In mid-February 2023, the SEC proposed rule changes to enhance protections of customer assets managed by registered investment advisers. If adopted, the changes would amend and redesignate rule 206(4)-2, the Commission’s custody rule, under the Investment Advisers Act of 1940, and amend certain related
recordkeeping and reporting obligations.

Rule 206(4)-2 (the current “custody rule”) has required investment advisers to safeguard client funds and securities in their possession or where they have authority to obtain possession of them. The rule is designed to protect these assets from the adviser’s own insolvency or bankruptcy, and from the assets being lost, misused, stolen, or misappropriated.

The proposed amendments would expand and modernize the scope of the current custody rule beyond client funds and securities to include any client assets (notably, e.g., crypto assets) of which an adviser has custody. The amendments would also redesignate the current custody rule as new rule 223-1 under the Advisers Act (the “safeguarding rule”). The safeguarding rule would explicitly include an adviser’s discretionary authority to trade client assets within the definition of custody, and, like the current custody rule, the safeguarding rule would require advisers with custody of client assets to entrust safekeeping of those assets to a qualified custodian.

The proposed safeguarding rule’s enhanced protections would also:

• Require that an adviser enter into a written agreement with and receive certain assurances from the qualified custodian to make sure the qualified custodian provides certain standard custodial protections when maintaining client assets;
•  Modify the current custody rule’s privately offered securities exception from the obligation to maintain client assets with a qualified custodian by expanding the exception to include certain physical assets;
• Expand the scope of who can satisfy the rule’s surprise examination requirement through financial statement audits by specifying that an entity is not required to be a limited partnership, limited liability company, or another type of pooled investment vehicle to rely on this provision;
• Amend the investment adviser recordkeeping rule 204-2 to require advisers to keep additional, more detailed records of trade and transaction activity and position information for each client account of which it has custody; and
• Amend Form ADV to align advisers’ reporting obligations with the proposal and to improve the accuracy of custody-related data available to the Commission, its staff, and the public.

Transition Period and Compliance Date

The SEC is proposing a one-year transition period to provide time for advisers to come into compliance with the redesignation of rule 206(4)-2 as new rule 223-1, and the corresponding amendments to rule 204-2 and Form ADV, as applicable. Accordingly, the compliance date of any adoption of the proposal would be one year following the rules’ effective dates which would be sixty days after the date of publication of the final rules in the Federal Register for advisers with more than $1 billion in regulatory assets under management (“RAUM”). For advisers with up to $1 billion in RAUM, the compliance date of any adoption of the proposal would be 18 months following the rules’ effective dates which would be sixty days after the date of publication of the final
rules in the Federal Register.

The comment period on the proposal will remain open for 60 days following publication of the proposing release in the Federal Register.

The full text of the proposal is available at https://www.sec.gov/rules/proposed/2023/ia-6240.pdf