NASAA Series 65, Uniform Investment Adviser Law ExaminationLaws, Regulations, and Guidelines, including Prohibition on Unethical Business PracticesMedium
A state-registered investment adviser (IA) firm holds client funds and securities. According to NASAA's Model Rule on Custody, which of the following is an acceptable method for the IA to satisfy its custody requirements?
- AReceiving third-party checks payable to the IA for deposit into client accounts, provided the checks clear within 3 business days.
- BHaving a qualified custodian maintain the funds and securities, and sending quarterly account statements to clients.
- CMaintaining client funds and securities in a pooled account under the IA's name, as long as detailed internal records are kept.
- DHolding physical certificates for client securities in a locked safe at the IA's office, accessible only by the chief compliance officer.
Show answer & explanationAnswer & explanation
Correct answer: B. Having a qualified custodian maintain the funds and securities, and sending quarterly account statements to clients.
NASAA's Model Rule on Custody emphasizes the use of a qualified custodian for client funds and securities. The IA must ensure that clients receive quarterly statements directly from the custodian, in addition to any statements the IA provides.
Why the other options are wrong
- A. Receiving third-party checks payable to the IA generally triggers custody and is highly restricted or prohibited unless immediately forwarded to a qualified custodian, not deposited into client accounts by the IA.
- C. Pooled accounts under the IA's name, even with internal records, are generally not permitted unless specific, strict conditions are met (e.g., commingling is prohibited).
- D. Holding physical certificates in the IA's office constitutes custody and requires more stringent safeguards and independent verification than described here.
IA Custody - Qualified Custodian
Under state and federal rules, an investment adviser that has custody of client funds or securities must generally place them with a 'qualified custodian' (e.g., bank, broker-dealer) and ensure clients receive statements directly from this custodian.
- Custody is broadly defined (e.g., direct control, legal ownership, power to withdraw).
- Qualified custodians provide independent oversight.
- Clients must receive direct statements from the custodian.
- Annual surprise audits may be required if the IA itself maintains custody.
Memory trick: Custody's Core: Qualified Custodian, Direct Statements, No IA's Own Safe!