An investment adviser is deemed to have custody when it (or a related person) has possession of client funds or securities. Thus, an adviser has custody if it physically holds client stocks certificates, bonds or cash, even if on a temporary basis. Rule 206(4)-2 of the Investment Advisers Act prescribes requirements or safeguards for advisers that are deemed to have custody, including a requirement for a surprise annual verification of assets by an independent auditor.
As a registered representative of the firm, you must be vigilant to avoid actions and activities that would subject the firm to custody requirements, including without limitation, the annual surprise independent audit requirement which can be rather costly (typically up to $15,000 for an independent audit plus the cost of corporate staff support for such audit).
As a reminder, the custody rule can be triggered even inadvertently in the following situations:
- Acting as trustee for a trust (where the trust is a RIA client)
- Acting as personal representative for an estate (where the estate is a client)
- Having standing letters of authorization to make payments to third parties
- Having client login credentials
- Acting as general partner or managing member of a pooled investment vehicle (where RIA clients are invested)
- Having a client loan the adviser money (assuming the client is not in the business of making loans like a bank or mortgage lender)
- Going into business with an RIA client (i.e., purchasing real estate together and managing the property)
