U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Investment Company Act of 1940
Investment Company Institute

RESPONSE OF THE OFFICE OF CHIEF COUNSEL
DIVISION OF INVESTMENT MANAGEMENT

September 5, 2012
Our Ref. No. 2012961030
Investment Company Institute
File No. 132-3

Your letter dated August 31, 2012 requests our assurance that we would not recommend enforcement action to the Securities and Exchange Commission (“Commission”) under Section 206(4) of the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 206(4)-2 thereunder (“Custody Rule”) against an investment adviser if it treats a state-created 529 plan trust that is a college savings plan for which it is a program manager (“529 Plan”) as a “pooled investment vehicle” for purposes of the Custody Rule, as described in your letter.

Facts

You state the following: qualified state tuition programs are college savings plans sponsored by states to help families save for future college costs.1 They enable individuals to accumulate savings for qualifying higher education costs of beneficiaries by purchasing interests in a state-created 529 plan trust. Proceeds from sales of 529 plan trust interests are in turn invested in one or more investment options selected by the accountholder. These investment options must be eligible under Section 529 of the Internal Revenue Code. Any earnings on these interests are tax deferred and may be withdrawn on a tax-free basis if used to pay for a qualified educational expense.

Generally speaking, states offering 529 plan programs contract with an investment adviser that is registered under the Advisers Act to act as the 529 Plan trust’s program manager (a “Program Manager”). The Program Manager makes arrangements with service providers on behalf of the state-created 529 Plan trust to service the 529 Plan and to invest the 529 Plan’s proceeds in appropriate investments, typically mutual funds. The Program Manager contracts with at least one custodian to maintain custody of the 529 Plan’s assets. You represent that each custodian is a “qualified custodian” as defined by paragraph (d)(6) of the Custody Rule. The Program Manager also contracts with a transfer agent that is registered under the Securities Exchange Act of 1934 (“1934 Act”) to be the 529 Plan’s recordkeeper.2 The transfer agent receives 529 Plan accountholders’ account applications and contributions, confirms the opening of the account and deposits the contributions in an account at the Fund’s custodian. The transfer agent also maintains individual account records, among other things.3

You believe that Program Managers have custody of client funds or securities under the Custody Rule. Therefore, you are concerned that the Custody Rule would require Program Managers to undergo a surprise examination of those assets by an independent public accountant. Under the circumstances described further below and in your letter, you request that a 529 Plan be treated as a “pooled investment vehicle” for purposes of the Custody Rule. Accordingly, you request relief from certain of the Custody Rule’s requirements, as described below.

Analysis

The Custody Rule provides that it is a fraudulent, deceptive or manipulative act, practice or course of business within the meaning of Section 206(4) of the Advisers Act for an investment adviser that is registered or required to be registered under the Advisers Act to have “custody” of client funds or securities unless they are maintained in accordance with the requirements of the rule. The Custody Rule is designed to protect client assets from being lost, misused, misappropriated or subject to investment advisers’ financial reverses.

Paragraph (a)(1) of the Custody Rule requires an investment adviser that has custody of client funds and securities to maintain them with a “qualified custodian” as defined in paragraph (d)(6) of the rule. Paragraph (d)(6) of the Custody Rule defines qualified custodian to include, among others, certain banks, registered broker-dealers and futures commission merchants and certain foreign financial institutions. You represent that the 529 Plan’s custodians are “qualified custodians” as defined by paragraph (d)(6) of the Custody Rule.

Paragraph (a)(4) of the Custody Rule requires an investment adviser with custody of client funds and securities to have those assets verified by an independent public accountant by a surprise examination at least once during each calendar year, among other things. Paragraph (b)(4) generally provides that an adviser to any limited partnership, limited liability company, or other type of pooled investment vehicle (“pooled investment vehicle”) that is subject to audit (as defined in Rule 1-02(d) of Regulation S-X) shall be deemed to comply with the surprise examination requirements of the Custody Rule by obtaining an audit of the pooled investment vehicle and distributing the audited financial statements to pooled investment vehicle limited partners (or members or other beneficial owners) within 120 days of the pooled investment vehicle’s fiscal year end. The audit must be conducted by an independent public accounting firm registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board (“PCAOB”).

You are concerned that 529 Plans may not be pooled investment vehicles under the Custody Rule. You represent that the 529 Plan can nonetheless satisfy most of the conditions in paragraph (b)(4) of the Custody Rule. You contend that your representations will address the unique structure of 529 Plans and provide 529 Plan accountholders with comparable custody protections as holders of pooled investment vehicles. You also assert that the surprise examination would not significantly add to these protections.

In particular, you represent that, consistent with paragraph (b)(4) of the Custody Rule for a pooled investment vehicle, the 529 Plan is subject to an annual financial statement audit (as defined in Rule 1-02(d) under Regulation S-X) by an independent public accountant that is registered with, and subject to regular inspection by the PCAOB in accordance with its rules.4 You further represent that the audit is conducted in accordance with generally accepted auditing standards (“GAAS”) and that the audited financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).5

You assert that during the course of the financial statement audit, the independent public accountant performs procedures that are comparable to those performed as part of a surprise examination under the Custody Rule. You also assert that the 529 Plan’s financial statement audits address additional matters important to the 529 Plan (and 529 Plan accountholders) that are not covered by a surprise examination performed pursuant to the Custody Rule, such as tests of valuation of the 529 Plan’s investments, income, operating expenses, and, if applicable, incentive fees and allocations that accrue to the Program Manager.6 You represent that the independent public accountant also obtains an understanding of the 529 Plan recordkeeper’s internal controls over the processing of investor transactions either through obtaining a SSAE 16 report on the recordkeeper’s internal control environment or by directly evaluating its internal control environment. You further represent that the 529 Plan’s recordkeeper will be registered as a transfer agent under the 1934 Act, and believe that the applicable 1934 Act rules provide important protections to the 529 Plan accountholders.7

With respect to the 529 Plan’s distribution of the financial statements as required by (b)(4) of the Custody Rule for a pooled investment vehicle, you represent that the annual financial statements of the 529 Plan are provided annually to the state agency or instrumentality responsible for oversight of the 529 Plan within 120 days of the end of the 529 Plan’s fiscal year, and that the annual financial statements will be available to all existing 529 Plan accountholders on the 529 Plan’s website. You represent that the Program Manager will ensure that the 529 Plan accountholders are provided written notification of the availability of the financial statements no later than the delivery of the accountholders’ next regularly scheduled quarterly account statement.8

Based on the facts and representations contained in your letter, we would not recommend enforcement action to the Commission under Section 206(4) of the Advisers Act and Rule 206(4)-2 thereunder against a registered investment adviser if it treats the 529 Plan for which it is a Program Manager as a “pooled investment vehicle” for purposes of the Custody Rule, as described in your letter. In particular, we rely on your representations that:

  • The 529 Plan is a college savings plan;

  • The 529 Plan’s recordkeeper is registered as a transfer agent with the Commission under Section 17A of the 1934 Act;

  • The 529 Plan’s custodian(s) is a “qualified custodian” as such term is defined in Rule 206(4)-2(d)(6) under the Advisers Act;

  • The assets of the 529 Plan are subject to annual audit as defined in Regulation S-X and the audit is conducted in accordance with GAAS;

  • The 529 Plan’s annual audit is conducted by an independent public accountant that: (i) is registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by, the PCAOB in accordance with its rules; and (ii) meets the standards of independence in Rule 2-01(b) and (c) under Regulation S-X;

  • The audited financial statements of the 529 Plan are prepared in accordance with GAAP;

  • The annual financial statements are annually provided to the state agency or instrumentality responsible for oversight of the 529 Plan within 120 days of the end of the 529 Plan’s fiscal year;

  • The annual financial statements are made available to all existing 529 Plan accountholders via the 529 Plan’s website; and

  • The Program Manager will ensure that the 529 Plan accountholders are provided written notification of the availability of the financial statements no later than the delivery of the accountholders’ next regularly scheduled quarterly account statement. Such notice may either be included with or on such statement or sent separately. The notice shall advise the accountholder of a website where such financial statements may be accessed and provide the accountholder information regarding how to contact the 529 Plan to obtain a hardcopy of such financial statements in lieu of accessing them online. A hardcopy of the financial statements shall be provided by mail within 3 business days of an accountholder requesting such copy.

This conclusion is based on all of the facts and representations set forth in your letter. You should note that any different facts or representations might require a different conclusion. Further, this response expresses our position only with respect to enforcement action, and does not express any legal conclusion on the issues presented.

Holly Hunter-Ceci
Senior Counsel


1 These plans are named after Section 529 of the Internal Revenue Code. Section 529 governs plan eligibility, investment of funds, how funds may be used and by whom, and transfers among 529 plan accounts, among others.

2 Depending on how the state has structured its plan, the state itself may be in privity of contract with each of these service providers rather than the Program Manager. Regardless of how the state has structured its 529 Plan program, each of these services is necessary to the program’s operation.

3 You state that because federal law requires that a 1099Q tax form reporting all account distributions, earnings, and trustee-to trustee-transfers be provided to both the IRS and to the accountowner/beneficiary, transfer agents must keep very detailed information regarding 529 Plan accounts.

4 You further represent that the independent public accountant meets the standards of independence in Rule 2-01(b) and (c) under Regulation S-X.

5 See Staff Responses to Questions about the Custody Rule, Q&A Nos. VI.5 and VI.6, available at http://sec.gov/divisions/investment/custody_faq_030510.htm (stating that the pooled investment vehicle exception to the surprise exam requirement in (b)(4) of the Custody Rule generally requires that the vehicle’s audit be conducted in accordance with GAAS and the financial statements be prepared in accordance with GAAP).

6 See Custody of Funds or Securities of Clients by Investment Advisers, Advisers Act Release No. 2968 (Dec. 30, 2009) at 16.

7 Section 17A of the 1934 Act imposes extensive recordkeeping and reporting obligations on registered transfer agents. For example, registered transfer agents file Form TA-2 with the Commission annually, which requires reporting about the transfer agent’s operations during the reporting period. In addition, Rule 17Ad-12 under the 1934 Act requires all registered transfer agents with custody or possession of funds or securities to assure that: (1) all such securities are held in safekeeping and handled, in light of all facts and circumstances, in a manner reasonably free from risk of destruction, theft, or other loss; and (2) all such funds are protected, in light of all facts and circumstances, against misuse.  Rule 17Ad-13 under the 1934 Act requires that registered transfer agents file an annual report with the Commission prepared by an independent accountant concerning the transfer agent’s system of internal accounting control and related procedures for the transfer of record ownership and the safeguarding of related securities and funds. Rule 17Ad-13 also requires that, if the accountant’s report describes any material inadequacy, the transfer agent shall, within sixty calendar days after receiving the report, notify the Commission and the transfer agent’s appropriate regulatory agency in writing regarding the corrective action taken or proposed to be taken.

8 You state that such notice may either be included with or on such statement or sent separately. You further state that the notice shall inform the accountholder of a website where such financial statements may be accessed. The notice shall also provide the accountholder information regarding how to contact the 529 Plan to obtain a hard copy of such financial statements in lieu of accessing them online. A hard copy shall be provided by mail within three business days of an accountholder requesting such copy.


Incoming Letter

The Incoming Letter is in Acrobat format.

 

http://www.sec.gov/divisions/investment/noaction/2012/ici090512.htm


Modified: 09/07/2012