July 15, 2009
Securities and Exchange Commission
Proposed Rule: Release IA-2876
Custody of Funds or Securities of Clients by Investment Advisors
We are very concerned about the unnecessary financial burden that the above proposed rule would place on small businesses like ours.
The proposed rule would require that registered investment advisors that have custody of client funds or securities submit to an annual examination by an independent public accountant to verify client funds and securities. Our concern is the expanded definition of “custody” which is revised to include solely the authorization to deduct investment management fees from client accounts.
We believe that there are adequate safeguards to protect client funds and securities without resorting to a costly financial audit if the only reason for the audit is the definition of “custody” to include the authorization to deduct fees from client accounts. Like many registered investment advisors, we do not have custody of any client funds or securities. Client investments are held by our third-party custodian, TD Ameritrade. Clients have online access to their accounts at TD Ameritrade and can see any activity in their accounts at any time. Our custodian also sends monthly account statements directly to the clients.
We send invoices to clients before we deduct our quarterly fees. The invoices describe the calculation of the fee and request that the client review the calculation. The fee deducted is consistent with our contract with the client, and it is shown on the statement sent by our third-party custodian directly to the client.
Additionally, TD Ameritrade blocks the deduction of a fee in excess of three percent, 0.75% quarterly, of the account value. We charge a maximum of 0.25% of account values quarterly, and we run into the control procedure when the fee applies to several accounts. We must explain the reason for the fee before proceeding.
The proposed requirement for an audit by independent public accountants would involve a significant cost, particularly for smaller firms. Appropriate procedures already employed by most RIA firms that deduct fees from client accounts administered by third-party custodians are, we believe, sufficient to protect client funds and securities. Moreover, the SEC periodically audits RIA firms, and its audits are comprehensive and sufficient if the client funds and securities are held by an unrelated, third-party custodian.
It appears that the benefits of the proposed rule with the expanded definition of “custody” do not justify the costs of implementing the rule. The proposed rule does not provide significant additional protection for investors. However, it levies a significant cost that falls most heavily on smaller RIA firms. Certainly the SEC does not want to put small businesses at a disadvantage.
It is understandable that the SEC is focused on preventing the well publicized frauds such as the Madoff and Stanford schemes. Certainly requiring an audit of RIA firms whose clients’ investments are held at an unrelated third-party custodian would not have prevented these frauds. RIA firms must disclose that they deduct fees from client accounts and that they send invoices to clients on their Form ADV. If RIA firms must follow the procedures that we describe above, investors should be adequately protected. An annual financial audit requirement would add no measurable investor protection.
I trust that you will review carefully the effects of the proposed rule before proceeding with its implementation.
Paul J. Corr
Paul J. Corr, CPA/PFS/CFP®
Capital Financial Advisors of New York, LLC