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 in a qualified custodian. The IA sends its own statements to clients on a quarterly basis. These statements, however, do not contain a legend advising clients to compare them to statements received directly from their custodian. Under NASAA's Model Rule on Custody, what is the regulatory implication?
- AThe IA is in violation for not having an annual surprise audit, which is implied by sending its own statements.
- BThe IA is in violation of custody rules for not including the required legend on its statements.
- CThis practice is acceptable as long as the IA's statements are accurate and timely.
- DThe IA is in violation because it is sending its own statements, which is only allowed for SEC-registered IAs.
Show answer & explanationAnswer & explanation
Correct answer: B. The IA is in violation of custody rules for not including the required legend on its statements.
When an IA with custody sends its own statements to clients, NASAA's Model Rule explicitly requires that these statements include a legend urging clients to compare them with the statements received directly from the qualified custodian. This is a crucial safeguard to help detect discrepancies and potential fraud.
Why the other options are wrong
- A. While an annual surprise audit is a custody requirement, the lack of a legend on statements is a separate, distinct violation.
- C. Accuracy and timeliness are necessary but not sufficient; the legend is a specific requirement.
- D. IAs (both state and SEC) can send their own statements, but with specific requirements like the legend.
IA Custody: Statement Legend
A mandatory disclosure on investment adviser-generated client statements when the IA has custody, advising clients to compare these statements with those from the qualified custodian.
- Required when IA sends its own statements.
- Promotes transparency and fraud detection.
- Ensures clients cross-reference information.
- Part of NASAA's Model Rule on Custody.
Memory trick: Statements from IA need a 'compare me' note.