May 27, 2009
The proposal, as I understand it, will classify Registered Investment Advisors which deduct fees directly from client accounts as having custody of client assets. Then, the RIA is subject to surprise audits (at their expense). It appears that such audits would increase operation costs significantly without great benefit.
Clients should be aware of their obligations under their fee agreement with the advisor. Requiring client notification whenever fees are withdrawn stating the amount withdrawn, the date withdrawn and the basis for the fee calculation should usually be adequate.
To help flag fraudulent situations, a higher level of disclosure could be required by the independent custodian when cumulative withdrawals are greater then some hurdle amount (percent of the accounts value) for the prior quarter. This may place some burden on the custodian, but this should also fall under the "know your client rules for the custodian. Many custodians already have such monitoring practices in place.
Establishing a safe harbor so RIAs can avoid the requirement for an annual audit would keep operational costs down while still maintaining a good environment for clients.
For cases where a RIA does not use an independent custodian, I do recommend a higher level of scrutiny and oversight.