BBD recently attended the Investment Adviser Association Compliance Conference, which was held last month in Washington, DC.  Among the hot topics covered were developments related to GIPS^® Performance Verification and the SEC's Custody Rule.

GIPS^® 20/20 Remains In Progress- Exposure Draft Expected To Be Issued By August 2018

In order to promote wider adoption of GIPS^® standards, particularly among alternative investment managers and managers of pooled funds, the CFA Institute has undertaken a project, GIPS^® 20/20, to revise GIPS^® standards.  These updates are the first significant revisions to the standards since 2010 and are expected to become effective January 1, 2020.

 A GIPS^® 20/20 Consultation Paper was released in 2017 and offered the CFA Institute’s assessment regarding potential updates, particularly related to the presentation of performance for pooled funds.  Following this report and subsequent comment period, a GIPS^® 20/20 Exposure Draft is expected to be issued by August 31, 2018, with a four-month comment period after the release.

Custody Rule- Analysis of Year-Old Custody Rule Guidance

The Conference also offered analysis of the now year-old new Custody Rule guidance, including issues related to:

• Inadvertent custody
• Non-delivery versus payment (DVP) transactions
• Implementation of no-action relief from surprise examinations with standing letters of authorization (SLOAs)
• First-party and third-party transfers

Inadvertent Custody

With inadvertent custody, a custodial agreement and advisory agreement conflict.  The agreement between the custodian and the client gives the advisor broader authorization than the agreement between the advisor and the client.

In the Custody Rule guidance, the SEC has suggested that, in this instance of inadvertent custody, the advisor provide a letter to the custodian limiting the advisor’s authority to delivery versus payment (DVP). The client and custodian would provide written acknowledgement of this new agreement.  Regarding DVP transactions, there has always been an assumption that an advisor does not have custody of client assets if they only have the ability to trade securities in client accounts, but this situation only applies if the advisor trades securities which settle DVP, where the cash receipt/disbursement settles at the same time securities are delivered/received. Examples of non-DVP transactions could include derivatives, bank loans, private funds, and foreign securities.

Noted at the conference was that in practice, custodians have been unwilling to cooperate with these requests for written acknowledgement of the new agreement.

Third-Party Transfers

The SEC issued no-action relief in February of 2017 for advisors who have a standing letter of authorization (SLOA) to move client assets via check, ACH or wire to a third-party.

No-action relief exempts advisors from surprise examination requirements if seven criteria are met with respect to these client accounts.  Note that, despite the no-action relief and resulting waiver of exam requirements, advisors are still deemed to have custody of these assets. 

The seven criteria include:

1. Client provides written, signed instruction to custodian
2. Client authorizes investment advisor to direct third-party transfers
3. The custodian verifies the client authorization (signature review) and notifies the client upon each transfer
4. The client can terminate or change the instruction
5. The advisor cannot change the instruction
6. The advisor has documentation proving the third-party account is not an account of a related party to the advisor
7. The custodian provides initial written notice to client confirming terms of the instruction and annually re-confirms

It’s important to note common implementation issues that have been experienced in these situations, including:

• Documentation that the third-party is not a related party
• Controls to help meet the seven requirements
• Trust accounts where personnel serve as trustees
• Sufficient or reasonable time periods to make changes

First-Party Transfers

The updated guidance related to custody and first-party transfers includes wire transfers between a client’s own accounts.  Transfers via ACH and check are not deemed to trigger custody.

The guidance states that, to avoid a custody determination, the advisor must receive signed, written authorization from the client accounts where the advisor is authorized to move money, including details of the accounts such as account names, account numbers and routing numbers.

Lack of signed, written instructions from the client would mean the advisor could have custody of these assets, even if they are only moving funds between the client’s own accounts.

Do you have questions about these topics?  BBD is a resource for you.  Please feel free to contact John Braun.

Do you know that BBD provides surprise custody examinations and performance verification services for advisors?  For more information about how we can help you, please contact John Braun.