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News March 19, 2012 Issue

Alternative Investments May Have a New Custody "Home"

Once upon a time Ė before December 30, 2009, to be exact Ė the custody rule entirely exempted privately offered securities from its reach. The most recent amendments to the custody rule changed all that, however.

Now, privately offered securities are outside the rule only where ownership of the securities is recorded solely on the issuerís books, and transfer of ownership is subject to the consent of the issuer or the issuerís shareholders. Where private securities are held for the account of a pooled investment vehicle, the custody rule can be avoided only if the pool undergoes an annual audit that is reported to interest holders.

Last month, the SEC may have signaled that alternative investments have another option when it comes to custody for alternative investments that is compliant with the rule.

On February 3, Charles Schwab & Co. received no-action relief from the SECís Division of Trading and Markets that permits it to custody alternative investments with the Depository Trust and Clearing Corporationís (DTCC) Alternative Investment Product (AIP) service. The letter allows that the AIP is a "good control location" for those client assets within the meaning of Securities Exchange Act Rule 15c-3(3).

The DTCC plans to take the relief in the letter a step further, and file a request for a rulemaking on the issue. Although no-action relief from the Division of Trading and Markets may be relied upon by other registrants in similar circumstances, other industry participants may require more concrete guidance. The plan is to leverage the no-action relief and request the adoption of a rule, so that the relief would extend to the whole marketplace, said DTCC director of wealth management services Ann Bergin.

TD Ameritrade and Fidelity have also been working with the AIP service. "Having a standard platform creates a lot of efficiencies," said TD Ameritrade managing director John Tovar.

"The AIP service offers a number of control improvements to the current manual, de-centralized and paper-based mechanisms that are used today for establishing a satisfactory control location for uncertificated securities of alternative investments," said the SECís no-action relief.

That sounds like a good basis for action to embed the policy in a rule.