The Hidden Costs of Helping Clients: How to Avoid Unintended Custody

As a Compliance Analyst here at AdvisorLaw, I recently ran into a situation with a client where understanding the implications of imputing custody to your firm could end up having massive ramifications on your business. The Securities and Exchange Commission (SEC) and each State Securities Regulator have strict regulations surrounding the handling of client assets, and inadvertently taking custody of client assets could lead to significant financial penalties.

Did I Accidentally Take Custody?

Custody refers to the possession and control of client funds or securities. You may accidentally take custody when you are listed as an executor or contingent executor of a will or if you are listed in a trust as the trustee or contingent trustee. If you accept the position of executor of a will or trustee of a client’s trust, your firm has custody. Some states consider Standing Letters of Authorization to be full custody. 

If you accept custody, you will need to update your regulatory documents and follow a set of expensive requirements. 

When a client asks you to help out because they “don’t have anyone else they can ask,” please consider the following requirements. If a firm has custody it must meet the following obligations: 

• Maintaining funds with a qualified custodian.
• Keeping client funds segregated in separate accounts for each client in the client’s name (or in an account containing only funds of the adviser’s clients under the adviser’s name as agent/trustee).
• Promptly notifying the client whenever a new account is opened with a qualified custodian. The notice must be in writing and include the qualified custodian’s name, address, and how funds/securities are maintained.
• Having reasonable belief that the custodian is sending statements to the clients. The qualified custodian must send these account statements at least quarterly to the client, including the amount of security funds at quarter end and a list of all account transactions during the statement period.
• Undergoing an annual surprise examination by an independent public accountant that is registered with and inspected by the Public Company Accounting Oversight Board (PCAOB), to verify client assets. These audits typically cost $15,000-$20,000+ 

Custody obligations begin on day one of the firm having custody whether you realize you have custody or not. These requirements apply even if you were only a trustee for a day or two. If you are a successor executor or trustee on any accounts, an auditor/examiner could deem that alone custody and it could be a costly deficiency.

Protecting Your Firm

To avoid the complexities and costs associated with custody, your firm may consider declining trustee positions. As I recommended to my client in this particular situation, by maintaining a clear understanding of when your firm does and does not have custody of client assets, you can protect your firm from being in violation of the Custody Rule and causing your firm to incur the cost of maintaining custody and the potential regulatory deficiencies that may bring costly penalties. 

If you are unsure about your firm’s role in a specific situation, clarifying your responsibilities and mitigating risks is essential. You may refer here for more information on custody.

By staying informed about custody regulations and seeking guidance when necessary, your firm can make informed decisions to protect its interests and maintain compliance.

If you have any questions, please consult with AdvisorLaw’s team for guidance specific to your firm’s situation.

Disclaimer: This blog post is intended for informational purposes only and does not constitute legal or financial advice.