Custody Analysis by K&L Gates LLP of
Rule 206(4)-2 under the Investment Advisers Act of 1940 (the “Custody Rule”)
A. DO YOU HAVE
CUSTODY?
Do you have:
a. possession of
client funds or
securities;
b. arrangement
under which you
are authorized
to withdraw
client funds or
permitted to
withdraw client
funds or
securities
maintained with
a custodian
NO
NO
c. any capacity that
gives you or your
supervised
person legal
ownership of or
access to client
funds or
securities (e.g.,
general partner
and investment
adviser)?
YES
YES
YES
If the Custody
Rule applies,
you must obtain
an Internal
Control Report.
NO
d. a Related Person
that holds, directly
or indirectly, client
funds or securities,
or has any authority
to obtain
possession of
them, in connection
with advisory
services you
provide to clients?
YES
Go to B to determine if
the Custody Rule
applies.
If the Custody Rule
applies, you are excepted
from the Surprise Annual
Examination.
Go to B to determine if
the Custody Rule applies.
Do you: (i) have custody solely as a result
of a related person holding client assets;
and (ii) is your related person
“operationally independent” of you?
NO
YES
B. DOES THE CUSTODY RULE APPLY?
Is your client a registered investment company?
YES
NO
You are not required to
comply with the Custody
Rule with respect to the
account of a registered
investment company.
C. Is your client an unregistered
pooled investment vehicle?
If the Custody Rule applies,
you are excepted from the
Surprise Annual
Examination. Go to B to
determine if the Custody
Rule applies.
YES
NO
D. Do you advise your client with respect to “privately
offered securities”?
YES
NO
You must comply with the
Custody Rule; however, you are
not required to maintain
investments in privately offered
securities with a Qualified
Custodian. Privately offered
securities are subject to the
Surprise Annual Examination.
Financial Statement Audit
Does the pooled investment
vehicle:
ƒ
undergo an audit at least
annually; and
ƒ
distribute its audited financial
statements prepared in
accordance with GAAP within
120 days of the end of its fiscal
year (or 180 days if the pooled
investment vehicle is a “Fund
of Funds”)?
NO
YES
You are excepted from the Surprise Annual Examination
and distribution of statements by a Qualified Custodian
Does the pooled investment vehicle invest in
“privately offered securities”?
E. Do you advise your client with respect to mutual fund
shares?
YES
YES
You must comply with the
Custody Rule, although you
may use a transfer agent or a
Qualified Custodian. Mutual
fund shares are subject to the
Surprise Annual Examination.
NO
You must comply with the Custody Rule;
however, if you comply with the Financial
Statement Audit, you are not required to
maintain investments in privately offered
securities with a Qualified Custodian (or have
the Qualified Custodian distribute account
statements). Privately offered securities are
subject to the Surprise Annual Examination.
F. You must comply with the Custody Rule.
NO
You do
not have
to comply
with the
Custody
Rule.
NO
Go to E.
If the
Custody
Rule
applies, you
must obtain
an Internal
Control
Report from
your
Related
Person. Go
to B to
determine if
the Custody
Rule
applies.
APPENDIX: Definitions
1. Financial Statement Audit: Pooled investment vehicle is subject to audit by an independent public
accountant registered with the Public Company Accounting Oversight Board at least annually and
distributes audited financial statements prepared in accordance with GAAP to all beneficial owners
within 120 days of the end of its fiscal year or, in the case of a Fund of Funds, within 180 days of the
end of its fiscal year. Additionally, upon liquidation the pooled investment vehicle is subject to audit
and distributes audited financial statements prepared in accordance with GAAP to all beneficial
owners promptly after the completion of the audit. Non-US based funds may prepare their audited
financial statements in accordance with local GAAP, so long as differences to US GAAP are
reconciled.
2. Fund of Funds: A limited partnership, limited liability company, or another type of pooled investment
vehicle that invests 10% or more of its assets in other pooled investment vehicles that are not, and
are not advised by, a related person of the limited partnership, its general partner, or its adviser.
3. Internal Control Report: When an adviser or its related person serves as a Qualified Custodian for
advisory client funds or securities, the adviser must obtain, or receive from its related person, no less
frequently than once each calendar year, a written report, which includes an opinion from an
independent public account with respect to the adviser’s or related person’s controls relating to
custody of client assets, such as a Type II SAS 70 report.
4.
Operationally Independent: A related person is “operationally independent” of the adviser: if: (i)
client assets in the custody of the related person are not subject to claims of the adviser’s creditors;
(ii) advisory personnel do not have custody or possession of, or direct or indirect access to, client
assets of which the related person has custody, or the power to control the disposition of such client
assets to third parties for the benefit of the adviser or its related persons, or otherwise have the
opportunity to misappropriate such client assets; (iii) advisory personnel and personnel of the related
person who have access to advisory client assets are not under common supervision; and (iv)
advisory personnel do not hold any position with the related person or share premises with the related
person.
5. Privately Offered Securities: Securities that are:
a. Acquired from the issuer in a transaction or chain of transactions not involving any public offering;
b. Uncertificated, and ownership thereof is recorded only on the books of the issuer or its transfer
agent in the name of the client; and
c. Transferable only with the prior consent of the issuer or holders of the outstanding securities of
the issuer.
6. Related Person: A related person means any person, directly or indirectly, controlling or controlled
by the adviser, and any person that is under common control with the adviser.
7. Surprise Annual Examination: Client funds and securities for which the adviser has custody are
verified by actual examination at least once during each calendar year, except as provided below, by
an independent public accountant, pursuant to a written agreement, at a time that is chosen by the
accountant without prior notice or announcement and that is irregular from year to year. Advisers
currently subject to the Custody Rule must have their first surprise annual examination conducted
before December 31, 2010.
The written agreement must provide for the first examination to occur within six months of becoming
subject to the Amended Rule (if you become subject to the Rule after the Effective Date), except that,
if client funds or securities are maintained at a qualified custodian, the agreement must provide for
the first examination to occur no later than six months after obtaining the internal control report. The
written agreement must require the accountant to:
(i) file a certificate on Form ADV-E with the Securities and Exchange Commission (“SEC”) within
120 days of the time chosen by the accountant;
(ii) upon finding any material discrepancies during the course of the examination, notify the SEC
within one business day of the finding; and
(iii) upon resignation or dismissal from, or other termination of, the engagement, or upon
removing itself or being removed from consideration for being reappointed, file within four
business days Form ADV-E accompanied by a statement that includes:
(A) the date of such resignation, dismissal, removal, or other termination, and the name,
address, and contact information of the accountant; and
(B) an explanation of any problems relating to examination scope or procedure that
contributed to such resignation, dismissal, removal, or other termination.
8. Qualified Custodian: A qualified custodian means (i) a bank as defined in section 202(a)(2) of the
Investment Advisers Act of 1940 or a savings association as defined in section 3(b)(1) of the Federal
Deposit Insurance Act that has deposits insured by the Federal Deposit Insurance Corporation
under the Federal Deposit Insurance Act ; (ii) a broker-dealer registered under section 15(b)(1) of the
Securities Exchange Act of 1934, holding the client assets in customer accounts; (iii) a futures
commission merchant registered under section 4f(a) of the Commodity Exchange, holding the client
assets in customer accounts, but only with respect to clients’ funds and security futures, or other
securities incidental to transactions in contracts for the purchase or sale of a commodity for future
delivery and options thereon; and (iv) a foreign financial institution that customarily holds financial
assets for its customers, provided that the foreign financial institution keeps the advisory clients’
assets in customer accounts segregated from its proprietary assets.