Reminder: Amendments to Investment Adviser Custody Rule
September 28, 2010
Candace Vaughn — Senior Manager, Assurance and Advisory Services
Rule 206(4)-2(a) of the Investment Advisers Act of 1940 (the “Act”) sets forth the requirements for an investment adviser to maintain clients’ funds and securities as a qualified custodian. On March 12, 2010, certain amendments to Rules 206(4)-2 and 204-2 of the Act (the “Amendments”), and Forms ADV and ADV-E went into effect, which will change how these investment advisers are monitored.
The Amended Rules
Under the amended rules, a registered investment adviser acting as custodian of clients’ assets, must contract with an independent public accountant to verify the existence of such assets. These contract services should include the following:
- Client funds and securities of which an investment adviser has custody are subject to an annual surprise examination by an independent public accountant to verify the existence of the assets, pursuant to a written agreement between the investment adviser and the accountant. The first examination must take place by December 31, 2010.
- The accountant must have a reasonable basis for believing that the qualified custodian sends account statements directly to the advisory clients at least quarterly.
- If client assets are maintained by the investment adviser itself or a related person to the investment adviser, it must obtain or receive from its related person an annual report on the internal controls relating to custody of those assets (known as a “SAS 70 Auditor’s Report”). The report must come from an independent public accountant that is registered with the Public Company Accounting Oversight Board (PCAOB). An investment adviser must obtain or receive such a report within six months of the effective date.
The Audit Provision Exception
For Hedge Funds, Private Equity Funds, and Fund of Funds, an investment adviser may rely upon the audit provision exception and is therefore not required to obtain a surprise examination if it obtains an audit of the pooled investment vehicle(s) financial statements for fiscal years beginning on or after January 1, 2010.
For an investment adviser to rely upon the audit provision exception, all of the following criteria must be met:
- The Auditor’s Report must be unqualified.
- The basis of accounting used for the financial statements is required to be U.S. Generally Accepted Accounting Principles.
- The audit is required to be performed in accordance with U.S. Generally Accepted Auditing Standards.
- The audit firm must be registered with, and subject to regular inspection by, the PCAOB and maintain SEC level independence.
- The audited financial statements must be distributed to investors within 120 days of year-end (180 days for fund of funds).
If you have questions about these amendments and their requirements, please contact Candance Vaughn for assistance or additional information.
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