Rule Atlas
SEC Rule Reference: Client Funds and Securities: Custody Requirements and Safeguards
Under SEC Rule Reference (NASAA / SEC Investment Advisers Act), client Funds and Securities: Custody Requirements and Safeguards establishes the authoritative rules tested on the NASAA Series 66. This lesson details the specific rules and safeguards an investment adviser must implement when maintaining custody of client funds or securities, including notification, account statements, and independent verification requirements. VoraPrep verifies every threshold, worked table, and practice question below against the current NASAA Series 66 blueprint.
Core Statutory Concepts
| Requirement | Description | USA/SEC Rule Reference | Key Details |
|---|---|---|---|
| Qualified Custodian | Client funds and securities must be held by a qualified custodian (e.g., bank, broker-dealer, trust company). | USA §404(b), SEC Rule 206(4)-2 | IA cannot hold assets directly unless specifically exempted. |
| Notification to Clients | Prompt written notification to clients of the qualified custodian's name, address, and manner in which funds/securities are maintained. | USA §404(b), SEC Rule 206(4)-2(a)(1) | Must be given at account opening and upon any change. |
| Account Statements | The qualified custodian must send at least quarterly account statements directly to clients. | USA §404(b), SEC Rule 206(4)-2(a)(3) | Must detail all transactions, funds, and securities. |
| IA's Notification to Administrator | IA must notify the Administrator on Form ADV that it has custody. | USA §203(c)(1), SEC Rule 206(4)-2(a)(2) | Required upon initial registration and any subsequent change. |
| Independent Verification (Surprise Audit) | An independent public accountant must conduct an annual surprise examination to verify client funds and securities. | USA §404(b), SEC Rule 206(4)-2(a)(4) | The accountant must be registered with the PCAOB (if applicable) and independent. |
| Internal Control Report (for Pooled Investment Vehicles) | For IAs to pooled investment vehicles (e.g., hedge funds), an annual internal control report (e.g., SOC 1 report) by an independent public accountant can substitute for the surprise audit, provided it includes an opinion on controls related to custody. | SEC Rule 206(4)-2(b)(4) | This is an alternative to the surprise audit for specific pooled vehicles. |
An Investment Adviser (IA) has established an agreement with clients allowing for the direct deduction of advisory fees from their accounts on a quarterly basis. The IA sends quarterly account statements directly to clients, detailing all transactions and fees. However, the IA has not informed the state Administrator about this fee deduction arrangement. Which of the following statements is most accurate regarding this situation under the Uniform Securities Act?
Practitioner Application: Client Funds and Securities: Custody Requirements and Safeguards
An investment adviser (IA) manages a high-net-worth client's portfolio, which includes several illiquid alternative investments. The client has granted the IA limited power of attorney to execute trades and transfer funds between accounts held at different qualified custodians. The IA also holds physical certificates for a small portion of the client's private equity holdings in a locked safe at their office. The Administrator has initiated an unannounced audit of the IA's books and records, specifically scrutinizing the handling of client assets. The IA is confident they have met all requirements, including sending quarterly statements and arranging for an annual surprise audit. However, the auditor questions whether the IA's actions constitute 'custody' under the Uniform Securities Act (USA) and if all necessary safeguards, including direct client notification and independent verification, have been properly implemented for all assets under their control, particularly the physical certificates and the inter-account transfers.
- The Uniform Securities Act (USA) and SEC rules impose stringent requirements on investment advisers (IAs) who maintain custody of client funds or securities. The primary goal is to protect client assets from misappropriation or misuse. Understanding what constitutes custody and the corresponding safeguards is critical for both compliance and exam success.
- Definition of Custody: An IA has custody if it holds, directly or indirectly, client funds or securities, or has the authority to obtain possession of them. This includes: Possession of client funds or securities (e.g., holding physical certificates, client checks endorsed to the IA). Any arrangement (including a power of attorney) under which the IA is authorized or permitted to withdraw client funds or securities from a client's account, even if held by a qualified custodian. Having legal ownership or access to client funds or securities, such as being a trustee or general partner of a limited partnership where clients are limited partners. The ability to deduct advisory fees directly from client accounts, unless specific conditions are met (e.g., client authorization, notice to custodian, and simultaneous notice to client).
Common NASAA Series 66 Distractors on SEC Rule Reference
- 1Custody Definition: Custody includes direct possession, authority to obtain possession (e.g., general power of attorney), or legal ownership (e.g., trustee). Limited power of attorney solely for trading at a qualified custodian is generally NOT custody.
- 2Qualified Custodian: Client funds and securities must be held by a qualified custodian (bank, broker-dealer, trust company).
- 3Client Notification: IA must promptly notify clients in writing of the qualified custodian's name, address, and how assets are held.
- 4Custodian Statements: The qualified custodian must send account statements directly to clients at least quarterly.
- 5IA Notification: IA must indicate custody on Form ADV to the Administrator.
Frequently Asked Questions: SEC Rule Reference
What is the core rule under SEC Rule Reference (Client Funds and Securities: Custody Requirements and Safeguards)?
Under SEC Rule Reference (NASAA / SEC Investment Advisers Act), client Funds and Securities: Custody Requirements and Safeguards establishes the authoritative rules tested on the NASAA Series 66. This lesson details the specific rules and safeguards an investment adviser must implement when maintaining custody of client funds or securities, including notification, account statements, and independent verification requirements. VoraPrep verifies every threshold, worked table, and practice question below against the current NASAA Series 66 blueprint.
How is SEC Rule Reference tested on the NASAA Series 66?
Custody Definition: Custody includes direct possession, authority to obtain possession (e.g., general power of attorney), or legal ownership (e.g., trustee). Limited power of attorney solely for trading at a qualified custodian is generally NOT custody. Qualified Custodian: Client funds and securities must be held by a qualified custodian (bank, broker-dealer, trust company).
Where can I practice NASAA Series 66 questions on Client Funds and Securities: Custody Requirements and Safeguards?
Test yourself instantly with the free playable NASAA Series 66 question on this page, or launch VoraPrep's full NASAA Series 66 adaptive question bank, interactive lessons, and 1:1 exam simulator at voraprep.com/series66.