“Custody” Is Not a Dirty Word

By Amy McIIwain, President, Financial Social Media on Friday, September 30th, 2011

This blog represents the personal opinion of the writer only. It does not reflect any position held by the SEC or any official viewpoint from a regulatory standpoint.
 

To custody, or not to custody, that is the question. The SEC’s recently revised rule 206(4)-2, otherwise known as the “custody rule,” has become a hot topic in the industry. In a nutshell, the rule serves to regulate custodial practices of advisors registered under the Advisors Act, and also further defines “custody.” (Link to the SEC site and rule at http://www.sec.gov/rules/final/ia-2176.htm.)
 

A sizable percentage of advisors have chosen to maintain custody, while others have chosen to change their business model and not take custody. Neither decision is “right” or “wrong,” but in today’s investment community, there does seem to be a negative vibe associated with the word “custody.”
 

The definitions of “custody” and “discretion” are a good starting point.

To understand the finer points of the custody question, it’s first necessary to take a step back for a moment and look at the definitions of “custody” and “discretion,” as there may be confusion between the two terms. Now please keep in mind, these are not official definitions. Rather, they’re what I infer from the current usage of the words: 
 

Custody: as an advisor, you are taking legal responsibility for your client’s securities. Quite simply, you are responsible for the management and safekeeping of these funds. You hold the funds or securities—either directly or indirectly—and have the authority to obtain possession of them. Some examples that come to mind: 1.) you have the ability to move funds to an unlike registration, or 2.) you can withdrawal funds from a client’s account. 
 

Discretion: gives you the authority to trade in your client’s account without their permission. This does not necessarily mean you have custody.
 

Okay, now that we’ve got our definitions in order—and we’ve established that we’re talking about custody here, and not simply discretion—let’s get back to the question of whether to custody or not to custody.
 

To this observer, it’s clear that custody is not a bad thing at all, although I feel it has become a taboo word. So…instead of getting caught up in the negative connotation, let us simply and objectively try to understand what actions are required when taking custody under the new rule.
 

What to be prepared for if you DO take custody…

If you decide you are going to start taking custody or continue taking custody, be prepared for any changes you will need to make in your internal operation. These include changes in processes, costs, and resources, to name a few. You will need to fully understand the definitions of the terms being used, speak directly with a custody firm or attorney who is fully versed on the new ruling, and ascertain which of your firm’s practices falls under the custody rule.
 

In doing so, you may need to bring on an additional compliance member on your staff, or spend money on a third-party consultant. Costs will vary. You’ll also be subject to surprise audits—and as mentioned earlier, you may be required to fundamentally alter your processes or monitoring of these processes.
 

And if you DO NOT take custody…

If you decide NOT to take custody, then you and your staff need to be prepared to make changes internally that ensure that none of your actions fall under the custody definition. Like the example of taking custody, this course may entail consulting a custody firm or attorney to help you fully grasp the term. These resources can also help you identify which processes you need to change in order to ensure you are not taking custody.  
 

At the end of the day, deciding whether or not to take custody is your own business decision, and it’s a matter of being prepared for the changes needed. Remember, there’s no “right” or “wrong” decision involved. This is purely business. Custody is not a dirty word.   
 

You Might Also Be Interested In:

comments powered by Disqus