- SEC Proposes Expanding Regulation
- New Proposition Details
- The History of SEC Custody Rules
- The Biggest Custody Change
SEC Proposes Expanding Regulation
The Securities and Exchange Commission is considering expanding regulatory oversight to cover all assets in a client’s portfolio, not just securities and funds. This means the agency proposes an expansion of custody rules for investment advisors so that they cover more assets and apply to advisors who have authority to trade in their clients’ accounts.
The Securities and Exchange Commission voted, 4-1, in favor of releasing the proposal, which for the first time since 2009, would amend regulations that govern advisors who maintain control of their clients’ assets.
New Proposition Details
The 434-page proposal would expand custody obligations beyond securities and funds, which are covered by the current rule, and include all assets in a client’s portfolio. That would sweep in private securities, real estate, derivatives and other assets. It also would expand custody to crypto assets that are not securities.
Under the proposal, an advisor who can make trades on behalf of a client would be deemed to have custody of the client’s assets, according to an SEC fact sheet. The proposal also would require advisors to enter a written agreement with a qualified custodian to protect customer assets. Qualified custodians include banks, broker-dealers and trust companies, among other institutions.
The proposal would amend the custody exception for private assets by requiring advisors to hold those with a qualified custodian unless they can show that it’s not reasonable to do so.
The History of SEC Custody Rules
The agency last changed the custody rule 14 years ago following massive investor fraud perpetrated by Bernie Madoff and others. In 2010, the Dodd-Frank law gave the SEC more latitude to protect client assets following the financial crisis.
SEC Chairman Gary Gensler said the agency was taking advantage of the Dodd-Frank provision to beef up the custody rule.
“I support this proposal because … it would help ensure that advisors don’t inappropriately use, lose or abuse investors’ assets,” Gensler said at an SEC open meeting.
Republican SEC commissioner Hester Peirce was the only agency member to vote against releasing the proposal, expressing misgivings about its scope.
“Significant aspects of the proposed approach and its implementation timeline raise such great questions and concerns about the rule’s workability and breadth that I can’t support today’s proposal,” Peirce said at the open meeting.
She added that she hoped some of her reservations would be addressed during the public comment period, which will be open for 60 days after the proposal is published in the Federal Register.
Peirce noted that she hoped she would be able to support the rule on adoption.
The Biggest Custody Change
Perhaps the biggest custody change for advisors centers on discretionary trading. Under the current custody rule, if an advisor places a trade for a client, custody is not triggered.
But under the proposal, custody occurs any time an advisor buys or sells assets on behalf of a client. This would make clear that advisors who trade an investor’s assets cannot circumvent the custody rule and the safeguards it provides.
According to Gail Bernstein, general counsel at the Investment Advisor Association, that new definition of custody represents a sea change for advisors. This organization has been pushing for years for reform of the custody rule. They consider that it is really a fundamental departure from where we are today on authorized trading.
The proposal would give smaller advisors more time than bigger firms to implement the reforms if they are ultimately approved by the SEC. The Investment Advisor Association approves of that accommodation but still, the proposal presents a potentially big burden for small advisory shops.
In fact, the flurry of SEC rulemaking proposals is a challenge because many of them overlap. Gail Bernstein considers that it’s got a disproportionate impact on smaller advisors.
What that means in practice is to be discovered yet.
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