the Commissioner set forth new electronic communications requirements for licensees of the DBO. The Order applies to financial services providers licensed or required to be licensed in California, including investment advisers and broker dealers. The Order requires a licensee to (i) establish an email address within its corporate email system for receiving communications from the DBO, and (ii) provide for daily monitoring of the email address by the licensee’s executive staff. The email address must be a generic, dedicated address (e.g., firstname.lastname@example.org) and have the capacity to receive email attachments.
The DBO set a compliance date of January 4, 2014.