SEC Proposes New Safeguarding Rule for Investment Advisers

Who may be interested: Investment Advisers. 

Quick Take: The SEC recently proposed rule changes that would amend and redesignate Rule 206(4)-2 under the Advisers Act (the “Current Custody Rule”) and amend certain recordkeeping and reporting requirements. The proposals would significantly expand the scope of the Current Custody Rule and add a number of new requirements for investment advisers and qualified custodians to enhance protections of client assets and ensure certain standard custodial protections. 

The SEC proposed a new rule which would amend and redesignate the Current Custody Rule as new Rule 223-1 under the Advisers Act (the “Safeguarding Rule”). The Safeguarding Rule would significantly broaden the scope and requirements of the Current Custody Rule beyond client funds and securities to include all client “assets” – including funds, securities, or other positions held in a client’s account (such as crypto assets) – in an investment adviser’s possession. The Safeguarding Rule would also revise the definition of “custody” to explicitly include any assets over which an adviser exercises discretionary trading authority. 

The Safeguarding Rule would retain, with modifications, the current requirement that an investment adviser with custody of client assets be subject to surprise examination by an independent public accountant to verify client assets. Investment advisers would be exempt from the surprise audit requirement when the sole basis for their having custody is due to discretionary trading authority to instruct a qualified custodian to transact in assets which settle on a delivery versus payment basis.   

The Safeguarding Rule would require investment advisers with custody of client assets to maintain such assets with a qualified custodian with limited exceptions, as is the case with the Current Custody Rule. If adopted as proposed, the Safeguarding Rule would also enhance custodial protections that client assets receive through new requirements for entities to be eligible as qualified custodians. For example, investment advisers would be required to contract directly with qualified custodians and obtain certain reasonable assurances, including with respect to proper segregation of client assets from the qualified custodian’s proprietary assets and liabilities.  In addition, the Safeguarding Rule would, among other things, and modify the Current Custody Rule’s exception from the obligation to maintain client assets with a qualified custodian for some privately offered securities, including expanding the exception to include certain physical assets

In addition to the above, the SEC proposed complementary amendments to the Advisers Act books and records rule and Form ADV to align reporting with the proposed Safeguarding Rule.

The SEC’s proposal is available here.