VIA ELECTRONIC MAIL
September 25, 2002
Mr. Jonathan G. Katz, Secretary
Subject: File No. S7-28-02 - Proposed Amendments to the Custody Rule
Dear Mr. Katz:
Bank One Corporation ("Bank One") appreciates the opportunity to comment on the Securities and Exchange Commission's (the "Commission") proposed amendments to the custody rule (the "Proposed Rule") issued under the Investment Advisers Act of 1940. Bank One is the nation's sixth-largest bank holding company, with assets of more than $270 billion. Two of Bank One's indirect subsidiaries, Banc One Securities Corporation and Banc One Investment Advisors Corporation, are registered investment advisors with the Commission.
Although Bank One supports the Commission's efforts to modernize the custody rule, Bank One recommends that the Commission modify and expand the examples included in the definition of custody, retain the current exemption for registered broker-dealers, and indicate that advisers may continue to rely on SEC no-action letters involving affiliated custodians and deduction of advisory fees from custodian accounts. Our specific comments are set forth below.
A. Definition of Custody. The Commission has requested comment on whether the examples included in the definition of custody are helpful. As currently drafted, Bank One does not believe that the examples provide clear guidance as to when an adviser will be found to have custody. In addition, Bank One believes that the examples may create situations where advisers will be found to have custody even if they adopt procedures that prevent them from gaining access or control of client assets.
Specifically, Bank One is concerned that the first example unnecessarily expands the definition of custody in situations where a client mistakenly sends assets or securities to the adviser. Currently, the Proposed Rule indicates that an adviser must send assets and securities inadvertently received from a client back to the sender within one business day of receipt. This time frame is too aggressive and could cause an adviser to unintentionally violate the rule. For example, an adviser may not be able to satisfy the one-day timeframe if there are internal delays in the adviser's mail room or if the client mistakenly sends assets to an officer who is attending meetings outside of the office for several days. In addition, the example should permit the adviser to forward the assets to the sender or the client's custodian as long as the adviser notifies the client where the assets have been sent. Such a procedure will permit advisers to prevent delays caused by the client's mistake without increasing the risk that an adviser will convert the client's assets to its own use.
Bank One is also concerned that the second and third examples are vague and may significantly expand the definition of custody so that all advisers will be deemed to have custody. The second example indicates that an adviser has custody if it enters into any arrangement (including a general power of attorney) under which the adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian upon the adviser's instructions to the custodian. Likewise, the third example indicates that the adviser has custody if it acts in any capacity that gives the adviser legal ownership of or access to client funds or securities. Bank One is concerned that these examples are too broad and may cause an adviser to have custody simply because it is named as the client's adviser and has the authority to provide investment instructions to the client's custodian or enter into trades on the client's behalf.
As a matter of industry practice, advisory clients authorize their custodians to accept instructions from the adviser so that the adviser can implement the client's investment objectives. Similarly, advisers are customarily appointed as the client's agent so that they can negotiate with brokers and counterparties in connection with making investments for the client's account. In the proposal, the Commission has not indicated that these standard industry practices have resulted in abuse or misappropriation of client assets. However, under the examples, an adviser could be deemed to have custody for providing any instructions to the custodian or entering into any transaction on behalf of the client even if the adviser does not have the ability to misappropriate client assets. As a result, Bank One recommends that the Commission modify examples two and three to indicate when an adviser will not be deemed to have custody such as when an adviser instructs a custodian to settle trades or when it enters into agreements on the client's behalf (provided the investments governed by such agreements are held at the client's custodian). In addition, Bank One recommends that the Commission indicate in its examples that an adviser may have its fee deducted from the Client's custody account without being deemed to have custody if the conditions in current SEC no-action letters are satisfied. See, e.g., Securities America Advisers, Inc., Sec No. Act. Ltr. (Pub. Avail. April 4, 1997).
B. Broker-Dealer Exemption. The Proposed Rule eliminates the exemption from the rule for advisers that are also registered broker-dealers on the basis that such advisers are "already in compliance with the proposed rule" and would face no "additional burdens." Banc One believes that the Commission should retain the current exemption from the rule for registered broker-dealers. Such advisers are already subject to requirements that provide protection to clients including annual audit requirements and account statement/confirmation requirements. Applying the custody rule to such advisers will subject them to duplicative regulation and examination without providing any corresponding benefits to clients.
C. Application of Existing No-Action letters. In many situations, whether an adviser has custody or not is fact specific and cannot be easily determined by reference to the rule or its examples. The existing no-action letters provide additional guidance in ascertaining whether an adviser has custody particularly with respect to affiliated custodians and deductions of advisory fees from custody accounts. Consequently, Bank One recommends that the Commission specifically provide that advisers may continue to rely on existing SEC no-action letters that define when an adviser has custody rather than attempt to make the examples in the rule all-inclusive.
Bank One appreciates the opportunity to comment on the Proposed Rules. If it would be helpful to discuss any of our comments in greater detail, please contact the undersigned at (614) 248-5749.
/s/Jessica K. Ditullio
Jessica K. Ditullio
cc: Chris Edwards