Advisors now must turn to banks, brokerages or other third-party custodians for safe storage of clients' stocks and mutual fund investments, but not necessarily with cryptocurrency, real estate, derivatives and other assets.
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The SEC voted 4-1 in a Feb. 15 virtual meeting to advance a proposal that would place registered investment advisors under greater obligations to make sure assets they are managing for clients are held with third-party banks, broker-dealers, trust companies or other custodians that have met certain investor-protection standards. The SEC's custody rule, added to the Investment Advisers Act in 1962, was last amended in
The rule seeks to deter schemes like Madoff's by placing third-party asset custodians in a position to detect any dodgy trading advisors might be carrying out. Custodians are now subject to surprise annual audits by public accountants to make sure they are living up to their obligations.
SEC Chairman Gary Gensler said at the agency's virtual meeting that the latest push to revise the custody rule is being driven by technological changes and other industry developments that have occurred since 2009. Gensler acknowledged that most people's first thought in this context is of cryptocurrencies and other digital assets.
But Gensler said there has also been a rise in the number of people putting money into private securities, real estate, derivatives and other so-called alternative assets. He and his fellow commissioners said they want to make sure that clients who turn to advisors for help
Dan Danford, an RIA and founder of the Family Investment Center in Kansas City, Missouri, said custodians provide the basic protection of making sure investor money isn't commingled with other accounts and used for purposes clients never intended.
"But with alternative investments, you don't have those same assurances," said Danford, who's also chairman of the National Association of Personal Financial Advisor's public policy committee. "The assets themselves may have a high degree of risk. But if they're not being held properly and the company that's holding them encounters an issue, you could lose money even if the security itself is OK."
Max Schatzow, a founder and partner at New York-based RIA Lawyers, said the SEC's proposal nonetheless threatens to complicate advisors' lives. One of its requirements would have planners enter into elaborate written agreements with any custodians they use for holding clients' assets. Among other things, the pacts would pledge the custodian to provide records on investor assets on request and would spell out how much authority advisors have over those assets.
Advisors would also have to obtain assurances that clients won't be deemed liable for any negligence by the custodian. And they'd have to make sure investor assets would be protected against creditors should the custodian go bankrupt.
Schatzow said these requirements are likely to fall most heavily on small advisors who aren't in a position to start telling large institutions how they should be handling investor accounts.
"I suspect many custodians aren't going to want to agree to these things," he said. "Either it's more work for them or they are going to hire people to perform these tasks."
Gail Bernstein, general counsel for the Investment Adviser Association — a group with more than 600 member advisory firms — said all wide-reaching regulatory changes tend to place a heavy compliance burden on small players in the industry.
"Whether a firm has five people or 52 people, by any rational measure, they are a small business," Bernstein said. "And they don't always have the personnel just to step in and implement all this new stuff, especially when you layer this proposal on top of
Bernstein noted that industry groups and other interested parties will have only 60 days to submit
"That's a pretty short runway," she said.
Bernstein said she and other Investment Adviser Association agree that the SEC's priority should be safeguarding investors' assets but they need more time to study the proposed amendment to decide if they can support it.
If the proposal were adopted following the 60-day comment period, advisors with $1 billion or less of assets under management would have 18 months for compliance. Firms with more AUM would have only a year. The SEC estimates that 10,454 advisors, or nearly 70% of all registered advisers in the U.S., would come under the 18-month deadline.
Schatzow said another big change would be to discretionary trading, which occurs when advisors have clients' permission to make purchases or sales without having to get permission for each individual transaction. The SEC's proposal would subject investments approved for discretionary trading to the same custody requirements as all other assets.
Schatzow said many advisors have their clients' permission to unilaterally make changes in investments in a retirement like a 401(k) in response to changing market conditions. Such accounts are now often held with third parties.
"But a lot of times, you won't have a very close relationship with these custodians," Schatzow said.
Under the SEC's proposed rule, advisors who wanted to continue discretionary trading would have to get these little-known third-party holders of investor money to agree to a heap of new requirements.
"How are they going to go about getting that custodian to sign these new written agreements?" Schatzow said. "I think it's going to damage that line of business."
Advisors would also have to keep more explicit records of any trades or other transactions they've engaged in and include some of that information in the Form ADVs they submit as part of their annual registrations with the SEC. The amendment would also forbid advisors to use foreign banks and other entities that act as custodians unless they've conformed with U.S. anti-money laundering policies and taken steps to protect client assets from bankruptcies.
Commissioner Mark Uyeda, who ultimately supported the amendment despite having objections, wondered how the proposed changes would interact with other rules now before the SEC.
Of particular concern, Uyeda said, is a so-called
"Given the plethora of rules being proposed, at a minimum it appears that little thought has been given to how one change interacts with another," Uyeda said.
Concerns have also arisen that the proposal's effects on the cryptocurrency industry could undermine the business of digital asset custodians like
"Make no mistake: Based upon how crypto platforms generally operate, investment advisors cannot rely on them as qualified custodians," Gensler said in a statement about the proposed amendments.
At the SEC meeting, though, Gensler repeated his position that many existing cryptocurrencies and other digital assets are technically securities. That means, he said, that any advisors who are dealing in them on the behalf of clients should already be storing them with qualified custodians.
Separately, the SEC voted 3 to 2 to adopt a rule to give broker-dealers one day to complete stock sales and purchases and other transactions from the day of the trade. That would be down from the current two days. The so-called "T+1" proposal is meant to protect investors by, say, preventing stock sellers from backing out of deals should their shares rise in value after they've agreed to sell them.
The rule comes in response to the popular online brokerage Robinhood's decision on Jan. 28, 2021 to restrict trading in shares of the video game store
Although the SEC's "T+1" rule will mainly apply to brokerages, it will also require advisors to keep extensive records of every stock transaction they've made on the behalf of clients. The rule is scheduled to take effect on May 28, 2024.
