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The BD/IA Regulator

Providing securities regulatory, enforcement and litigation trends for broker-dealers, investment advisers and investment funds

SEC Grants Limited Relief from the Custody Rule for Advisers Relying on Clients’ Standing Letters of Instruction

Posted in Investment Adviser Regulation, SEC Enforcement

In a letter to the Investment Adviser Association (IAA), the Staff of the Division of Investment Management said that investment advisers acting pursuant to a standing letter of instruction or other similar asset transfer authorization (SLOA) established by a client with a qualified custodian would be deemed to have custody of client assets for purposes of Rule 206(4)-2 (the “Custody Rule”).  Nonetheless, the Staff said it would not recommend enforcement action if an adviser, acting pursuant to a SLOA, did not obtain a surprise examination of custody accounts under certain circumstances.  The no-action relief does not extend to investment advisers who are deemed to have custody of client assets because they have the ability to authorize payment of their own advisory fees.

The IAA argued that an adviser that exercises only limited authority pursuant to a SLOA should not be deemed to have custody of a client’s assets.

According to the IAA, many clients provide their registered investment adviser with a SLOA giving the adviser limited authority to disburse funds to one or more identified third parties.  Such clients also instruct the qualified custodian for their accounts to accept the investment adviser’s direction on the client’s behalf to move money only to the designated third party.  Because the qualified custodian takes that instruction in writing directly from a client, and the investment adviser’s authority is limited by the terms of the SLOA, the IAA argued that the investment adviser is merely acting as an agent for its client and should not be deemed to have constructive custody of client assets.

The Staff disagreed, stating that an investment adviser with the “power to dispose of client funds or securities for any purpose other than authorized trading has access to the client’s assets.”  The Staff said that an investment adviser that enters into a SLOA or similar asset transfer authorization with its client would therefore have custody of client assets and would be required to comply with the Custody Rule.

Notwithstanding this view, the Staff said that it would not recommend enforcement action to the SEC if an investment adviser operating pursuant to a SLOA does not obtain a surprise examination and the adviser complies with the following:

  1. The client must provide an instruction to the qualified custodian, in writing, that includes the client’s signature, the third party’s name, and either the third party’s address or the third party’s account number at a custodian to which the transfer should be directed.
  1. The client must authorize the investment adviser, in writing, either on the qualified custodian’s form or separately, to direct transfers to the third party either on a specified schedule or from time to time.
  1. The client’s qualified custodian must perform appropriate verification of the instruction, such as a signature review or other method to verify the client’s authorization, and must provide a transfer of funds notice to the client promptly after each transfer.
  1. The client must retain the ability to terminate or change the instruction to the qualified custodian.
  1. The investment adviser can have no authority or ability to designate or change the identity of the third party, the address, or any other information about the third party contained in the client’s instruction to the qualified custodian.
  1. The investment adviser must maintain records showing that the third party is not a related party of the investment adviser or located at the same address as the investment adviser.
  1. The client’s qualified custodian must send the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.

The Staff also said that, beginning with the next annual updating amendment after October 1, 2017, an investment adviser should include client assets that are subject to a SLOA that result in custody in its response to Item 9 of Form ADV.  For most investment advisers, this disclosure will be required for their annual filing in the first quarter of 2018.

Our Take.  Given continuing confusion about “constructive custody,” any clarity regarding the Custody Rule is welcome.  Moreover, giving clients the ability to instruct their advisers and qualified custodians to make regular transfers to identified third parties should be a welcome client service.  That said, implementation of the Staff’s instructions will take some time.  Qualified custodians must develop forms for client instructions, ensure that their systems are able to accommodate such instructions, and establish procedures for the required client notices.  Likewise, investment advisers will need to review their compliance policies and procedures and update their compliance manuals to implement the Staff’s instructions and to ensure that appropriate records are maintained.  What’s more, the Staff just gave most investment advisers one more thing to consider in connection with their next annual update to their Form ADV; previously announced amendments to Form ADV must also be implemented in filings made after October 1, 2017.

One Step Forward, Two Steps Back?

Posted in Broker-Dealer Regulation, Fund Regulation, Investment Adviser Regulation

Market participants who are not enamored by the current state of federal securities regulation may have been heartened by the new administration’s January 30, 2017 “two for one” order.  The order contemplated that, for each new rule issued by an executive department or agency, two regulations would need to be identified for elimination.

The order can be found at the following link: https://www.whitehouse.gov/the-press-office/2017/01/30/presidential-executive-order-reducing-regulation-and-controlling.

As usual, the devil is in the details.  How this principle might apply in the world of securities regulation is a bit unclear.  For example, if new broker-dealer regulations were proposed, would it make sense to, for example, eliminate Regulation S and Rule 144A?  After all, in some cases, securities regulation is beneficial to issuers and underwriters (and investors) because it removes or softens the restrictions that might otherwise be implied by the Securities Act of 1933.

However, these interesting questions were put to rest very quickly.  Subsequent guidance issued on February 2, 2017 clarified that independent agencies, such as the SEC, are not covered by the order.  (In addition, the original order does not cover “self-regulatory organizations,” such as FINRA.)

The interim guidance can be found at: https://www.whitehouse.gov/the-press-office/2017/02/02/interim-guidance-implementing-section-2-executive-order-january-30-2017.

Accordingly, while the market expects that the SEC will continue to consider costs and benefits of its regulatory proposals, the SEC will not be required to remove regulations in connection with any new proposals.

SEC 2017 Exam Priorities: Key Takeaways

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

Far from the White House and the halls of Congress, compliance officers are preparing their compliance plans for 2017. On everyone’s mind: What will the Trump administration’s commitment to deregulate mean for compliance priorities? The short answer is “not much,” at least for the near-future. To predict what’s in store for the immediate future, compliance officers need only to look at the Examination Priorities for 2017 of the National Exam Program (NEP) of the SEC’s Office of Compliance Inspections and Examinations (OCIE). Regulations may come and go, but OCIE will stay focused on these key areas, and OCIE’s examination efforts are likely to be insulated from the swirl of political and regulatory intrigue that surrounds them.

Read our article in Fund Operations.

The Future of Investment Management Regulation: What to Expect in 2017

Posted in Broker-Dealer Regulation, Fund Regulation, Investment Adviser Regulation

In this fast-changing regulatory environment, the long-term consequences – both intended and unintended – of the recent White House remain uncertain, but looking into our crystal ball, we certain trends emerging.  These trends may lead to long-term shifts in how the Securities and Exchange Commission approaches regulation and enforcement, but, at least in the short-term, we see little change in the oversight responsibilities of fund directors.

Of course, while nobody knows for sure what the future will bring, we’ve made our best guess.

Read our client alert.

ALI CLE Webinar: SEC in 2017 – What’s Next? SEC Veterans Weigh In

Posted in Enforcement, Events

Thursday, March 9, 2017
12:30 p.m. – 2:00 p.m. EST

As the Trump Administration takes charge in 2017, the only thing that seems inevitable is that the regulatory and enforcement outlook will change. Initial indications point to a desire to relax or repeal certain regulations that may be regarded as burdensome to public companies. Also, proposed legislation would relax certain corporate governance and compensation-related measures that formed part of the Dodd-Frank Act. Proposed legislation also would address the types of cost-benefit analysis that would be required to support proposed regulation.

Don’t miss this chance to learn SEC regulations’ status and how they will likely change from experts who have been directly involved in rule-making and implementation of U.S. securities laws.

Topics to be discussed include:

  • Rules that were proposed but not adopted by the SEC as part of the Dodd-Frank Act rule-making mandate;
  • What to expect as far as corporate governance and executive compensation requirements;
  • Final rules adopted pursuant to the Dodd-Frank Act mandate relating to extractive minerals and specialized disclosures;
  • Future of the Disclosure Effectiveness initiative;
  • Likely status of the rules proposed by the SEC and not yet adopted;
  • Proposed changes affecting investment companies and their likely status; and
  • Anticipated enforcement areas of focus.


  • Andrew J. “Buddy” Donohue
    Former Chief of Staff, Director of Enforcement, and Director of Investment Management, SEC
  • Roberta Karmel
    Centennial Professor of Law, Brooklyn Law School,
    former SEC Commissioner
  • Troy Paredes
    Paredes Strategies LLC, former SEC Commissioner
  • Anna Pinedo
    Partner, Morrison & Foerster LLP

For more information, or to register, please click here.

Please contact cmg-events@mofo.com for a promotional code for discounted $99 tuition.

OCIE Identifies Top Five Adviser Compliance Issues

Posted in Investment Adviser Regulation

In a new Risk Alert, OCIE’s National Exam Program provided investment advisers with insight into the five compliance topics most frequently identified in its exam deficiency letters.  Registered investment advisers should review their compliance policies and procedures to ensure they have adequately addressed these issues.

OCIE also provided examples of the types of deficiencies they see within each compliance topic.

Compliance Rule.  OCIE continues to find deficiencies in compliance programs adopted and implemented by registered investment advisers as required by Rule 206(4)-7.

  • According to OCIE, advisers continue to use “off-the-shelf” compliance manuals without adequately tailoring their compliance programs to the types of clients and strategies that they manage.
  • OCIE also raised concerns that some advisers are not conducting annual reviews of their compliance programs, as required by Rule 206(4)-7. Moreover, even when reviews are conducted, OCIE is concerned that such reviews do not address the effectiveness of a compliance program or address identified issues.
  • OCIE underscored that the Rule requires advisers not only to adopt compliance policies but also to implement them. Advisers should be able to document that they follow their procedures.
  • Finally, OCIE raised concerns that some advisers are not maintaining their compliance policies and procedures as their businesses change.

Regulatory Filings.  OCIE said that it has found deficiencies related to advisers’ complying with their regulatory filing obligations.  In particular, OCIE raised concerns about filings on Form ADV, Form PF, and Form D.

  • OCIE called out inaccurate disclosures in Form ADV Part 1A and Part 2A, including inaccuracies related to whether an adviser has custody of client assets, calculation of regulatory assets under management, disciplinary history and conflicts of interest.
  • OCIE also said that it continues to identify advisers that fail to promptly update Form ADV as required by the Form, or to timely file their annual amendment.
  • OCIE is concerned that advisers that have an obligation to file Form PF or Form D are not completing such forms accurately.

Custody Rule.  In addition to the concerns raised regarding disclosure about custody of client assets, OCIE separately voiced a concern that advisers continue to misinterpret the custody rule.

  • OCIE said that advisers continue to fail to recognize when they have custody of client assets. In particular, this can arise when an adviser has online access to client accounts or a power of attorney that gives the adviser the ability to withdraw client funds or securities.  This includes the use of a client’s personal username and password.
  • Moreover, OCIE said, advisers with custody of client assets are failing to provide independent accountants charged with conducting surprise examinations with a full list of accounts over which an adviser has custody. As a result, accountants may not be able to timely file accurate Forms ADV-E.  OCIE also questioned whether surprise audits were actually conducted on a “surprise” basis.

Code of Ethics.  OCIE raised several concerns about advisers’ compliance with the requirement to adopt and maintain a code of ethics.

  • OCIE said that advisers are not identifying all of their access persons for purposes of reviewing personal securities transactions. In addition, according to OCIE, certain codes of ethics fail to specify review of such access persons’ personal securities holdings reports and transaction reports.
  • OCIE noted that some access persons were submitting transaction and holdings reports less frequently than required by Rule 204A-1.
  • OCIE reminded advisers that Part 2A of Form ADV requires advisers to describe their code of ethics and to offer to make a copy of the code of ethics available to clients or prospective clients on request.

Books and Records.  Recordkeeping errors are a perennial favorite of the examination staff, and OCIE said that advisers continue to demonstrate recordkeeping weaknesses.

  • Some advisers failed to maintain all books and records required by the Advisers Act and its related regulations.
  • Moreover, some required records may not be accurate or updated. Among other things, this includes the failure to update fee schedules in client accounts and having stale client lists.
  • OCIE also raised concerns that some advisers have contradictory information in separate sets of records.

Our Take.  OCIE provided investment advisers with trends related to the types of compliance issues the examination staff is seeing with regularity.  In general, once OCIE staff have admonished advisers of potential violations, they are less likely to simply identify these types of errors as deficiencies and may move more quickly to recommend enforcement.  That is, advisers have been forewarned.  Failure to take a look at compliance policies and procedures to ensure that they do not include these types of errors and omissions is more likely to result in enforcement after such a warning.

President Trump Directs DOL to Review the Fiduciary Rule and Consider Modifications or Revocation

Posted in Broker-Dealer Regulation, Investment Adviser Regulation

On February 3, 2017, President Trump directed the Department of Labor (“DOL”) to review the fiduciary rule adopted in April 2016 (the “Fiduciary Duty Rule”) and consider whether the Fiduciary Duty Rule should be modified or rescinded.  The President’s order instructed the DOL to consider whether the Fiduciary Duty Rule would:

  • Harm investors’ access to financial advice and certain retirement products;
  • Disrupt the retirement services industry in a manner that would adversely affect investors; and
  • Cause an increase in litigation or the prices investors would pay to gain access to retirement services.

If, after completing this review, the DOL concludes that it would adversely affect investors, then it is directed to publish for notice and comment a rule rescinding or revising the Fiduciary Duty Rule.

The focus of the analysis set forth in the President’s order, as well as a number of statements made by senior Administration officials, suggests that, after completing its review, the DOL will propose revocation or major changes to the Fiduciary Duty Rule.  Because the Fiduciary Duty Rule is already effective, any changes by the DOL must be made in compliance with the Administrative Procedure Act (“APA”).

The President did not direct the DOL to delay the April 10, 2017 implementation date of the Fiduciary Duty Rule.  However, a delay seems likely in order to enable the DOL to complete the analysis ordered by the President, as well as to provide time for the DOL to proceed with rulemaking to rescind or amend the Fiduciary Duty Rule should it conclude that such action would be appropriate.  We assume that the DOL will seek to delay the implementation date by invoking the “good cause” exception in the APA, which permits agencies for “good cause” to act without going through the full notice and comment process otherwise applicable under the APA.   “Good cause” is not defined, and invocation of “good cause” by the DOL could be subject to judicial challenge.   While the outcome of any legal challenge cannot be predicted, it may be more difficult to challenge a “good cause” determination that delays implementation of a rule, as compared to challenging a “good cause” determination that is used to bypass APA procedures for adoption of a new rule.

Assuming the implementation date is successfully delayed, the future of the Fiduciary Duty Rule may not be clear until the latter part of 2017 at the earliest. Irrespective of actions by the DOL, many firms may choose to continue with their plans to adopt a fiduciary standard that would require them to act in the best interest of their customers.