Eleanor Finch
The North American Securities Administrators Association (NASAA) has established rules and guidelines for investment advisers to follow when dealing with client funds and securities. The NASAA Model Custody Rule permits investment advisers to take custody of client assets under specific conditions, including obtaining proper permissions and adhering to state regulations. This rule, which aligns with the SEC custody rule, ensures that investment advisers providing advice for a fee are subject to additional scrutiny when they have direct or indirect access to client funds. The rules aim to protect investors and maintain ethical business practices in the investment adviser industry.
| Characteristics | Values |
|---|---|
| Definition of custody | If an adviser has direct or indirect access to client funds or securities, it is considered to have custody of client funds. |
| Requirements for custody | The adviser must notify the Administrator and ensure that custody is not prohibited by state rules. |
| State rules | States have either adopted the NASAA model custody rule or language similar to either the NASAA model custody rule or the SEC custody rule. |
| NASAA model custody rules | Model Rule 102(e)(1)-1 under the 1956 Uniform Securities Act and Model Rule USA 2002 411(f)-(1) under the 2002 Uniform Securities Act. |
| Amendments | In September 2011, NASAA approved amendments to its custody model rule, aligning it closely to the SEC custody rule. |
| Customer permission | Customer permission is required prior to entering into the contract. |
| Notification | The adviser must notify the Administrator that they have or may have custody. |
| State rules | Custody must not be prohibited by the state's rules. |
| Record-keeping | The adviser must maintain the required records of client assets in its custody. |
| Client statements | The client should receive an itemized statement at least every three months showing the assets in the adviser’s custody and the activity in the account. |
| Audits | A surprise audit of client assets should be conducted at least annually by an independent accountant. |
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What You'll Learn
Custody requirements for state-registered investment advisers
The North American Securities Administrators Association (NASAA) has established rules and guidelines for investment advisers to ensure ethical business practices and protect client interests. The NASAA Model Custody Rule permits investment advisers to take custody of client securities or funds, but only under specific conditions and with proper authorizations. State-registered investment advisers must be familiar with the custody requirements in their respective states, as these rules may vary.
According to the NASAA Model Custody Rule, an investment adviser can take custody of client funds or securities if they obtain prior permission from the client and notify the state Administrator. It is crucial for advisers to ensure that taking custody does not violate the specific state's rules. Most states require investment advisers to register or obtain a license before providing advice for a fee. These regulations aim to protect investors and maintain transparency in the investment advisory industry.
The custody requirements for state-registered investment advisers are designed to safeguard client assets and ensure proper record-keeping. Investment advisers are fiduciaries, obligated to act in their clients' best interests and avoid conflicts of interest. To comply with custody requirements, advisers must maintain client assets in segregated accounts and provide itemized statements to clients at regular intervals, typically quarterly. These statements detail the assets in the adviser's custody and any account activity.
Additionally, the NASAA rules mandate surprise audits of client assets by independent accountants at least annually. This proactive measure helps identify any unethical practices, such as excessive trading, self-dealing, or unauthorized transactions. Investment advisers must also adhere to disclosure requirements, ensuring that clients are informed about all aspects of their relationship and any potential conflicts. These disclosures enable clients to make informed decisions and hold advisers accountable for their actions.
While the NASAA Model Custody Rule sets a standard for the industry, individual states may have variations in their custody rules. Some states have adopted the NASAA model directly, while others have made amendments to suit their specific needs. As a result, state-registered investment advisers must be diligent in understanding the specific custody requirements in their jurisdiction to ensure compliance and maintain the trust of their clients.
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Client permission
The North American Securities Administrators Association (NASAA) has established a set of rules and guidelines that govern the conduct of investment advisers and ensure the protection of their clients' interests. Among these rules is the NASAA Model Custody Rule, which outlines the conditions under which an investment adviser may take custody of client securities or funds.
One of the critical requirements for an investment adviser to obtain custody under the NASAA Model Custody Rule is to obtain client permission. This means that prior to entering into any contractual agreement, the adviser must obtain explicit authorisation from the client, granting them permission to take custody of their securities or funds. This authorisation ensures that the client is aware of and consents to the adviser's access to and control over their assets.
The requirement for client permission is a fundamental aspect of the NASAA Model Custody Rule and is designed to protect the interests and rights of investors. By obtaining explicit consent, investment advisers ensure that their actions align with the wishes and expectations of their clients. This authorisation also helps to establish a clear understanding between the adviser and the client regarding the nature and scope of the services provided.
In addition to obtaining client permission, the NASAA Model Custody Rule mandates that investment advisers fulfil several other conditions before taking custody of client assets. One such requirement is the notification to the relevant state Administrator. Investment advisers must inform the securities regulator within the state where they operate that they have or may have custody of client assets. This notification process ensures that the appropriate authorities are aware of the adviser's activities and can provide oversight and protection for investors.
Furthermore, the NASAA Model Custody Rule emphasises the importance of record-keeping and disclosure requirements. Investment advisers are typically obligated to maintain detailed records of the client assets in their custody and provide transparent and frequent account statements to their clients. These statements offer investors visibility into the activity within their accounts and enable them to monitor their assets and identify any discrepancies or unauthorised transactions. Regular disclosure of account information is a key aspect of safeguarding client assets and promoting transparency in the investment advisory relationship.
While the NASAA Model Custody Rule provides a framework for investment advisers to operate within, it is essential to recognise that individual states may have their own specific regulations and requirements. These state rules can further dictate the conditions under which investment advisers are permitted to take custody of client assets. As such, investment advisers must be diligent in understanding and complying with the laws and regulations of the state(s) in which they are registered or seeking registration to ensure full adherence to the applicable custody requirements.
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State rules and regulations
The North American Securities Administrators Association (NASAA) has a set of model rules that states can choose to adopt, including the NASAA Model Custody Rule, which outlines the regulations governing how IAs can take custody of client securities or funds. Under this rule, an IA is allowed to have custody if specific conditions are met, including obtaining the proper permissions and notifying the appropriate authorities, namely the state Administrator. This means informing the relevant securities regulator that they have or may have custody of client assets and ensuring that taking custody is not in violation of the state's rules.
In addition to the NASAA Model Custody Rule, there are also state-specific rules that IAs must comply with. For example, some states have adopted the NASAA model custody rule, while others have language similar to either the NASAA model custody rule or the SEC custody rule. As such, it is important for IAs to be familiar with the custody requirements in the state(s) in which they are registered or seeking registration.
Furthermore, the anti-fraud provisions of the Investment Advisers Act of 1940, the NASAA Model Rule on Unethical Business Practices of Investment Advisers, and most state laws impose a fiduciary duty on IAs to act in the best interests of their clients. This includes avoiding conflicts of interest and maintaining impartiality in their recommendations. To ensure compliance with these rules, IAs may be subject to surprise audits of client assets by an independent accountant at least annually.
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Record-keeping and disclosure requirements
Investment advisers and investment adviser representatives are persons who provide advice to others about investments for a fee and are required by most states to register or become licensed. The North American Securities Administrators Association (NASAA) has developed a set of guidelines and rules, known as the NASAA Model Rules, that govern the conduct of investment advisers and protect the interests of investors. These rules include regulations related to record-keeping, disclosure requirements, and the custody of client funds or securities.
Regarding record-keeping and disclosure requirements, investment advisers have specific obligations to ensure compliance and maintain the trust of their clients. Firstly, advisers must maintain accurate and up-to-date records of all client assets in their custody. This includes maintaining segregated accounts for each client and providing itemized statements to clients at regular intervals, typically at least once every three months. These statements should detail the assets in the adviser's custody and reflect any activity in the account. Additionally, investment advisers are encouraged to conduct surprise audits of client assets at least annually, performed by an independent accountant, to ensure the integrity of their record-keeping practices.
Another critical aspect of record-keeping is obtaining proper permissions and providing notifications to relevant authorities. Before entering into a contract, investment advisers must obtain customer permission to take custody of their securities or funds. Additionally, they are required to notify the state Administrator, typically the securities regulator within the state where they operate, of their custody or potential custody of client assets. This notification process ensures that the investment adviser complies with state rules and that custody is not prohibited by those rules.
The disclosure requirements for investment advisers are equally important. Advisers must provide full disclosure of all information relating to their relationship with their clients. This includes disclosing any conflicts of interest, such as holding positions or licenses that may influence their recommendations. In cases where the adviser has discretionary authority over the client's account, they must be vigilant in avoiding excessive trading, self-dealing, preferential treatment, unsuitable recommendations, unauthorized transactions, and incomplete disclosure.
To enhance investor protection, NASAA has proposed and implemented various rules and revisions over the years. For instance, NASAA's Investment Adviser Section and Investment Adviser Regulatory Policy and Review Project Group have worked to address changes made by the U.S. Securities and Exchange Commission (SEC) to its custody and brochure rules. These efforts aim to maintain high standards of investor protection while aligning with corresponding SEC rules and revisions to Form ADV.
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Conflicts of interest
According to the NASAA rules, conflicts of interest should be avoided whenever possible. However, it is recognised that some conflicts are inevitable, such as when an individual is licensed as both a securities agent of a broker-dealer and an adviser. In such cases, advisers must clearly and accurately describe the conflicts and explain how they will maintain impartiality in their recommendations to clients. This disclosure is crucial to ensuring that clients are fully informed and that advisers act in their clients' best interests.
The NASAA Investment Adviser Regulatory Policy and Review Project Group plays a vital role in this regard. The group is responsible for reviewing and amending the NASAA model rules to address changes made by the U.S. Securities and Exchange Commission (SEC) to its custody and brochure rules for investment advisers. This includes ensuring that the increased investor protection standards required by states are maintained while aligning with corresponding SEC rules.
One example of a conflict of interest that NASAA aims to prevent is an adviser's discretionary authority over a client's account. Advisers with custody of client assets must comply with rules relating to safeguarding those assets. This includes maintaining segregated accounts, providing itemised statements to clients at least quarterly, and undergoing surprise audits by independent accountants. By enforcing these rules, NASAA helps prevent conflicts of interest that could lead to excessive trading, self-dealing, preferential treatment, unsuitable recommendations, unauthorised transactions, or incomplete disclosure.
In summary, conflicts of interest in the investment adviser industry are addressed through a combination of regulatory requirements, disclosure obligations, and ongoing scrutiny of advisers' activities to ensure compliance with custody rules and fiduciary duties. These measures aim to protect investors and maintain the integrity of the investment adviser industry.
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Frequently asked questions
Custody, under NASAA rules, is defined as an investment adviser having direct or indirect access to client funds or securities. This access is subject to additional scrutiny and advisers must comply with the rules relating to safeguarding client assets.
Under the NASAA Model Custody Rule, an investment adviser must notify the state Administrator and ensure that custody is not prohibited by state rules. Customer permission must also be obtained prior to entering into any contract.
Investment advisers with custody of client assets must provide investors with detailed quarterly account statements. Additionally, clients must receive an itemized statement at least every three months showing the assets in the adviser's custody and the activity in the account.
