There has been a level of uncertainty for Registered Investment Advisors (“RIA”) over the past year in regards to the SEC’s position on Rule 206(4)-2 (“Custody Rule”) (see the AdvisorAssist blog post on Custody for additional information) and how it applies to standing letters of authorization (“SLOA”) for a client at a qualified custodian (“Custodian”). It has been a common business practice for RIAs and clients to establish a SLOA at the Custodian which authorizes the RIA to instruct the Custodian to disburse client funds to a third party account or payee. Generally speaking, the intent of this practice is to minimize the administrative steps for RIAs to service the money movement requests of their clients. However, there has been much confusion by both RIAs and examiners as to which SLOA scenarios constitute custody of client funds and trigger the Custody Rule requirements for the RIA.
On February 21, 2017, the SEC provided clarity to this question through a no-action letter. The SEC confirmed their stance that the business practice of using SLOAs as instructions for payments to third parties fall under the definition of custody. Thereby requiring RIAs to disclose that they have custody of client funds. However, the SEC also provided some relief for RIAs as it relates to the independent surprise examination requirement of the Custody Rule.
The SEC advised that they would not seek enforcement action against RIAs who do not obtain a surprise examination as long as the RIA follow the below guidelines:
CCO Best Practices
To ensure that you are properly dealing with custody issues AdvisorAssist recommends the best practices of:
RIAs have until October 1, 2017 to comply with the above described actions. Also, there will be a new requirement for RIAs to state client assets that are subject to a SLOA on their ADV1, Item 9.