Investment Management Alert
March 2010
Authors:
Rebecca O’Brien Radford
rebecca.radford@klgates.com
+1.617.261.3244
Michael S. Caccese
michael.caccese@klgates.com
+1.617.261.3133
K&L Gates includes lawyers practicing
out of 35 offices located in North
America, Europe, Asia and the Middle
East, and represents numerous GLOBAL
500, FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
SEC Offers Guidance on Looming Custody
Rule Amendments
The SEC staff released its much-anticipated frequently asked questions (“FAQs”) on
amended Rule 206-4(2) under the Investment Advisers Act of 1940, as amended (the
“Rule”), one week in advance of the Rule’s effective date.1 A more detailed
discussion of the Rule can be found in our January 2010 K&L Gates Client Alert
“SEC Releases Amended Custody Rule.”
The FAQs shed light on the amended Rule’s compliance dates and the annual
financial statement provisions. The FAQs also afforded some relief for advisers with
omnibus accounts and advisers having custody of client assets as a result of
inadvertent receipt of tax refunds or settlement proceeds. Some of the more
interesting FAQs are summarized below.
Compliance Date Clarifications and Relief
•
Q: When must a Qualified Custodian first send account statements to an
adviser’s clients?
A: The first quarterly statement must cover the period from March 12, 2010
through March 31, 2010.
•
Q: When must the first surprise examination occur?
A: The first surprise examination must begin before December 31, 2010, but
need not be completed by that date. It must be completed within 120 days
of commencement.
Annual Audited Financial Statements
•
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Q: To rely upon Rule 206(4)-2(b)(4)’s “audit approach,” does the audit of
annual financial statements have to be performed in accordance with US
generally accepted accounting principles (“GAAP”)?
A: Yes, except that funds organized outside of the US or having a general
partner or other manager with a principal place of business outside of the
US may have the financial statements prepared in accordance with
accounting standards other than US GAAP, so long as they contain
information substantially similar to statements prepared in accordance with
US GAAP and any material differences are reconciled. However, all funds
relying on the audit approach must be audited in accordance with US
Generally Accepted Accounting Standards by an independent public
accountant as defined in the Rule.
See “Staff Responses to Questions about the Custody Rule” (March 5, 2010) at
http://www.sec.gov/divisions/investment/custody_faq_030510.htm.
Investment Management Alert
•
•
Q: What does it mean for an adviser to a fund to
be “contractually obligated” to obtain an audit of
the financial statements?
A: The “obligation” to obtain an audit can
arise from the fund’s operating agreement,
private placement offering memorandum or
an engagement letter with the auditor (or
presumably other ways, such as an
agreement between the fund and the adviser).
Q: May a single-investor limited partnership or
single-member limited liability company rely on
the audit approach?
A: Yes, however, the adviser may not use the
audit approach with respect to clients that
are not “pooled investment vehicles” such as
an endowment, pension plan or individual
client, even if it invests side-by-side with a
pooled investment vehicle.
sent no later than the time the adviser sends
its account statements for the first quarter of
2010.
Inadvertent Custody Relief
The original FAQ addressed the issue of what to do
if an adviser receives client securities from a client.
The revised FAQ now also addresses the situation
of receiving cash, checks or stock certificates in
connection with tax refunds, settlement proceeds or
dividends relating to lawsuits, legal actions,
bankruptcies or business reorganizations.
•
Omnibus Accounts Relief
The FAQs confirm that omnibus accounts held in the
name of an adviser (that is not also a qualified
custodian) are no longer permissible. The beneficial
owners of an omnibus account are only recorded on
the books of the omnibus account holder, not the
custodian. The omnibus account’s custodian
therefore cannot – by definition – send quarterly
account statements to the beneficial owners of the
account. Acknowledging this sea change, the SEC
staff afforded modest relief to advisers that must
reconfigure their relationships in order to comply
with the Rule.
•
Q: Advisers are converting omnibus account
arrangements to meet the Rule’s new
requirements, including obtaining new account
documentation and system reprogramming.
May these advisers have more time to complete
these conversions?
A: An omnibus account adviser must have a
qualified custodian send out quarterly
account statements to clients for the third
quarter 2010, so long as the adviser (i)
notifies clients of how it intends to modify its
service to comply with the Rule, (ii) provides
an estimate of when the modifications will
occur; and (iii) undergoes a surprise
examination for 2010. The notice must be
Q: If an adviser inadvertently receives
securities from a client, may the adviser
forward the securities to the qualified custodian
instead of returning the securities to the client?
A: If an adviser receives client securities
from a client, it still must return them to the
client within three business days. If it
receives tax refunds, client settlement
proceeds, stock certificates, dividends, or
evidence of new debt from issuers in
connection with class action lawsuits
involving bankruptcy or business
reorganizations, it will not be deemed to have
custody if it forwards them within five
business days of receipt.
The SEC staff did not specify whether these types of
client assets must be forwarded to the qualified
custodian, or may be sent to the client.
Internal Control Report
•
Q: What is the compliance date for the internal
control report (if applicable)?
A: If an adviser is required to obtain an
internal control report on March 12, 2010,
the deadline to obtain the report is
September 12, 2010. If an adviser becomes
subject to the requirement to obtain an
internal control report after March 12, 2010,
it must obtain the report within six months
of becoming subject to the requirement.
Additional FAQs are included on the SEC’s web
site, and the SEC staff has indicated that it expects
to update the FAQs from time to time to amend
their responses or to add additional questions.
March 2010
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Investment Management Alert
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K&L Gates includes lawyers practicing out of 35 offices located in North America, Europe, Asia and the Middle East, and represents numerous
GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market
participants and public sector entities. For more information, visit www.klgates.com.
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This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon
in regard to any particular facts or circumstances without first consulting a lawyer.
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March 2010
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