To comply with the new proxy voting regs, Schafer says, "I chose to get one of the templates from one of the compliance consultants, an off-the-shelf product, that I could customize and format for my needs. It represents an additional cost and paperwork burden. I still just vote proxies in clients' best interests, but it seems there's now more emphasis on process than end result. The template enables me to demonstrate that I've got a policy, and that I am sending notifications to clients annually to show them I'm in compliance."
While advisors frequently discuss best execution and proxy voting, the regulation attracting the most attention of late is the SEC's new ruling on custody of client assets. Effective November 5, 2003, the SEC adopted long-awaited amendments to Rule 206(4)-2 intended to modernize the Investment Adviser Act of 1940 custody rule to enhance protections for advisory clients' assets, harmonize the rule with current custodial practices, and clarify when advisers have custody.
What many advisors don't realize is that, for most of us, the new rule is a liberalization of the rule previously in effect. Essentially, if you keep your clients' assets at an "approved custodian" (e.g., a bank or broker-dealer) that provides at least a quarterly statement to your client, if you send the client an invoice showing how his fee was calculated, if you turn over to custodians within three days any stock certificates a client may give you, if you don't receive client payments of more than $500 more than six months in advance of service, and if you don't hold power of attorney to sign checks on a client's behalf, then you probably don't have custody. That means you aren't subject to the requirement that you give clients audited financial statements, you don't have to pay for surprise CPA audits, and you won't incur SEC scrutiny for crimes such as embezzlement.
One exception-an exception that applies to many advisors-is that the SEC deems an advisor to have custody if he has the ability to debit his client's account for payment of advisory fees. However, he will not be required to undergo an annual surprise CPA examination, nor provide an audited financial statement based upon this one factor.
So what's the bottom line to the custody rule? Things will be easier for most advisors because they now have the option of declining to send clients quarterly investment reports if their custodian is already doing it. All you really need to do is have a page in your compliance manual that spells out where you custody client funds, when and what kind of investment report your clients receive, how and when you charge client fees, and that you do not directly hold client funds or securities.
Advisors who have been avoiding the need to develop procedures and documentation of their regulatory compliance should have a better idea of what to do now, knowing what other industry participants recommend and do. But, even with this roadmap, these new regulations will still seem to most advisors-and the sole practitioners who make up a huge percentage of our industry-to be an added burden.
To satisfy that burden, is it enough for the small firm or practitioner to follow Schafer's procedure of leaning on templates to communicate his compliance policies?
Matt Bienfang, a senior analyst in the retail brokerage and investing area TowerGroup, a Needham, Mass., research and advisory firm to the global financial services industry, isn't so sure. "The SEC is going to frown on the sole practitioner wearing all hats," he says. "It's the fox guarding the chicken house thing. I believe they'll look for a third-party relationship with an attorney or consultant specializing in compliance issues."
So, if you haven't yet implemented a set of regulatory policies, you might want to study what others in the industry are doingæbut take to heart Bienfang's advice as well.David J. Drucker, MBA, CFP ([email protected]), a fee-only financial advisor since 1981, is editor of the Virtual Office News monthly newsletter, and co-author of the book Virtual Office Tools for a High-Margin Practice (Bloomberg Press, 2002), both available at www.virtualofficetools.net.