In late 2009, the SEC adopted amendments to Rule 206(4)-2 (Custody Rule) under the Investment Advisers Act of 1940, as amended (Advisers Act).  (The Hedge Fund Law Report has analyzed the implications of the amended Custody Rule for, among other things, compliance policies and procedures; the balance of power between hedge fund managers and accountants; structuring of managed accounts; internal control reporting; and hedge fund liquidations.)  As amended, the Custody Rule provides that any investment adviser deemed to have custody of client securities or assets – and most hedge fund managers would have deemed custody within the Custody Rule’s broad definition of custody – is required to undergo an annual surprise examination conducted by an independent public accountant.  However, an adviser to a pooled investment vehicle (such as a hedge fund) is excepted from the surprise examination requirement if its hedge fund is audited annually in accordance with GAAP by “an independent public accountant that is registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by, the Public Company Accounting Oversight Board (PCAOB) in accordance with its rules” (Annual Audit Exception).  The exemption also requires a hedge fund manager to distribute the relevant fund’s audited financial statements to investors within 120 days (180 days for funds of funds) of the fund’s fiscal year-end.  For hedge fund managers, the Annual Audit Exception provided welcome relief from the annual surprise examination requirement of the Custody Rule.  However, two of the requirements of the Annual Audit Exception proved difficult for hedge fund managers to comply with in practice.  This article analyzes recent SEC guidance applicable to hedge fund managers relying on the Annual Audit Exception.