Speech by SEC Chairman:
Statement at SEC Open Meeting
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
May 14, 2009
Good Morning. This is an open meeting of the U.S. Securities and Exchange Commission on May 14, 2009. Today, we are considering a recommendation from the Division of Investment Management that the Commission propose rules to strengthen the custody controls that apply to investment advisers.
We are taking this action in response to major investment scams — such as Madoff — and many other potential Ponzi schemes. Investors' confidence in the markets has been shaken and troubling concerns have been raised about the safekeeping of investor assets. Indeed, the Commission has brought nearly two dozen enforcement actions involving alleged Ponzi schemes since January — in many cases, halting the fraud and seeking the return of money for investors.
Approximately 9,600 SEC registered investment advisers have custody of client assets, in one form or another. That means that they either physically control the assets directly or through an affiliate or have the authority to withdraw their clients' funds. As a result, many clients understandably are concerned about whether their investment advisers are properly handling their hard-earned dollars. These investors are looking to the SEC to assure the safekeeping of their assets. And we cannot let them down.
We have conducted a comprehensive review of the custody controls that exist under our rules. And today we are considering a proposal that would substantially increase the controls that apply to investment advisers that maintain custody of client assets.
Our proposal protects investors by promoting independent custody — that is taking the assets out of the control of the adviser or an affiliate of the adviser and putting them in the control of a truly independent third party. The proposal also would place enhanced reliance on independent public accountants, including those that are PCAOB registered and inspected, as a third-party check on custody controls and client assets.
At its core, the proposal would effectively require that client assets be maintained with a qualified custodian that is independent of the adviser. But, in the case where an adviser or its affiliate maintains custody of client assets, then a PCAOB-registered and inspected public accountant would have to perform an annual custody control examination.
That accountant would also be required to prepare a report describing the custody controls in place and the tests conducted of their operating effectiveness. This report is commonly referred to as a Type II SAS 70 report.
Because of the heightened concern that attaches to self-custody and affiliated-custody arrangements, the independent accountant that performs the custody control examination would have to be registered and inspected by the PCAOB. And the custody control examination and internal control report would have to be prepared in accordance with PCAOB standards. Requiring PCAOB registration and inspection would provide an additional level of quality control over the accountants performing this critical custody compliance review. This quality control is particularly important when an adviser, or its affiliate, rather than an independent custodian, maintains client assets.
These controls essentially focus on who serves as the custodian of client assets. The second proposal would apply to all registered advisers with custody of client assets. The proposal would require the investment adviser to engage an independent public accountant to conduct an annual "surprise exam" to verify those assets. This surprise examination would provide "another set of eyes" on client assets, and thereby provide additional protection against their theft or misuse.
The reforms we are considering today directly address the shortfalls of the current custody control regulations highlighted by the Madoff case, as well as the series of recent allegations involving frauds that relate to Ponzi schemes and misappropriation of client assets.
By requiring on-site, third party, independent public accountant examinations both to verify client assets and to assess the quality of custody controls — if the custodian is not independent — our proposals would greatly enhance the independent checks on client assets of investment advisers.
At the same time, these controls are designed to decrease the likelihood that an investment adviser could misappropriate client assets and go undetected — because an independent public accountant will be looking over their shoulder on at least an annual basis.
I believe that use of third-parties to hold client assets, verify the existence of client assets, or assess the custody controls employed by the adviser or an affiliated custodian will provide a critical, independent layer of protection for advisory clients.
The investment adviser custody control regime we are considering today represents a significantly strengthened approach to assuring the safekeeping of investor assets.
We will be interested, however, in hearing from commenters on the proposal.
Will our proposals serve to better protect investor assets?
Will the proposals encourage even greater use of independent custodians?
Are the estimated costs associated with the proposals reasonable, and appropriately borne by investment advisers?
These are important questions that investors and industry representatives will assist us with in the weeks ahead.
I want to emphasize that the new rules that we are considering today are part of a larger package of reforms — all of which are intended to better protect investors from fraud.
Related reforms include improvements to our exam process designed to better identify potential fraud, improvements to the agency's risk assessment process, improvements in the agency's ability to handle complaints and tips, and improvements in the enforcement program designed to ensure that the Commission's enforcement cases are, in the words of our Enforcement Director, "strategic, swift, smart and successful."
For now, I'll turn the meeting over to Buddy Donohue, Director of the Division of Investment Management, to hear more about the Division's recommendation. Before I do that, however, I would like to thank those who have worked tirelessly with Buddy to prepare the recommendation before us today: Bob Plaze, Sarah Bessin, Dan Kahl, Vivien Liu, Rick Sennett, Bryan Morris and Jaime Eichen and their colleagues in the Office of the Chief Accountant, Office of the General Counsel and Office of Compliance Inspections and Examinations. Thank you all so much for your hard work.