§ 404.014. Custody requirements for investment advisers.
(a) Safekeeping required. It is unlawful and considered to be a fraudulent, deceptive or manipulative act, practice or course of business, within the meaning of section 404 of the act (70 P.S. § 1-404), for an investment adviser, registered or required to be registered under section 301 of the act (70 P.S. § 1-301), to have custody of client funds or securities unless:
(1) The investment adviser notifies the Department promptly in writing on Form ADV that the investment adviser has or may have custody.
(2) A qualified custodian maintains those funds and securities in one of the following:
(i) A separate account for each client under that client’s name.
(ii) Accounts that contain only the investment adviser’s clients’ funds and securities under the investment adviser’s name as agent or trustee for the clients or, in the case of a pooled investment vehicle that the investment adviser manages, in the name of the pooled investment vehicle.
(3) The investment adviser meets the following conditions:
(i) If the investment adviser opens an account with a qualified custodian on its client’s behalf, under the client’s name, under the name of the investment adviser as agent or under the name of a pooled investment vehicle, the investment adviser shall notify the client in writing of the qualified custodian’s name, address and how the funds or securities are maintained, promptly when the account is opened and following any changes to this information.
(ii) If the investment adviser sends account statements to a client to which the investment adviser is required to provide the notice in subparagraph (i), the investment adviser shall include in the notification provided to that client and in any subsequent account statement the investment adviser sends that client a statement urging the client to compare the account statements from the custodian with those from the investment adviser.
(4) The investment adviser meets the following conditions:
(i) The investment adviser has a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each client for which it maintains funds or securities and the account statement:
(A) Identifies the amount of funds in the account.
(B) Identifies the amount of each security in the account at the end of the period.
(C) Sets forth all transactions in the account during that period.
(ii) If the investment adviser or a related person is a general partner of a limited partnership (or managing member of a limited liability company, or holds a comparable position for another type of pooled investment vehicle), the account statements required under paragraph (3) shall be sent to each limited partner (or member or other beneficial owner).
(5) The investment adviser meets the following conditions:
(i) The client funds and securities of which the investment adviser has custody are verified by actual examination at least once during each calendar year, by an independent certified public accountant, under a written agreement between the investment adviser and the independent certified public accountant, at a time that is chosen by the independent certified public accountant without previous notice or announcement to the investment adviser and that is irregular from year to year.
(ii) The written agreement provides for the first examination to occur within 6 months of becoming subject to this paragraph, except that, if the investment adviser maintains client funds or securities under this section as a qualified custodian, the agreement must provide for the first examination to occur no later than 6 months after obtaining the internal control report.
(iii) The written agreement must require the independent certified public accountant to:
(A) File a certificate on Form ADV-E with the Department within 120 days of the time chosen by the independent certified public accountant in this paragraph, stating that it has examined the funds and securities and describing the nature and extent of the examination.
(B) Notify the Department within 1 business day of the finding, by means of a facsimile transmission or e-mail, followed by first class mail, directed to the attention of the Department on finding any material discrepancies during the course of the examination.
(C) File Form ADV-E within 4 business days of the resignation or dismissal from, or other termination of, the engagement or removing itself or being removed from consideration for being reappointed, accompanied by a statement that includes:
(I) The date of resignation, dismissal, removal or other termination, and the name, address and contact information of the independent certified public accountant.
(II) An explanation of any problems relating to examination scope or procedure that contributed to resignation, dismissal, removal or other termination.
(6) If the investment adviser has custody because a related person maintains client funds or securities under this section as a qualified custodian in connection with advisory services the investment adviser provides to clients, the investment adviser shall obtain, or receive from its related person, within 6 months of becoming subject to this paragraph and thereafter no less frequently than once each calendar year a written internal control report prepared by an independent certified public accountant that performs the independent verification required under paragraph (5) that complies with the following:
(i) The internal control report must include an opinion of an independent certified public accountant as to whether controls have been placed in operation as of a specific date, and are suitably designed and are operating effectively to meet control objectives relating to custodial services, including the safeguarding of funds and securities held by either the investment adviser or a related person on behalf of the investment adviser’s clients, during the year.
(ii) The independent certified public accountant shall verify that the funds and securities are reconciled to a custodian other than the investment adviser or the investment adviser’s related person.
(7) A client may designate an independent representative to receive, on his behalf, notices and account statements as required under paragraphs (3) and (4).
(b) Exceptions.
(1) Shares of mutual funds. With respect to shares of an open-end company as defined in section 5(a)(1) of the Investment Company Act of 1940 (15 U.S.C.A. § 80a-5(a)(1)) (mutual fund), the investment adviser may use the mutual fund’s transfer agent instead of a qualified custodian to comply with subsection (a).
(2) Certain privately offered securities.
(i) The investment adviser does not need to comply with subsection (a)(2) with respect to securities that are:
(A) Acquired from the issuer in a transaction or chain of transactions not involving any public offering.
(B) Uncertificated and ownership is recorded only on the books of the issuer or its transfer agent in the name of the client.
(C) Transferable only with previous consent of the issuer or holders of the outstanding securities of the issuer.
(ii) Notwithstanding subparagraph (i), the provisions of this paragraph are available with respect to securities held for the account of a pooled investment vehicle only if the pooled investment vehicle is audited, and the audited financial statements are distributed, in accordance with § 303.042(a)(3)(ii) (relating to investment adviser capital requirements) and the investment adviser notifies the Department in writing on Form ADV that the investment adviser intends to provide audited financial statements, as described in this subparagraph.
(3) Fee deduction. Notwithstanding subsection (a)(5), an investment adviser does not need to obtain an independent verification of client funds and securities maintained by a qualified custodian if the investment adviser is in compliance with § 303.042(a)(3)(i).
(4) Limited partnerships subject to annual audit. An investment adviser does not need to comply with subsection (a)(3) and (4) and will be considered to have complied with subsection (a)(5) with respect to the account of a pooled investment vehicle that is subject to audit and is in compliance with § 303.042(a)(3)(ii).
(5) Registered investment companies. The investment adviser does not need to comply with this section with respect to the account of an investment company registered under the Investment Company Act of 1940 (15 U.S.C.A. § § 80a-1—80a-64).
(c) Delivery to related persons. Sending an account statement under subsection (a)(4) or distributing audited financial statements under subsection (b)(4) does not satisfy the requirements of this section if the account statements or financial statements are sent solely to limited partners (or members or other beneficial owners) that themselves are limited partnerships (or limited liability companies, or another type of pooled investment vehicle) and are related persons of the investment adviser.
(d) Department authority. An investment adviser who cannot comply with one or more of the specific provisions in this section may request that the Department waive the specific provisions if the investment adviser can establish that undue hardship would be placed on the investment adviser and that investment adviser can establish sufficient alternative safeguards.
Authority The provisions of this § 404.014 issued under section 202.C of the Department of Banking and Securities Code (71 P.S. § 733-202.C); section 609(a) of the Pennsylvania Securities Act of 1972 (70 P.S. § 1-609(a)); and section 9(b) of the Takeover Disclosure Law (70 P.S. § 79(b)).
Source The provisions of this § 404.014 adopted January 12, 2018, effective January 13, 2018, 48 Pa.B. 389.
Cross References This section cited in 10 Pa. Code § 102.021 (relating to definitions); and 10 Pa. Code § 305.019 (relating to dishonest and unethical practices).
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