SEC No-Action Letter Eliminates Surprise Examination Requirement Under Custody Rule for Certain Sub-Advisers

In 2009, in the wake of the Madoff Ponzi scheme and other adviser frauds, the SEC revised Rule 206(4)-2 under the Investment Advisers Act of 1940, the so-called “custody rule.” See “SEC Adopts Investment Adviser Custody Rule Amendments” (Jan. 6, 2010). A critical element of the revised rule is that, absent an applicable exception, an adviser with custody of client funds or securities must undergo a surprise annual examination by an independent public accountant to verify custody. The revised custody rule requires both a sub-adviser and a related primary adviser to have a surprise annual exam when the primary adviser (or an affiliate) also serves as the qualified custodian. The SEC recently issued a no-action letter indicating that it would not take enforcement action against a sub-adviser in such circumstances if certain conditions are met. This article summarizes the terms of the relief provided by the SEC. For examples of the SEC’s severe treatment of custody rule violations, see “Repeat Custody Rule Offenders Face Severe SEC Sanctions” (Dec. 10, 2015); and “SEC Sanctions Two Private Fund Managers for Custody Rule Violations, Including Imposing Statutory Bars on Their Chief Compliance Officers” (Nov. 8, 2013).

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