For most registered investment advisers (RIAs), their annual update to Form ADV will be due on March 31, 2025.
We have received several questions about “custody” and peculiar situations where RIAs may inadvertently have “custody” of their client assets. Of course, many alternative asset managers who are RIAs do have “custody” of their funds' assets, but they can rely on exceptions within the Custody Rule under the Investment Advisers Act of 1940 (the Advisers Act) to many of the more strict requirements of the Custody Rule, such as the surprise audit requirement or the requirement that RIAs receive a special internal controls report from their accountant. However, many RIAs whose practice focuses on individuals and small businesses may inadvertently have custody.
The SEC Staff, in a 2017 no-action letter, said that “Standing Letters of Authorization” or “SLOAs” may cause RIAs to have “custody” of client funds or securities. SLOAs are commonly used throughout the RIA industry, and they permit clients to instruct their adviser to pay funds from a securities account to a designated third party. SLOAs, which can come in many names and forms, are normally limited instructions that are kept by the qualified custodian of the securities account.
However, the SEC staff concluded that an “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” and could (or “would”) constitute “custody” for purposes of the Advisers Act. Interestingly, in the one enforcement action related to SLOAs, the SEC alleged that the presence of an SLOA was only one of many facts that suggested custody and a violation of the Custody Rule. There, the SEC alleged that, in addition to having an SLOA, the RIA's principal had made herself a trustee of clients' trusts and a signatory on clients' personal banking accounts. The SEC did not allege that the presence of an SLOA alone was sufficient to constitute “custody” but that there were multiple factors. Additionally, anecdotal information suggests that the treatment of assets for which an RIA has an SLOA in place is not consistent among SEC examiners.
I can make reasonable arguments both ways as to whether an RIA has “custody" of client assets because of an SLOA. If the terms of an SLOA give an adviser no discretion over the payments, the adviser can do very little to affect the client's funds. Whether the RIA has “custody” for purposes of the Advisers Act may be a facts-and-circumstances call (everyone's favorite kind of call), as suggested by the SEC's prior enforcement action.
Regardless, the 2017 no-action letter provides that, if a RIA meets seven factors regarding their SLOAs, they do not have to comply with the surprise audit requirements of the Custody Rule. But, RIAs with client assets subject to an SLOA must report the assets as assets for which they have “custody” in Item 9.A. of the Form ADV Part IA.
