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The concept of “custody” under Rule 206(4)-2 of the Investment Advisers Act of 1940 refers to an adviser’s ability to access or control client funds or securities. Rule 206(4)-2 (the “Custody Rule”) is designed to protect investors through the safeguarding of client assets from loss or misuse. As audit season approaches, it is important for registered investment advisers to revisit the SEC’s Custody Rule and your Firm’s approach to compliance with the Rule to ensure your obligations under the Rule are met.     Overview of the Custody Rule  The Custody Rule requires Registered Investment Advisers (“RIAs”), or those required to be registered with the commission, who have custody of client funds or securities to safeguard those assets appropriately. Custody includes physical possession of assets and authority to access client funds through methods such as fee deduction or an affiliated entity serving as a general partner to a private fund.   Under the Custody Rule, RIAs deemed to have custody are required to: 
  • Maintain client assets with a qualified custodian; 
  • Provide written notification to the client identifying the custodian;  
  • Ensure clients receive quarterly account statements directly from the qualified custodian; and 
  • Undergo an annual surprise examination by an independent public accountant, unless an exception applies
The Audit Exception for Private Fund Advisers  Private fund advisers may rely on the “audit exception” if each fund: 
  • Is audited annually (including upon liquidation); 
  • The audit is completed by a PCAOB-registered and examined independent public accountant; 
  • The audited financial statements are prepared in accordance with U.S. GAAP requirements; and 
  • The audited financials are distributed to investors within the required time frame under the Rule 
  • Generally, 120 days after year end; or  
  • 180 days after year end for fund-of-funds 
Choosing the Right Auditor  Selecting a PCAOB-registered auditor experienced in the investment advisory and private fund space is an important factor in complying with the Custody Rule. Auditors unfamiliar with the Custody Rule’s nuances may overlook key entities or reporting obligations.     SEC Focus   The SEC has continued to prioritize Custody Rule compliance, private fund advisers’ reliance on the audit exception, timeliness of delivery of completed audits, and the accuracy of Form ADV disclosures relating to completed audits. Additionally, examiners have emphasized that advisers must not only meet the Rule’s requirements but also follow their own policies and procedures with respect to compliance with the Rule.     Staying Compliant this Audit Season  As you engage auditors and prepare your year-end reports, consider: 
  • Finalizing engagement letters early;  
  • Clarifying audit timelines that support the delivery window relevant to your funds; and  
  • Reviewing your policies and procedures for how you meet Custody Rule obligations.