1990 M STREET, N.W.
(202) 223-4418            (202) 331-3813

September 25, 2002

Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Mail Stop 6-9
Washington, D.C. 20549

Re: Commission File No. S7-28-02

Dear Mr. Katz:

We submit these comments regarding the Commission's proposal to modernize the custody rule under the Investment Advisers Act of 1940 (the "Advisers Act"). In general, we believe that the proposal provides a common-sense, practical way to harmonize rule 206(4)-2 with current custodial practices. However, for the reasons described below, we urge the Commission to amend the proposal to eliminate the Form ADV balance sheet schedule entirely.

* * * * *

Since 1979, advisers who either (i) have custody or possession of clients' funds or securities or (ii) require pre-paid advisory fees in excess of $500 per client and six months or more in advance have been obligated to include an audited balance sheet on Schedule G with Part II of their Form ADVs.1 In connection with its proposed amendments to the custody rule, the Commission also proposes to eliminate the balance sheet requirement for advisers who have custody of client assets, but retain the requirement for those who charge de minimis prepaid advisory fees. There is no reason to draw this distinction. The cogent arguments the Commission has advanced for doing away with the balance sheet requirement for advisers who have custody apply with equal force to those who charge prepaid fees.

For example, as the Commission recognizes in the proposing release, a balance sheet may give an imperfect impression of an investment adviser's financial health, since a profitableadviser may have few financial assets.2 More importantly, rule 206(4)-4 already obligates advisers who require prepayment of more than $500 of advisory fees from a client more than six months in advance to disclose to such client any financial condition that is reasonably likely to impair the adviser's ability to meet its contractual commitments to the client.3 As the Commission acknowledges in the proposing release, the disclosure requirement in rule 206(4)-4 (which did not exist when Schedule G was adopted) is a more effective way to warn clients about risks to their assets than having them review balance sheet information they may not have the experience to interpret. Simply put, Schedule G has outlived its usefulness.

Finally, the cost-benefit analysis applicable to eliminating the balance sheet requirement for advisers who maintain custody of client assets is relevant to all advisers obligated to deliver a Schedule G to their clients. In this regard, the Commission estimates that an adviser not otherwise required to prepare audited financial statements currently spends approximately $15,000 annually to comply with the Schedule G requirement, and that 184 advisers incur these costs under the advance fees provision. The Commission further opines that eliminating the balance sheet requirements would not reduce protections to clients. It appears, therefore, that liberating advisers who charge prepaid advisory fees from the obligation to deliver an audited balance sheet to clients would result in an additional $2,760,000 cost savings each year without any concomitant harm to investors. This is a sensible thing to do.


For the reasons discussed herein, we respectfully suggest that the Commission eliminate the requirement that advisers who charge $500 or more in prepaid advisory fees six months or more in advance deliver an audited balance sheet with their client disclosure brochures, thus removing Part II, Item 14 and Schedule G from Form ADV altogether. We appreciate this opportunity to comment on this important proposal.

Very truly yours,

Mari-Anne Pisarri

cc: (By Hand)

Hon. Harvey Pitt
Hon. Paul S. Atkins
Hon. Roel C. Campos
Hon. Cynthia A. Glassman
Hon. Harvey J. Goldschmid
Mr. Paul Roye
Ms. Vivien Liu

1 Form ADV, Part II, Item 14. We note that it has been our experience that the Commission's staff reads the phrase "requires prepayment" of advisory fees to mean "accepts prepayment" of advisory fees. Thus, some of our investment adviser clients who offer their clients a choice of payment options for subscription services have become subject to the Schedule G delivery obligations if their clients choose to pay on a semiannual or annual, rather than quarterly basis.
2 Indeed commentators on the original Schedule G proposal expressed concern that providing a balance sheet would not necessarily provide clients with relevant information on which to base a judgment about the advisers's financial condition and might easily be misinterpreted. IA Release No. 664 (Jan. 30, 1979) 44 Fed. Reg. 7870 (Feb. 7, 1979).
3 Because the $500 threshold in rule 206(4)-4 was modeled after the Schedule G limit, which in turn, was set twenty-three years ago, it seems that a technical adjustment should be made to rule 206(4)-4 to account for the effects of inflation. According to an inflation calculator provided by the Bureau of Labor Statistics of the U.S. Department of Labor, $500 in 1979 would be worth approximately $1250 today. We think using a figure of $1500 in rule 206(4)-4 would be advisable.