There is an exception for sole trustees with a "family or personal relationship. In the amended custody rule's adopting release, the SEC explained that if the adviser or its employee is appointed trustee solely due to a family or personal relationship with the client, the SEC would not view the adviser as having "custody" of the assets of the trust. Therefore, such a trusteeship would not trigger the surprise exam requirement. Note: this exception does not include a family or personal relationship developed as a result of the provision of advisory services.
Under certain conditions, co-trustees are not deemed to have "custody" and therefore are not subject to the surprise exam requirement. According to the SEC's recent guidance, the SEC will not consider an adviser to have "custody" where, under the trust instrument or by law:
- Each co-trustee is required to obtain the written consent of all the other co-trustees to withdraw any assets of the trust, and
- One of the following requirements is met:
a. Unrelated Bank or Trust Company as Co-Trustee. The trust has a co-trustee that (a) is a bank or a trust company meeting the definition of "qualified custodian" under the custody rule and (b) is not a "related person" of the adviser, meaning an entity that controls, is controlled by, or is under common control with the adviser. The qualified custodian serving as co-trustee must also provide account statements directly to each other co-trustee.
b. Grantor as Co-Trustee of Revocable Trust. The adviser or the adviser's employee serves as a co-trustee along with the grantor(s) in a revocable trust where (a) each grantor contributing assets to the trust acts as a co-trustee; and (b) the qualified custodian with physical custody of trust assets delivers account statements directly to each co-trustee. Here, the qualified custodian may be any entity meeting the definition of "qualified custodian" under the custody rule.
Practical Considerations. Thus, to avoid a surprise exam stemming from a trustee or co-trustee relationship with a client, consider implementing policies and procedures that prohibit employees from serving in those capacities without the written approval of your firm's chief compliance officer ("CCO"). Such approval should not be given unless the CCO determines that (a) the potential appointment as trustee or co-trustee arises solely out of a family or personal relationship or (b) in the case of a potential appointment as co-trustee only, the arrangement meets the conditions outlined above.
Note on Future Tip. On May 20, 2010, the U.S. Senate passed the Restoring American Financial Stability Act of 2010 (the "Act"). The Act contains significant proposed reforms on a wide array of issues, including several directly affecting the investment advisory industry. We will continue to track the progress of this legislation, and we will send out another Tonkon Tip explaining the Act's impact on investment advisers if and when the Act is enacted.
For further questions concerning the SEC's new custody rule, please contact our Financial Services practice group.