THE CUSTODY RULE
As summarized in a previous Flash, the SEC published a ‘no-action’ letter in February 2017, stating that custody requirements can be triggered under certain circumstances when an adviser participates in first-party and third-party asset movement. If triggered, advisers must either comply with the custody rule and undergo an annual surprise examination or meet the exemption discussed below. In order to avoid custody requirements, advisers should be aware of what constitutes first-party and third-party movement, as well as how to avoid triggering custody under the Custody Rule.
FIRST-PARTY MONEY MOVEMENT
First-party money movement authority is considered an ongoing authority granted by the client to their adviser allowing the adviser to perform the following activities:
- Move money between the client’s accounts at a single financial institution;
- Issue checks payable to the account holder directly or mailed to their address of record; and
- Wire money between the client’s accounts at different financial institutions.
First-party money movement triggers custody if conducted through a money wire. However, advisers can avoid triggering custody and subsequent annual surprise examinations with a signed authorization form. The client must complete the authorization form, including the title and details of the destination account information, and provide a signed copy of the completed form to the sending custodian.
THIRD-PARTY MONEY MOVEMENT
Third-party money movement authority is usually triggered through a standing letter of authorization (“SLOA”) or any other related asset transfer authorization which permits advisers to transfer funds on behalf of their clients to third parties. Once the adviser is authorized, it can then conduct the following disbursements periodically or at a scheduled time, upon request:
- Move money from the client’s accounts to a third party’s account at a single financial institution;
- Issue checks or journals payable to a third party; and
- Wire money from a client’s account at the holding custodian to a third party’s account at a different financial institution.
The SEC announced in its ‘no-action’ letter that under the Custody Rule, SLOAs and similar asset transfer authorizations qualify as custody. However, registered investment advisers will be exempt from the annual surprise examination requirement if the involved parties abide by the following (7) conditions:
- The client provides written instruction to the qualified custodian with their signature, the third party’s name, and either the third party’s address or account number at the custodian where the transfer should be directed;
- The client provides written authorization to the investment adviser directing transfers to the third party either periodically or as scheduled;
- The qualified custodian performs adequate verification of the instruction and provides a transfer of funds notice to the client in a timely manner;
- The client can terminate or adjust the instruction to their qualified custodian;
- The investment adviser is unable to change any information about the client designated third party;
- The investment adviser maintains records verifying that the third party is neither a related party of the investment adviser nor do they share the same address; and
- The qualified custodian provides a written initial and annual notice confirming the instruction.
Custodians will need to help advisers comply with the SEC’s seven conditions. For example, Charles Schwab has announced that it will meet six of the conditions (1-5 and 7), as confirmed on advisercenter.com. Advisers should work with their custodians to verify if they will meet any of the conditions.
WHAT DOES THIS MEAN FOR ME?
Advisers are encouraged to review their role in all client accounts and identify whether they are authorized to conduct either first-party or third-party money movement. If any form of an asset transfer authorization letter has been provided by the client, then advisers should ensure that it captures detailed destination account information.
If the letter authorizes the adviser to conduct third-party money movement, then the adviser must be prepared to meet the Custody Rule requirements or the seven conditions set forth by the SEC.
Advisers who wish to avoid having custody over client accounts will have until January 30, 2018, to complete the blanket removal of authorizations granting them custody. Fairview® will continue to provide updates on the Custody Rule as more information is made available.