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News March 16, 2009 Issue

SEC to Post ‘Down the Chain’ Custody Confirmation Letter and Form on SEC Website

So by now you’ve probably heard that the SEC examination staff is going to be confirming custody of assets "down the chain" by contacting advisory firm clients directly, asking them what they think the value of their assets is and inquiring about specific transactions, and then comparing the client-provided information to account values provided by the adviser. (See ACA Insight, February 23, 2009, "Gohlke: SEC Examiners Will Check Custody by Confirming Balances Directly with Firm Clients.")

Early last week, SEC associate director Gene Gohlke issued a letter to two industry trade groups — the Investment Adviser Association and the Money Management Institute — describing the nature of the examiners’ inquiry: "In requesting confirmations from advisory clients, the examination staff will ask clients to confirm that their account balances as of a specific date were consistent with their records and that their contributions to and withdrawals from their accounts over a period of time were transactions they authorized," said the letter. "Please be advised that these account confirmation requests should not be considered as an indication by the Commission or its staff that any violations of law have occurred, nor should these requests be construed as an adverse reflection upon the adviser or any person or entity associated with the firm," the letter added.

Despite that assurance, advisers were nervous. "Won’t this freak out the clients?" asked one attendee at last week’s IA Week/IAA conference. In light of the Madoff scandal, many advisers last week expressed concern that their advisory clients might misconstrue the SEC’s inquiry as a sign that their money manager was being investigated for fraud. These advisers questioned how they could effectively reassure their clients that the SEC was, instead, conducting a routine custody review.

In an apparent effort to address these concerns, OCIE chief counsel John Walsh subsequently announced that the SEC staff will publicly post a copy of the letter and form that will be sent to advisory firm clients. "It is our expectation that we will publicly release the confirmation form and the letter, so that it can be reviewed by any adviser and any advisory client," Walsh told ACA Insight in an interview. Walsh said that he hoped the letter and form will be published on OCIE’s page on the SEC’s public website in a matter of days (although, he noted, it may take longer than that). "We’re doing this so that all advisers and potentially all advisory clients can see the nature of the request we are making" and the form of the request. Walsh declined to specify the exact language that would be used in the letter, but expressed confidence that the language "will make it plain" that the request for confirmation is now a standard step in the SEC examination process of registered investment advisers.

The practical upshot: Once the letter and form are posted on the SEC’s website, advisers wanting to proactively head off any client worries about SEC examiners’ interest in their assets will be able to simply point clients to the SEC’s website for proof that seeking custody confirmations directly from advisory firm clients is now a routine SEC examination procedure for all SEC-registered advisers. Various speakers at the IA Week/IAA conference agreed that advisers should proactively notify clients that this custody review is now routine. "Tell them this is going to happen," advised Nuveen CCO Mary Keefe. Of course, advisers should consider whether they want to notify clients ahead of time, even though there may be no actual SEC examination in sight, or whether they want to wait until the start of their next exam.

Walsh, speaking at the conference, encouraged the idea of "advisers actually getting involved" and "helping their clients understand" the nature of inquiry. However, he indicated that the SEC staff would not look favorably on situations where an advisory firm appears to be taking steps to encourage clients not to cooperate with the examiners.