SEC Charges Advisor and President for Custody Rule Violations; Resources for Your Lingering Rollover Advice Questions; SEC Speaks on Digital Assets and Growing Cybersecurity Challenges; Lessons Learned and Worth Reading for December 2021



Yes, Virginia, There is an SEC and RIAs with Custody Must Use a Qualified Custodian – Advisor and President Charged with Custody Rule Violations.

At the heart of this case, an advisor and its president failed to comply with the Advisers Act Custody Rule (Rule 206(4)-2) because promissory notes held by its clients were not custodied with a “qualified custodian.” The problem started when the firm’s president suggested that several clients invest in promissory notes issued by a mortgage company that was also a client of the firm. The clients agreed and, instead of placing the notes with a qualified custodian as required by the Custody Rule, the president requested that copies of the promissory notes be placed in each client’s online “drop box.” The firm had Custody Rule policies and procedures that (1) prohibited taking custody of securities absent CCO approval, and (2) required compliance and others to review client accounts periodically for compliance with portfolio and trading procedures. However, because the promissory notes were not held at the firm’s usual broker-dealer custodian, the clients custodial did not reflect the promissory notes. As a result, the CCO and CIO were unaware of the investments and unable to monitor them.

The Custody Rule includes an exception from the qualified custodian requirement applicable to certain privately offered and uncertificated securities[1]; however, the promissory notes were apparently not eligible. The SEC’s order found that the advisor and its president violated the Custody Rule and failed to implement their policies and procedures. Without admitting or denying the findings, the firm agreed to pay a civil penalty of $50,000, engage a compliance consultant, and be censured by the SEC. The president agreed to pay a civil penalty of $20,000.

The action also specifically notes the following were true: The advisor and president had no prior disciplinary history; no compensation was received by the advisor or president in connection with the promissory note investments; the promissory notes were repaid in full ahead of maturity; and no clients lost money. This case serves as a reminder of the Custody Rule’s technical requirements and that the SEC can, and does, bring enforcement actions even when no clients are harmed. Firms that invest in non-traditional securities should carefully consider where these securities will be custodied and how the investments will be monitored to ensure compliance with the Custody Rule and their fiduciary duties. It may also be advisable to consult outside counsel when determining if any the firm can rely on the exemption from the Custody Rule for privately offered securities. Contributed by Andrea Penn, Senior Director.


[1] 17 CFR § 275.206(4)-2 – Custody of funds or securities of clients by investment advisers. Privately Offered Securities under the Investment Advisers Act Custody Rule, Commission Guidance Regarding Independent Public Accountant Engagements Performed Pursuant to Rule 206(4)-2 Under the Investment Advisers Act of 1940,

Photo Credit: Photo by Markus Winkler on Unsplash.

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