
[Federal Register: January 11, 2010 (Volume 75, Number 6)]
[Rules and Regulations]               
[Page 1492-1494]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11ja10-12]                         

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 276

[Release Nos. IA-2969; FR-81]

 
Commission Guidance Regarding Independent Public Accountant 
Engagements Performed Pursuant to Rule 206(4)-2 Under the Investment 
Advisers Act of 1940

AGENCY: Securities and Exchange Commission.

ACTION: Interpretation.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is 
publishing interpretive guidance for independent public accountants in 
connection with the adoption of amendments to Rule 206(4)-2 under the 
Investment Advisers Act of 1940 (the ``Custody Rule''). This guidance 
provides direction with respect to the independent verification and 
internal control report as required under the amended Custody Rule.

DATES: Effective Date March 12, 2010.

FOR FURTHER INFORMATION CONTACT: General questions about this release 
should be referred to Bryan J. Morris, Assistant Chief Accountant, 
Jaime L. Eichen, Assistant Chief Accountant, or Richard F. Sennett, 
Chief Accountant at (202) 551-6918 or IMOCA@sec.gov, Office of the 
Chief Accountant, Division of Investment Management, U.S. Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-8626. 
Questions about Rule 206(4)-2 should be directed to staff of the Office 
of Investment Adviser Regulation, Division of Investment Management, 
U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, 
DC 20549-8549 at (202) 551-6787 or IArules@sec.gov.

SUPPLEMENTARY INFORMATION:

I. Background

    Rule 206(4)-2(a) under the Investment Advisers Act of 1940 (the 
``Act'') provides, among other things, that it is a fraudulent, 
deceptive or manipulative act, practice, or course of business within 
the meaning of Section 206(4) of the Act for any investment adviser 
registered (or required to be registered) under Section 203 of the Act 
(herein ``investment adviser'') to have custody of client funds or 
securities unless:
    (1) A qualified custodian maintains those funds and securities in a 
separate account for each client under that client's name; or in 
accounts that contain only clients' funds and securities, under the 
investment adviser's name as agent or trustee for the clients;
    (2) Clients are notified promptly in writing of the qualified 
custodian's name, address, and the manner in which the funds or 
securities are maintained, when an account is opened by an investment 
adviser on a client's behalf and following any changes to this 
information; and
    (3) The investment adviser has a reasonable basis, after due 
inquiry, for believing that the qualified custodian sends an account 
statement, at least quarterly, to each of its clients for which it 
maintains funds or securities, identifying the amount of funds and of 
each security in the account at the end of the period and setting forth 
all transactions in the account during that period.
    Rule 206(4)-2(a) generally requires that client funds and 
securities of which an investment adviser has custody under the rule be 
verified by actual examination at least once during each calendar year 
by an independent public accountant \1\ (``accountant''), pursuant to a 
written agreement, between the investment adviser and the accountant, 
at a time that is chosen by the accountant without prior notice or 
announcement to the investment

[[Page 1493]]

adviser and that is irregular from year to year.
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    \1\ If the investment adviser itself or a related person 
maintains clients' funds and securities as qualified custodian, the 
independent public accountant must be registered with, and subject 
to inspection by, the Public Company Accounting Oversight Board 
(``PCAOB''). See Rule 206(4)-2(a)(6)(i).
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II. Independent Verification of Funds and Securities

    The objective of the accountant's examination \2\ is to verify that 
client funds and securities of which an investment adviser has custody 
are held by a qualified custodian in a separate account for each client 
under that client's name, or in accounts that contain only clients' 
funds and securities, under the investment adviser's name as agent or 
trustee for the clients. The accountant should obtain from the 
investment adviser records that detail client funds and securities of 
which the investment adviser has custody and the identification of the 
qualified custodian(s) of those funds and securities.\3\ The accountant 
should also obtain records of accounts that were closed during the 
period or that have a zero balance as of the date of the examination.
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    \2\ The examination is a compliance examination to be conducted 
in accordance with American Institute of Certified Public 
Accountants' (``AICPA'') attestation standards. See AT Section 601, 
Compliance Attestation (``AT 601'').
    \3\ Rule 204-2(b) under the Act requires that an investment 
adviser who has custody or possession of funds and securities of any 
client must record all transactions for such client in a journal and 
in separate ledger accounts for each client and must maintain copies 
of confirmations of all transactions in such accounts and a position 
record for each security in which a client has an interest. Rule 
204-2(h) of the Act indicates that records maintained and preserved 
in compliance with Rules 17a-3 and 17a-4 under the Securities 
Exchange Act of 1934 (i.e., records maintained by a broker-dealer) 
can be deemed to satisfy the requirements of Rule 204-2(b), provided 
that they are substantially the same types of records. See Rule 204-
2(b) and Rule 204-2(h) under the Act.
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    For a sample of client accounts, the accountant should obtain 
records of the purchases, sales, contributions, withdrawals and any 
other debits or credits to each selected client's account occurring 
since the date of the last examination. The accountant's procedures to 
meet the objective of the examination should normally include, but are 
not limited to, the following with respect to each selected client 
account:
     Confirmation with the qualified custodian(s) of client 
funds and securities as of the date of the examination and that the 
client's funds and securities are held in either a separate account 
under the client's name or in accounts under the name of the investment 
adviser as agent or trustee for clients;
     Confirmation with the client of funds and securities held 
in the account as of the date of the examination and contributions and 
withdrawals of funds and securities to and from the account since the 
date of the last examination; where confirmation replies are not 
received, the accountant should perform alternative procedures; and
     Reconciliation of confirmations received and other 
evidence obtained to the investment adviser's records.

Privately Offered Securities

    Rule 206(4)-(2)(b)(2) generally exempts privately offered 
securities from the qualified custodian requirements established under 
Rule 206(4)-(2)(a)(1).\4\ Under the rule, a privately offered security 
is a security that is:
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    \4\ The exemption provided by the rule is available with respect 
to securities held for the account of a limited partnership (or a 
limited liability company, or other type of pooled investment 
vehicle) only if the limited partnership is audited, and the audited 
financial statements are distributed, as described in paragraph 
(b)(4) of the rule.
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    (1) Acquired from the issuer in a transaction or chain of 
transactions not involving any public offering;
    (2) Uncertificated, and ownership thereof is recorded only on the 
books of the issuer or its transfer agent in the name of the client; 
and
    (3) Transferable only with prior consent of the issuer or holders 
of the outstanding securities of the issuer.
    The accountant's verification procedures with respect to any 
privately offered security selected for testing should include 
confirmation with the issuer of or counterparty to the security, or, 
where replies are not received, alternative procedures.

Reporting--Independent Verification

    The accountant's examination report should include an opinion as to 
whether, with respect to the rules under the Act, the investment 
adviser was in compliance, in all material respects, with paragraph 
(a)(1) of Rule 206(4)-2 as of the examination date and had been 
complying with Rule 204-2(b) during the period since the prior 
examination date. The accountant should identify the date as of which 
the examination was made within the report.
    Pursuant to the written agreement required under Rule 206(4)-
2(a)(4), upon finding any material discrepancy during the course of the 
examination, the accountant should notify the Commission within one 
business day of the finding, by means of a facsimile transmission or 
electronic mail, followed by first class mail, directed to the 
attention of the Director of the Office of Compliance Inspections and 
Examinations. For purposes of this examination, a material discrepancy 
is material non-compliance with the provisions of either Rule 206(4)-2 
or Rule 204-2(b) under the Act.\5\
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    \5\ Reporting on material non-compliance is discussed within AT 
601 of the AICPA attestation standards. See AT 601.
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    Pursuant to the written agreement required under Rule 206(4)-
2(a)(4), the examination should be completed and the resulting 
examination report should be filed on Form ADV-E by the accountant 
within 120 days of the time chosen by the accountant. The accountant 
should also file Form ADV-E with the Commission upon resignation or 
dismissal from, or other termination of, the engagement, or upon 
removing itself or being removed from consideration for being 
reappointed within four business days. Such filing should be 
accompanied by a statement that includes:
    (1) The date of such resignation, dismissal, removal, or other 
termination, and the name, address, and contact information of the 
accountant; and
    (2) An explanation of any problems relating to examination scope or 
procedure that contributed to such resignation, dismissal, removal, or 
other termination.

III. Internal Control Report

    Rule 206(4)-2(a)(6) establishes additional requirements for an 
investment adviser that itself, or its related person, maintains client 
funds or securities as a qualified custodian in connection with 
advisory services provided to clients. Such an investment adviser must 
at least once each calendar year obtain or receive from its related 
person an internal control report related to its or its affiliates' 
custody services, including the safeguarding of funds and securities, 
prepared by an independent public accountant that is registered with, 
and subject to inspection by, the PCAOB.\6\
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    \6\ A Type II SAS 70 Report conducted in accordance with AU 
Section 324, Service Organizations (``AU 324'') of the AICPA 
auditing standards would be sufficient to satisfy the requirements 
of the internal control report. In addition to the Type II SAS 70 
Report, an examination on internal control conducted in accordance 
with AT 601 would also be sufficient.
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    The objective of the examination supporting the internal control 
report is to obtain reasonable assurance that the qualified custodian's 
controls have been placed in operation as of a specific date, and are 
suitably designed and are operating effectively to meet control 
objectives related to custody of funds and securities during the period 
specified. The internal control report should address control 
objectives and associated controls related to the areas of client 
account setup and

[[Page 1494]]

maintenance, authorization and processing of client transactions, 
security maintenance and setup, processing of income and corporate 
action transactions, reconciliation of funds and securities to 
depositories and other unaffiliated custodians, and client reporting. 
Control objectives addressing these areas should include--
     Documentation for the opening and modification of client 
accounts is received, authenticated, and established completely, 
accurately, and timely on the applicable system.
     Client transactions, including contributions and 
withdrawals, are authorized and processed in a complete, accurate, and 
timely manner.
     Trades are properly authorized, settled, and recorded 
completely, accurately, and timely in the client account.
     New securities and changes to securities are authorized 
and established in a complete, accurate and timely manner.
     Securities income and corporate action transactions are 
processed to client accounts in a complete, accurate, and timely 
manner.
     Physical securities are safeguarded from loss or 
misappropriation.
     Cash and security positions are reconciled completely, 
accurately and on a timely basis between the custodian and 
depositories.
     Account statements reflecting cash and security positions 
are provided to clients in a complete, accurate and timely manner.
    Rule 206(4)-2(a)(6)(ii)(B) states that, as part of the internal 
control report, the independent public accountant must verify that 
funds and securities are reconciled to a custodian other than the 
adviser or its related person (for example, the Depository Trust 
Corporation). The accountant's tests of the custodian's 
reconciliation(s) should include either direct confirmation, on a test 
basis, with unaffiliated custodians or other procedures designed to 
verify that the data used in reconciliations performed by the qualified 
custodian is obtained from unaffiliated custodians and is unaltered.

Reporting--Internal Control Report

    The accountant's internal control report should identify the 
control objectives included within the scope of the examination and 
include the accountant's opinion as to whether controls have been 
placed in operation as of the specific date, and are suitably designed 
and are operating effectively to meet the identified control objectives 
during the specified period. The report should also describe the 
nature, timing, extent and results of the accountant's procedures 
performed to verify that funds and securities are reconciled to 
depositories and other unaffiliated custodians.\7\
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    \7\ Paragraph .62 of AU 324 discusses reporting on substantive 
procedures as part of a Type II SAS 70 report. See AU 324.
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IV. Relationship Between Independent Verification and Internal Control 
Report

    When performing an independent verification of client funds and 
securities for an investment adviser that itself, or its related 
person, maintains custody as a qualified custodian, the accountant 
should obtain a copy of the most recently issued internal control 
report and determine whether there are any findings in the internal 
control report that would affect the nature and extent of his or her 
procedures. If findings within the internal control report indicate 
information provided by the qualified custodian may not be reliable, 
the accountant should consider whether the circumstances warrant the 
issuance of a qualified or adverse opinion, or a disclaimer of opinion.
    If a significant period of time has elapsed since the issuance of 
the internal control report, the accountant should perform appropriate 
procedures to determine whether there have been significant changes to 
the procedures and controls related to custody at the qualified 
custodian since the date of the report. If significant changes have 
occurred, the accountant should perform procedures to update his or her 
understanding of whether the controls at the qualified custodian have 
been placed in operation, are suitably designed, and are operating 
effectively to meet the identified control objectives, as appropriate 
in the circumstances. The accountant can perform these procedures 
directly or can request that the accountant that prepared the internal 
control report perform such procedures.

V. Codification Update

    The ``Codification of Financial Reporting Policies'' announced in 
Financial Reporting Release No. 1 (April 15, 1982) [47 FR 21028] is 
updated by replacing Section 404.01.b. Investment Advisers with the 
text in Sections I, II, III, and IV of this release. The Codification 
is a separate publication of the Commission. It will not be published 
in the Federal Register/Code of Federal Regulations.

List of Subjects in 17 CFR Part 276

    Reporting and recordkeeping requirements, Securities.

Amendments to the Code of Federal Regulations

0
For the reasons set out in the preamble, the Commission is amending 
title 17, chapter II of the Code of Federal Regulations as set forth 
below:

PART 276--INTERPRETATIVE RELEASES RELATING TO THE INVESTMENT 
ADVISERS ACT OF 1940 AND GENERAL RULES AND REGULATIONS THEREUNDER

0
Part 276 is amended by adding Release No. IA-2969 and the release date 
of December 30, 2009 to the list of interpretive releases.

    Dated: December 30, 2009.

    By the Commission.
Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-19 Filed 1-8-10; 8:45 am]
BILLING CODE 8011-01-P

