NAREIM Presents: SEC Custody Rule Amendments -- Practical Implications & Actions March 3, 2010
<ul><li>Speaker :   Lawrence Cohen, Esq. Gibbons P.C. One Pennsylvania Plaza, 37th Floor New York, NY 10119-370 Direct: 2...
<ul><li>Moderator :    Leo Karwejna Vice President - Compliance Officer Prudential Investment Management, Inc. Prudential ...
Amended Custody Rule <ul><li>Overview/Definitions </li></ul><ul><li>Investment Advisers Act of 1940 Custody Rule (Rule 206...
Amended Custody Rule <ul><li>Overview/Definitions </li></ul><ul><li>Qualified Custodian (“QC”) </li></ul><ul><ul><li>Ban...
Amended Custody Rule <ul><li>Overview/Definitions </li></ul><ul><li>RIA also has custody if a related person holds, dire...
Annual Surprise Exam <ul><li>RIAs must undergo an Annual Surprise Examination only for client accounts for which they ha...
Annual Surprise Exam <ul><li>Exemptions from Annual Surprise Exam ( continued ) </li></ul><ul><ul><li>RIA of an Pooled In...
Annual Surprise Exam <ul><li>RIA with custody of non-pooled client assets must still undergo an Annual Surprise Exam for...
Privately Offered Securities <ul><li>No longer permits the accountant conducting the annual verification of client assets ...
Internal Control Report <ul><li>New requirement : Where advisory client assets are maintained by the RIA itself or a rela...
Internal Control Report ( continued) <ul><li>Type II SAS 70 Report: </li></ul><ul><ul><li>Custodians often provide this to...
Statements to Related Persons; Look-Through Provisions <ul><li>Funds of Funds: </li></ul><ul><ul><li>Sending account stat...
Delivery of Account Statements & Notice to Client <ul><li>Old Rule – Required an RIA that had custody, with certain limit...
Delivery of Account Statements & Notice to Client <ul><li>Old Rule – Required an RIA to notify clients promptly upon open...
Amendments to Form ADV <ul><li>Amended Form ADV requires RIAs to report more detailed information about their custody prac...
Compliance Policies and Procedures <ul><li>RIAs, especially those that advise Funds, are likely to need to update their cu...
Timing to Properly Comply <ul><li>Effective Date: March 12, 2010 </li></ul><ul><li>Annual Surprise Examination: </li></ul...
Timing to Properly Comply <ul><li>Agreement with Accountant for Surprise Exam – Accountant must . . . </li></ul><ul><ul><...
<ul><li>[Discussion Among Participants] </li></ul>
Implications/interpretations specific to real estate assets/investments <ul><li>How are complex securities/assets treated...
Practical first steps to take for conducting a review <ul><li>Should you conduct a refresh analysis of the current status ...
Initial and potential challenges <ul><li>Meeting the timeline </li></ul><ul><ul><li>3/12/2010 Effective date </li></ul></...
Questions & Comments
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NAREIM Presents: SEC Custody Rule Amendments -- Practical ...

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Transcripts - NAREIM Presents: SEC Custody Rule Amendments -- Practical ...

  • 1. NAREIM Presents: SEC Custody Rule Amendments -- Practical Implications & Actions March 3, 2010
  • 2. <ul><li>Speaker :   Lawrence Cohen, Esq. Gibbons P.C. One Pennsylvania Plaza, 37th Floor New York, NY 10119-370 Direct: 212-613-2037 Fax: 212-554-9640 lcohen@gibbonslaw.com </li></ul><ul><li>Lawrence Cohen has a varied national business practice. Mr. Cohen has, over his career, represented a broad range of investment industry clients, from boutique and regional broker/dealers and investment advisers to multi-billion dollar money management firms and money-center banks, advising clients on securities transactional and regulatory matters, including compliance and capital markets issues. </li></ul><ul><li>As a former legal officer and compliance director of mutual fund groups, he brings practical experience to the regulation and registration of public investment companies (closed-end funds and mutual funds, unit investment trusts, ETFs, etc.) and the formation and operation of private investment companies (hedge funds, private equity funds, VC funds). </li></ul>
  • 3. <ul><li>Moderator :    Leo Karwejna Vice President - Compliance Officer Prudential Investment Management, Inc. Prudential Real Estate Investors </li></ul><ul><li>Mr. Karwejna joined Prudential Investment Management’s Global Compliance team in 2008 with ten years experience providing compliance support to firms in the investment advisory and securities-trading businesses including equity, fixed income, real estate (direct property and securities), and additional alternative investment strategies. </li></ul><ul><li>Mr. Karwejna is currently responsible for the global regulatory compliance program efforts related to PREI and PIM’s International business activities and personnel. In this capacity, he provides business specific guidance, and co-leads the team’s efforts to develop, maintain, and monitor compliance within the appropriate policies, procedures and regulatory requirements. Prior experiences include Deutsche Asset Management and RREEF Alternative Investments compliance. </li></ul><ul><li>Mr. Karwejna earned a BS in finance from Saint Joseph’s University and a JD from Temple University School of Law. He regularly serves as a FINRA Arbitrator for securities-related disputes among the investing public or industry participants which are heard and decided upon within the regulatory organization’s dispute resolution mechanism. </li></ul>
  • 4. Amended Custody Rule <ul><li>Overview/Definitions </li></ul><ul><li>Investment Advisers Act of 1940 Custody Rule (Rule 206(4)-2) applies to Registered Investment Advisers (“RIAs”). Most RIAs do not maintain actual physical custody of client assets. </li></ul><ul><li>Custody - holding, directly or indirectly, client funds or securities or having any authority to obtain possession of them. </li></ul><ul><ul><ul><li>Direct possession of client funds or securities; </li></ul></ul></ul><ul><ul><ul><li>Any arrangement (including a power of attorney) under which the RIA is authorized or permitted to withdraw client funds or securities maintained with a custodian upon the RIA’s instruction to the custodian; and </li></ul></ul></ul><ul><ul><ul><li>Any capacity ( e.g ., a GP of a partnership, managing member of LLC, trustee of a trust or comparable position for another type of pooled investment vehicle) that gives the RIA or a supervised person legal ownership of or access to client funds or securities. </li></ul></ul></ul>
  • 5. Amended Custody Rule <ul><li>Overview/Definitions </li></ul><ul><li>Qualified Custodian (“QC”) </li></ul><ul><ul><li>Bank, savings association, registered broker/dealer, registered futures commission merchant, and 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. </li></ul></ul><ul><ul><li>The QC maintains client funds and securities (i) in a separate account for each client under such client's name; or (ii) in accounts that contain only client funds and securities, under the RIA’s name as agent or trustee for the clients. </li></ul></ul><ul><ul><li>Amended Rule does not require use of an independent custodian, but the SEC encourages the use of custodians independent of the RIA, whenever feasible. </li></ul></ul>
  • 6. Amended Custody Rule <ul><li>Overview/Definitions </li></ul><ul><li>RIA also has custody if a related person holds, directly or indirectly, client funds or securities or has any authority to obtain possession of them, in connection with advisory services the RIA provides to clients. </li></ul><ul><li>Related Person – a person directly or indirectly controlling or controlled by the RIA and any person under common control with the RIA. May include BDs and banks. </li></ul><ul><li>Privately Offered Securities – the Amended Rule retains the current definition of “privately offered securities” as securities that are: </li></ul><ul><ul><li>acquired from the issuer in a transaction or chain of transactions not involving any public offering, </li></ul></ul><ul><ul><li>uncertificated, and ownership thereof is recorded only on the books of the issuer or its transfer agent in the name of the client, and </li></ul></ul><ul><ul><li>transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer. </li></ul></ul>
  • 7. Annual Surprise Exam <ul><li>RIAs must undergo an Annual Surprise Examination only for client accounts for which they have custody (including via power of attorney, acting as GP or trustee, or other similar legal authority). </li></ul><ul><li>Exemptions From Annual Surprise Exam </li></ul><ul><ul><li>If RIA is deemed to have custody solely as a result of fee deductions from client accounts, or </li></ul></ul><ul><ul><li>RIA’s related custodian holds client assets and the RIA can demonstrate “ operational independence ” from the related custodian (note that the internal control report will still be required for the related custodian). </li></ul></ul><ul><ul><li>“ Operational Independence” : </li></ul></ul><ul><ul><ul><li>Client assets held by related custodian are not subject to claims of the RIA’s creditors; </li></ul></ul></ul><ul><ul><ul><li>RIA personnel do not have custody, possession of, or the power to control the disposition of such client assets; </li></ul></ul></ul><ul><ul><ul><li>No common supervision of RIA personnel and personnel of the related custodian; and </li></ul></ul></ul><ul><ul><ul><li>RIA personnel do not hold any position or share premises with the related custodian. </li></ul></ul></ul>
  • 8. Annual Surprise Exam <ul><li>Exemptions from Annual Surprise Exam ( continued ) </li></ul><ul><ul><li>RIA of an Pooled Investment Vehicle (“ Fund ”) is deemed to have complied with the Annual Surprise Exam requirement with respect to a Fund: </li></ul></ul><ul><ul><ul><li>That is subject to an audit at least annually </li></ul></ul></ul><ul><ul><ul><li>That distributes its audited financial statements, prepared in accordance with GAAP, to all investors within 120 days of the fund’s fiscal year-end (or within 180 days for funds of funds); </li></ul></ul></ul><ul><ul><ul><li>Whose audit is conducted by an independent public accountant registered with and subject to regular inspection by the PCAOB, as of the commencement of the professional engagement period and as of each calendar year-end; and </li></ul></ul></ul><ul><ul><ul><li>That, upon its liquidation, distributes its audited financial statements, prepared in accordance with GAAP, to all of the investors promptly after the completion of the final audit. </li></ul></ul></ul>
  • 9. Annual Surprise Exam <ul><li>RIA with custody of non-pooled client assets must still undergo an Annual Surprise Exam for those separately managed assets. </li></ul><ul><li>The Accountant’s Procedures (under AICPA Attestation Standards Section 601) should normally include, on a sample basis per client account, confirmation of </li></ul><ul><ul><li>Clients’ funds and securities, with both the qualified custodian and the client (inclusive of privately offered securities) and </li></ul></ul><ul><ul><li>Contributions and withdrawals, with clients. </li></ul></ul>
  • 10. Privately Offered Securities <ul><li>No longer permits the accountant conducting the annual verification of client assets to forego examining privately offered securities; thus, RIAs that maintain custody of privately offered securities will be subject to the surprise exam requirement. </li></ul><ul><li>Par. (b)(2) generally exempts from the QC requirements privately offered securities held for the account of a Fund, but only if the Fund is audited and the audited financial statements are distributed, as described in par. (b)(4) of the Rule. </li></ul><ul><li>Accountant’s verification procedures should include confirmation with the issuer of or counterparty to the security, or, where replies are not received, alternative procedures. </li></ul>
  • 11. Internal Control Report <ul><li>New requirement : Where advisory client assets are maintained by the RIA itself or a related person, rather than an independent QC, the RIA must obtain, or receive from its related person, no less than once each calendar year, a written, internal control report (such as a Type II SAS 70 Report ) prepared by an independent public accountant. </li></ul><ul><ul><li>QC only needs to obtain an internal control report if it maintains the funds or securities of its own advisory clients or clients of related persons. </li></ul></ul><ul><li>Accountant must be registered with, and subject to regular inspection, as of beginning of engagement and each calendar year-end, by PCAOB </li></ul><ul><li>Goal of Examination – obtain reasonable assurance that QC’s controls (i) have been in operation as of a specific date; (ii) are suitably designed and (iii) operating effectively to meet control objectives related to custody of funds and securities during a specific period </li></ul><ul><li>Internal control report must include an opinion from the independent public accountant with respect to the RIA’s or related person’s controls relating to custody of client assets. </li></ul>
  • 12. Internal Control Report ( continued) <ul><li>Type II SAS 70 Report: </li></ul><ul><ul><li>Custodians often provide this to clients who demand a rigorous evaluation of internal control. </li></ul></ul><ul><ul><li>SEC does not require this specific report , but any other report must also fully address the following items: </li></ul></ul><ul><ul><ul><li>Controls related to the areas of client account setup (documents for opening and modifying accounts should be received, authenticated and established on the applicable system) </li></ul></ul></ul><ul><ul><ul><li>Maintenance, authorization and processing of client transactions </li></ul></ul></ul><ul><ul><ul><li>Security maintenance and setup </li></ul></ul></ul><ul><ul><ul><li>Processing of income and corporate action transactions </li></ul></ul></ul><ul><ul><ul><li>Reconciliation of funds and securities to depositories and other unaffiliated custodians </li></ul></ul></ul><ul><ul><ul><li>Client reporting </li></ul></ul></ul><ul><ul><ul><li>Nature, timing, extent and results of the procedures to verify that funds and securities are reconciled to depositories and other unaffiliated custodians. </li></ul></ul></ul><ul><li>RIAs must obtain an internal control report within 6 months of becoming subject to the requirement. </li></ul>
  • 13. Statements to Related Persons; Look-Through Provisions <ul><li>Funds of Funds: </li></ul><ul><ul><li>Sending account statements or distributing audited financials will not satisfy the requirements of the Amended Rule “if such account statements or financial statements are sent solely to limited partners (or members or other beneficial owners) that themselves are limited partnerships (or limited liability companies, or another type of pooled investment vehicle) and are your related persons.” </li></ul></ul><ul><li>SPVs </li></ul><ul><ul><li>RIA must either: </li></ul></ul><ul><ul><ul><li>treat the SPV as a separate client, in which case, the SPV itself must have annual audited financial statements and deliver the statements to the beneficial owners of the investment funds participating in the SPV; or </li></ul></ul></ul><ul><ul><ul><li>treat the assets of the SPV as assets of the Funds of which the RIA has indirect custody, in which case, the annual audited financial statements of each Fund participating in the SPV must look through the SPV to audit each such participating Fund’s share of the SPV’s assets. </li></ul></ul></ul>
  • 14. Delivery of Account Statements & Notice to Client <ul><li>Old Rule – Required an RIA that had custody, with certain limited exceptions, to maintain client funds or securities with a QC that the RIA has a “reasonable basis” for believing sends an account statement, at least quarterly, to each client for which the QC maintains funds or securities. </li></ul><ul><ul><li>Allowed the RIA to send out quarterly account statements, provided it underwent an Annual Surprise Exam by an independent public accountant </li></ul></ul><ul><li>Amended Rule – </li></ul><ul><ul><li>Eliminates Surprise Exam alternative (“Annual Audit Provision”) </li></ul></ul><ul><ul><ul><li>SEC: “We believe that direct delivery of account statements by [QCs] will provide greater assurance of the integrity of account statements received by clients” </li></ul></ul></ul><ul><ul><li>“ Reasonable basis” must be formed after “due inquiry” </li></ul></ul><ul><ul><ul><li>No single method prescribed. </li></ul></ul></ul><ul><ul><ul><li>SEC suggested that the QC provide the RIA with a copy of the account statement that was delivered (merely viewing statements on QC’s web site is insufficient). </li></ul></ul></ul>
  • 15. Delivery of Account Statements & Notice to Client <ul><li>Old Rule – Required an RIA to notify clients promptly upon opening a custodial account on their behalf and when there were changes to the information required in that notification. </li></ul><ul><li>Amended Rule – Requires the RIA to include a cautionary legend in the notice and subsequent account statements, urging clients to compare the account statement they receive from the QC with those they receive from the RIA (note that the legend is needed only if the RIA elects to also send its own account statement to clients). </li></ul>
  • 16. Amendments to Form ADV <ul><li>Amended Form ADV requires RIAs to report more detailed information about their custody practices in the form and to update the information. </li></ul><ul><li>RIAs are required to report in Form ADV the month in which the last surprise examination occurred. </li></ul><ul><li>The RIA is required to report whether it has determined that it has overcome the presumption that it is operationally independent from a related QC, and thus is not required to obtain a surprise examination for the clients’ assets maintained at that QC. </li></ul>
  • 17. Compliance Policies and Procedures <ul><li>RIAs, especially those that advise Funds, are likely to need to update their custody arrangements and/or compliance policies to satisfy the requirements of the Amended Rule. </li></ul><ul><li>The SEC Release provides guidance with respect to policies and procedures relating to the safekeeping of client assets that RIAs should consider when updating their compliance manuals. </li></ul><ul><li>RIAs should consider mandating that any problems be brought to the immediate attention of management and give the Chief Compliance Officer access to sufficient information to enforce these policies and procedures. </li></ul><ul><li>RIAs with custody of client assets should consider enhancing their policies and procedures by including, for example, requirements for the authorization of more than one employee before the movement of client assets and creating a firewall between advisory and custodial personnel. </li></ul>
  • 18. Timing to Properly Comply <ul><li>Effective Date: March 12, 2010 </li></ul><ul><li>Annual Surprise Examination: </li></ul><ul><ul><li>First examination to take place by December 31, 2010 </li></ul></ul><ul><ul><li>Dates for Fund Distribution of Audited Financials: RIA is deemed to comply with the Annual Surprise Exam requirement with respect to a Fund that is subject to an audit at least annually and distributes its audited financials to all Fund investors within 120 days of its fiscal year-end (or within 180 days for funds of funds). </li></ul></ul><ul><ul><li>RIA may rely on this Annual Audit Provision with respect to a Fund if the RIA becomes contractually obligated to obtain an audit of the financials of the Fund for fiscal years beginning on or after January 2010. </li></ul></ul>
  • 19. Timing to Properly Comply <ul><li>Agreement with Accountant for Surprise Exam – Accountant must . . . </li></ul><ul><ul><li>notify SEC within 1 business day of finding any material discrepancy during the course of the exam </li></ul></ul><ul><ul><li>submit Form ADV-E to the SEC, with accountant’s certificate, within 120 days of the time chosen by the accountant for surprise examination </li></ul></ul><ul><ul><li>within 4 business days of resignation or dismissal, file a statement regarding the termination along with Form ADV-E </li></ul></ul><ul><li>Internal Control Report </li></ul><ul><ul><li>September 12, 2010 (six months after the Rule’s effective date) </li></ul></ul><ul><li>Delivery of Account Statements </li></ul><ul><ul><li>Starting as of March 12, 2010 (60 days from the Rule’s effective date) </li></ul></ul><ul><li>Form ADV </li></ul><ul><ul><li>RIAs must provide responses to the revised Form ADV in their first annual amendment after January 1, 2011. </li></ul></ul>
  • 20. <ul><li>[Discussion Among Participants] </li></ul>
  • 21. Implications/interpretations specific to real estate assets/investments <ul><li>How are complex securities/assets treated under the amendments? </li></ul><ul><li>How do direct real property holdings fit into the amendments? </li></ul><ul><li>What role will Custodians play if statements are required? </li></ul>
  • 22. Practical first steps to take for conducting a review <ul><li>Should you conduct a refresh analysis of the current status of custody within your firm? </li></ul><ul><li>Dialogue with your Auditors/Accountants </li></ul><ul><li>Need for implementation of compliance program guidance </li></ul><ul><li>Update language within policy and procedures to reflect changes </li></ul>
  • 23. Initial and potential challenges <ul><li>Meeting the timeline </li></ul><ul><ul><li>3/12/2010 Effective date </li></ul></ul><ul><ul><li>9/12/2010 Auditors </li></ul></ul><ul><ul><li>01/01/2011 Form ADV </li></ul></ul><ul><li>Areas of interpretation </li></ul><ul><ul><li>Custodian diligence/ “due inquiry” </li></ul></ul><ul><ul><li>Direct delivery of account statements </li></ul></ul><ul><li>Determining which policies or procedures (Risk, Ops, Finance, etc.) relate to custody </li></ul>
  • 24. Questions & Comments

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