CFP Board Recommends Changes to SEC Custody Rule Proposal
Additionally, CFP Board agreed that the SEC’s internal control report proposal should provide sufficient protection of client assets where use of an independent qualified custodian is not feasible.
One of the SEC’s proposed amendments to the custody rule, Rule 206(4)-2 under the Investment Advisers Act of 1940, would require all registered investment advisers with “custody” of client funds and securities to engage an independent public accountant to conduct an annual surprise examination to verify those client assets. Under the proposed amendments, “custody” would continue to include arrangements in which a registered adviser is authorized to withdraw client funds or securities held by a custodian upon the adviser’s instruction to the custodian. In commenting on the proposed amendments, CFP Board suggested that minor modifications to the proposed amendment would provide the consumer safeguards against the misuse of clients’ assets that the SEC is seeking.
CFP Board noted in its comment letter to the SEC that many of the nearly 60,000 financial planners who hold the CERTIFIED FINANCIAL PLANNER™ certification are individual investment advisers who use independent qualified custodians to hold those client assets and who do not have custody of the assets, other than to withdraw their fees from those assets.
“Our experience in overseeing such advisers as CFP® certificants has shown that they do not pose a risk of misappropriating client assets,” CFP Board wrote. “This is not surprising given the safeguards that are in place to protect client assets managed by them. First, client assets are held by independent qualified custodians rather than by the adviser or a related person. Second, the adviser is only authorized to withdraw his or her fees from client accounts. This practice, coupled with the use of independent qualified custodians, greatly reduces the adviser’s ability to misappropriate client assets. Finally, account statements are sent to clients by the independent qualified custodians rather than by the adviser. This practice prevents the adviser from manufacturing false account statements.”
CFP Board recommended that the SEC exempt from the surprise examination proposal all advisers that use independent qualified custodians to hold all client assets; are deemed to have custody solely because they have the authority to withdraw fees from client accounts, and rely on the custodians to send account statements to clients. As an added consumer safeguard, CFP Board suggested the SEC require such advisers to send a statement to their clients listing their annual fee and itemizing the fees that they have deducted from client accounts.
“This will serve as an additional check on such advisers’ activities, and will provide clients with the ability to compare custodian statements with their advisers’ statements,” the letter said. The cost of complying with the surprise examination proposal would greatly outweigh the benefits and would impose needless fees on clients, CFP Board said. The average annual cost of such a surprise examination would range from $5,000 to $10,000, and would ultimately be borne by clients.
CFP Board expressed its support for another proposed amendment to the custody rule which would require independent, third-party evaluations of custody arrangements when a registered investment adviser, or an affiliate of the adviser, maintains custody of client assets. The proposal calls for a written report from an independent public accountant registered with the Public Company Accounting Oversight Board assessing the controls over client assets. CFP Board recognized that this proposal is designed to address the type of fraud that was perpetrated by Bernard L. Madoff, noting that it is reasonable to provide the needed protection where an adviser maintains custody of client assets directly or through a related person.
While requiring that all advisers maintain custody of client assets with an independent custodian would be consistent with the general practice of the majority of CFP® professionals, CFP Board recognized that maintaining client assets with an independent custodian may not be feasible under all business models and circumstances. In its letter, CFP Board said the internal control report proposal would provide needed protection for investors when is not feasible or desirable for an adviser to use an independent custodian.
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