July 28, 2009
PFM Asset Management LLC, a registered investment advisor under the Investment Advisers Act of 1940, objects as follows to the amendments of Rule 206(4)-2 under the Advisers Act proposed by the Commission for comment in Release No. IA-2876; File No. S7-09-09 (“Proposed Amendment”).
It has been helpful to the investment advisor community that the Staff has made available on the Commission’s website the comments which have been submitted on the Proposed Amendment, including prototypes of certain classes of comments.
PFM Asset Management LLC endorses the views expressed in the comments published by the Staff, particularly the objections to the new provision which would subject the accounts managed by an investment advisor and held by an independent custodian to an annual surprise audit, contracted for by the advisor, solely for the reason that the advisor and the client have agreed that the advisor’s periodic fee would be paid on application by the custodian, notwithstanding that the client is furnished with periodic statements of account. There is absolutely no empirical support for such a draconian measure, which represents, according to the Commission’s doubtless conservative estimate, a $77 million gift to the accounting profession.
Even though we support the position that an investment advisor’s agreement with its client that the custodian will pay the advisor’s fee upon invoice is not a satisfactory justification for the burden that the Commission proposes, we believe the following additional points are compelling:
1. Where the contractual arrangement between the advisor and the client permits the advisor to be paid out of funds held by the custodian, any surprise audit of the client’s account should be confined to the reason for the audit - - the fee computation, which is the only financial charge which the advisor can exercise independently. There is no demonstrated need for the auditor to “verify” securities in the hands of a non-affiliated major bank custodian which is required to issue account statements to all clients. And it is unreasonable for the Commission to suggest that an advisor who holds only the authority to be paid for its services might be required to incur the costs of a surprise audit to verify the valuation of securities that are held by the custodian. That evidences a regulatory disposition that the overwhelming number of dutiful investment advisors or their clients should be made to pay dearly for the loss of a horse by reason of the stabler’s inaction.
2. Whatever disposition the Commission makes of the improvident proposal for surprise examinations, there should be an exemption for client relationships which inherently involve protections against abuse. Such are typified by the accounts of PFM Asset Management LLC. All clients of PFM Asset Management affected by the Proposed Amendment are local and state governments, government agencies and various other governmental instrumentalities, or non-profit institutions, all of whose funds are invested in individual accounts or statewide pools. These funds, substantially all of which are invested with reference to Rule 2a-7 under the Investment Company Act, are the property of institutional investors who have operating financial professionals and who are dependent almost exclusively upon the managed funds to make current payrolls and complete bond-financed construction programs. It would be unjustified to presume that such clients would not take notice of any irregularities in the amount deducted for management fees, and it would be an unreasonable burden to impose the cost of surprise audits on accounts in which there is such a substantial amount of traffic and such vigilant professional management.
Joseph J. Connolly
PFM GROUP