It is becoming more common to find clauses in custodial agreements that lead to the SEC informing you that your RIA has custody of client accounts. On September 19, 2016, Bob Veres wrote an article titled “The Hidden Risk in your Custodial Agreements”. The article highlighted the fact that the checks and balances relationship between the custodian and fiduciary advisor is breaking down. Custodians are moving more of their responsibilities to Registered Investment Advisors.
One example Veres highlights is the Schwab Advisor Services Account Agreement. The Schwab Agreement includes a clause which reads as follows:
Trading and Disbursement Authorization. By checking the circle and signing this Application, I authorize Schwab (1) to execute trades in my account at the direction of IA as provided under the Trading Authorization heading in the attached Schwab One® Account Application Agreement; (2) to disburse assets for investment purposes or to me personally, as instructed by IA; (3) to remit checks, wire funds and make certain disbursement of funds held in the account as regulations permit (i) to banks, broker-dealers, investment companies or other financial institutions for credit to an account of identical registration, or (ii) to me at my address of record. This disbursement authorization does not apply to Schwab Moneylink® distributions or direct, ongoing electronic payments of dividends, interest and money market income. I acknowledge and agree that Schwab cannot confirm the account registration at the receiving financial institution and will rely solely on the representations of my IA as to the identical registration of the receiving accounts. (Note: This option is not available for Estate, Guardianship or Conservatorship accounts in the name of the aforementioned account types.) (emphasis added)
The clause has been interpreted as informing your client that your RIA firm has the authority to wire funds to a third-party account and the client is responsible for ensuring the assets are ,transferred to the correct account. The clause removes any responsibility from the custodian to ensure the correct transfer of the assets. With the absence of verification from the custodian, third party asset transfers are concerning to the SEC. Also, now the question arises of who maintains custody of client assets. Many RIA firms as well as custodians have asked the SEC to clarify this issue.
The custody issue is not unique to the Schwab Advisor Services Account Agreement. Other custodians, including Fidelity, have agreements that contain language leading to confusion on who has custody of the client’s assets. Fidelity’s Asset Movement Authorization form now includes Level Zero: You have not authorized Fidelity to accept instructions from your Authorized agent/Advisor to distribute assets from your account without direct written instructions from you, to help add clarity of who maintains custody of client assets. If the client selects Level 1, Level 2, or Level 3 as an option, the selection may lead to the SEC determining that your RIA firm has custody of client assets.
The importance of reviewing your custodial agreement for custody is becoming more important than ever. RIA firms want to avoid an SEC deficiency letter indicating you have custody, and hiring an accounting firm to conduct surprise audits can be a costly expense.
About Red Oak Compliance Solutions
Red Oak Compliance Solutions is a leading provider of intelligent compliance software, offering a range of AI-powered solutions designed to help firms of all sizes successfully navigate the increasingly complex regulatory landscape. Our suite of 17(a)-4/WORM compliant features offer risk minimization, cost reduction, and process optimization capabilities with features that are designed to evolve with our client’s needs. Our flagship advertising review software enables firms to deliver compliant content to the market with confidence, faster. Our Disclosure Management and Intelligence solution simplifies the management of disclosures, while our Registration Management solution automates and streamlines the licensing and registration process, further enhancing your internal processes.