SEC Proposes Tighter Adviser Custody Rules

In light of fraud of money managers such as Bernard Madoff, the SEC voted 5-0 to propose that investment advisers who hold their client’s assets undergo a surprise exam once a year to make sure those assets exist, Reuters reported.

If adopted, the amendments to the Investment Advisers Act of 1940 would require investment advisers having custody of client funds and securities to obtain a surprise examination by an independent public accountant, and, unless the client assets are maintained with an independent custodian, obtain a review of custodial controls from an independent public accountant, according to the SEC.

The surprise exam would apply to about 9,600 of the approximately 11,000 registered investment advisers (RIAs) and includes advisers who are deemed to have custody or the ability to deduct fees from their client’s assets, according to Reuters.

The SEC also proposed requiring about 360 investment advisers who physically hold their client assets in the firm or through an affiliate to undergo a written review by a certified public accountant, the news report said. The review would describe the controls the adviser has in place, test the operating effectiveness of those controls, and provide the results of those tests. That review would have applied to Madoff.

“We are taking this action in response to major investment scams such as Madoff and many other potential Ponzi schemes,” SEC Chairman Mary Schapiro said at the SEC meeting, according to the news report. “A surprise exam would provide another set of eyes on client’s assets and provide additional protection against theft or misuse.’

The proposed SEC plan is open for public comment.