Speech by SEC Commissioner:
Statement at SEC Open Meeting on Custody Rule Adoption
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
December 16, 2009
Thank you, Chairman Schapiro.
I would like to add my own thanks to the Division of Investment Management, the Office of General Counsel, the Office of Chief Accountant, and the Division of Risk, Strategy and Financial Innovation for being very responsive to requests for information and points of clarification throughout the rulemaking process as well as for their work on the very thoughtful guidance for accounting engagements to be conducted in concert with the new rule.
Rule 206(4)-2, the custody rule, was designed to protect client assets from being lost, misused, or stolen by an adviser or its personnel or from an adviser’s insolvency. For the first forty years the rule was in operation, the Commission staff addressed evolving custodial practices and clarified its application through no-action and interpretive letters and releases. More recently in 2003, the Commission carefully reviewed and made various fundamental improvements to the way the rule and custodial practices themselves functioned. Throughout the rule’s evolution, the Commission and its staff have sought to strike a thoughtful balance, carefully crafting adviser and custodial requirements to achieve important investor protections.
In light of various high profile frauds we witnessed over the past year and, in particular, the collapse of a number of Ponzi schemes and revelations of other kinds of misconduct, custodial practices have again become a key area of focus as the Commission looks for additional ways to secure investor assets.
During this rulemaking process, it has been important to me that we be clear-eyed as to how proposed changes would or would not likely protect investors against fraud and that we balance the additional costs and burdens that accompany our proposals against the value of the additional protections we can reasonably hope to achieve. Critically, we should look to the substance rather than the mere form of custodial practices. With this in mind, I believe the rule we are adopting today offers meaningful enhancements to the custody rule, but better calibrates our response than some of the approaches set forth for comment in our proposing release. I will mention just three.
First, I am pleased we are not including within the rule’s reach advisers that have custody solely because of their ability to deduct advisory fees. As commenters noted, and I agree, the nature and magnitude of risks we are concerned with do not warrant an examination requirement of the type the proposal would have required for these advisers. Second, I think we are making the right choice by not imposing a duplicative examination requirement with respect to advisers to pooled investment vehicles who already obtain annual audits of their financial statements. I note, too, that these advisers must now obtain audits from PCAOB-registered and examined firms and I commend this step. Third, I appreciate the adaptation of an old staff idea — the rebuttable presumption concept outlined in the Crocker letter and its progeny — for the purpose of tailoring certain additional protections where custodians who, while related persons of an adviser, nevertheless can substantiate that they are operationally independent of the advisers for whom they provide these services.
At the time of the proposing release, I said that “[t]o the degree that flaws in custodial practices or the custody rule itself are not at the heart of the matter, we must be confident that these proposals do more than give false assurances against similar frauds given the costs these amendments would impose on investors and advisers.” With respect to these several policy choices, I believe the Commission is making thoughtful decisions today.
I continue to believe, however, that important work lies ahead, including a more wholesale reevaluation of our approach to investment advisory and broker-dealer oversight and conduct. Further review of custodial practices [particularly in the context of broker-dealers who perform these functions] is an essential element of any such discussion and may, I hope, lead to changes that may bring down some of the costs and burdens — to be shared by registrants and investors alike — that are associated with the rule we are adopting today. More fundamentally, I believe a more wholesale evaluation of the intersections between brokers, advisers, and other service providers will provide us with other important means of preventing opportunities for potential fraud.