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Securities Act Policy Statement Regarding the Custody Requirements for Investment Advisers with Standing Letters of Authorization (SLOA) Arrangements Established by a Client with a Qualified Custodian

Question Presented

What are the custody requirements for investment advisers, registered or required to be registered in Washington State, with letters of instruction or other similar asset transfer authorization arrangements established by a client with a qualified custodian under which an investment adviser is authorized to withdraw client funds or securities maintained with a qualified custodian upon the investment adviser’s instruction to the qualified custodian?

Applicable Statute and Rules:

An investment adviser has custody of client funds or securities where it “hold[s], directly or indirectly, client funds or securities, or ha[s] any authority to obtain possession of them or the ability to appropriate them.” WAC 460-24A-005(1). Custody includes, under WAC 460-24A-005(1)(a)(ii) “[a]ny arrangement (including a general power of attorney) under which an investment adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian upon an investment adviser's instruction to the custodian.” Furthermore, if a related person, as defined in WAC 460-24A-005(6), has custody of an investment adviser’s client’s funds or securities, the custody is imputed to the investment adviser.1

Investment advisers registered or required to be registered in Washington State that have custody of client funds or securities are required to comply with all of the custody requirements outlined in the Securities Act of Washington (RCW 21.20) and the investment adviser rules enacted thereunder (WAC 460-24A). At least three of the regulatory custody requirements apply to SLOA arrangements: WAC 460-24A-060(1), WAC 460-24A-105, and WAC 460-24A-170(1).

WAC 460-24A-060(1) requires investment advisers with custody of client funds or securities to file with the director an audited balance sheet as of the end of your fiscal year. This audited balance sheet must be (a) prepared in conformity with GAAP (generally accepted accounting principles) and audited in accordance with GAAS (generally accepted auditing standards) by an independent certified public accountant and (b) accompanied by an audit opinion of the accountant on the audit of the balance sheet. WAC 460-24A-105 requires investment advisers with custody of client funds or securities to: (1) promptly notify the director on Form ADV that the investment adviser has or may have custody; (2) maintain all client funds and securities with a qualified custodian (as defined in WAC 460-24A-005(4); (3) notify all clients of the identity of the qualified custodian; and (4) send, or have the qualified custodian send, account statements to all clients (there are different requirements depending on if the investment adviser or the custodian send the statements to clients).

Finally, pursuant to WAC 460-24A-170(1), investment advisers with custody have a higher minimum financial requirement. Investment advisers, registered or required to be registered in Washington State, who have custody of client funds or securities, must maintain at all times a minimum net worth of $35,000.

Discussion:

Investment advisory clients can establish standing letter of instructions or other similar asset transfer authorization arrangements (e.g. SLOA) with their qualified custodians to grant their investment advisers the power to disburse funds to accounts as specifically designated by the client. Investment advisers, qualified custodians, and their clients have developed a wide variety of SLOA arrangements. With a SLOA a client can typically authorize first-party and/or third-party transfers. If an investment adviser enters into a SLOA with a client which permits the investment adviser to transfer the client’s funds or securities to a third party’s account, the investment adviser would have custody and must comply with the regulatory custody requirements.2

However, if the investment adviser has custody solely because the investment adviser has a third-party SLOA transfer arrangement with a client, the Division will not require the investment adviser to comply with the requirement to file an audited balance sheet as set forth in WAC 460-24A-060(1) if the investment adviser complies with WAC 460-24A-060(3), the safekeeping requirements in WAC 460-24A-105, the higher minimum financial requirement required by WAC 460-24A-170(1), and the following conditions:

  1. The client provides an instruction to the qualified custodian, in writing, that includes the client’s signature, the third party’s name, and either the third party’s address or the third party’s account number at a custodian to which the transfer should be directed.
  2. The client authorizes the investment adviser, in writing, either on the qualified custodian’s form or separately, to direct transfers to the third party either on a specified schedule or from time to time.
  3. The client’s qualified custodian performs appropriate verification of the instruction, such as a signature review or other method to verify the client’s authorization, and provides a transfer of funds notice to the client promptly after each transfer.
  4. The client has the ability to terminate or change the instruction to the client’s qualified custodian.
  5. The investment adviser has no authority or ability to designate or change the identity of the third party, the address, or any other information about the third party contained in the client’s instruction.
  6. The investment adviser maintains records showing that the third party is not a related party of the investment adviser or located at the same address as the investment adviser.
  7. The client’s qualified custodian sends the client, in writing, an initial notice confirming the instruction and an annual notice reconfirming the instruction.
  8. In addition to including the client funds and securities that are subject to a SLOA that result in custody in its response to Item 9 of Form ADV and explaining the arrangement(s) in Item 15 of Form ADV Part 2, the investment adviser must specify in Schedule D – Miscellaneous of Form ADV Part 1 and Item 15 of Form ADV Part 2: (a) both the amount and number of clients included in the Item 9 custody figures solely because of the SLOA(s); and (b) attest that the investment adviser is complying with each of the requirements and conditions enumerated in this policy statement.

Adopted: September 29, 2017
William Beatty, Securities Administrator
Prepared by: Licensing and Examinations Unit

1 Please note that related person includes, but is not limited to, the investment adviser’s associated persons/advisory affiliates such as officers, investment adviser representatives, and administrative assistants.

2 A SLOA arrangement would not fall within the WAC 460-24A-005(1) definition of custody if: (1) the client’s SLOA with the qualified custodian specifies the (a) amount, (b) the payee, and (c) the timing of the transfers; and (2) the investment adviser cannot provide any instructions to the qualified custodians regarding the SLOA.