A recent report by the Government Accountability Office found that the requirements of the SEC’s custody rule on investment advisers’ custody of client assets imposes costs on investment advisers who need to hire independent accountants for surprise examinations.
The SEC rule requires that advisers with custody use qualified custodians, such as banks or broker-dealers, to hold client assets, and that advisers have reason to believe the custodian sends account statements directly to clients, Accounting Today reports.
In the wake of Bernard Madoff’s Ponzi scheme, in which his office sent fraudulent statements to clients for years, the rule was designed with the aim of protecting investors. Madoff’s scam cheated investment clients out of billions of dollars, which brought a sense of urgency to the rule.
Additionally, under the rule, advisers with custody must hire an independent public accountant to conduct a surprise examination every year to verify custody of client assets, unless the adviser qualifies for an exemption. Accountants interviewed in the GAO report said the examination cost depends on the number of clients under custody, as well as other factors, according to Accounting Today.
Advisers are also required to maintain client assets or use a qualified custodian to obtain an internal control report to determine the effectiveness of controls.
The SEC, however, exempts advisers deemed to have custody only because of their use of a related but “operationally independent” custodian. The regulator said “operationally independent” advisers and custodians under common ownership reduce the risk to investors, because misuse of client assets would likely require collusion between the firms, Accounting Today reports.
Approximately two percent of advisers registered with the SEC qualify for the exemption. If the exemption were eliminated, examination costs would vary across advisers.
The rule was amended in 2009 to require a broader range of advisers to undergo annual examinations by independent accountants. Dodd-Frank required the GAO to study the costs associated with the custody rule, according to Accounting Today.