Cal. Code Regs. Tit. 10, § 260.237 - Custody or Possession of Funds or Securities of Clients
(a)
Safekeeping required. It is unlawful and deemed to be a fraudulent, deceptive,
or manipulative act, practice or course of business within the meaning of
Section 25235 of the Code for an investment adviser licensed or required to be
licensed, to have custody of client funds or securities unless:
(1) Notice to the Commissioner. The
investment adviser notifies the Commissioner that the investment adviser has or
may have custody. Such notification is required to be given on Form ADV.
(2) Qualified custodian. A
qualified custodian maintains those funds and securities:
(A) In a separate account for each client
under that client's name; or
(B)
In accounts that contain only the investment adviser's clients' funds and
securities, under the investment adviser's name as agent or trustee for the
clients, or, in the case of a pooled investment vehicle that the investment
adviser manages, in the name of the pooled investment vehicle.
(3) Notice to clients. If the
investment adviser opens an account with a qualified custodian on the
investment adviser's client's behalf, under the client's name, under the
investment adviser's name as agent or trustee, or under the name of a pooled
investment vehicle, the investment adviser shall notify the client in writing
of the qualified custodian's name and address, and the manner in which the
funds or securities are maintained, promptly upon the opening of the account
and following any changes to this information. If the investment adviser sends
an account statement to a client to which the investment adviser is required to
provide this notice, the investment adviser shall include in the notice
provided to that client and in any subsequent account statement sent to that
client, a statement urging the client to compare the account statements from
the custodian with those from the investment adviser.
(4) Account statements. The investment
adviser has a reasonable basis, after due inquiry, for believing that the
qualified custodian sends an account statement, at least quarterly, to each
client for which it maintains funds or securities, identifying the amount of
funds and of each security in the account at the end of the period and setting
forth all transactions in the account during that period including investment
advisory fees.
(5) Special rule
for limited partnerships and limited liability companies. If the investment
adviser or a related person is a general partner of a limited partnership (or
managing member of a limited liability company, or holds a comparable position
for another type of pooled investment vehicle):
(A) The adviser sends to all limited partners
(or members or other beneficial owners) at least quarterly, a statement
showing:
1.the total amount of all additions
to and withdrawals from the fund as a whole as well as the opening and closing
value of the fund at the end of the quarter based on the custodian's records;
2.a listing of securities
positions on the closing date of the statement required to be disclosed under
Generally Accepted Accounting Principles (GAAP) for investment companies that
are non-registered investment partnerships, pursuant to Financial Accounting
Standards Board (FASB) Accounting Standards Codification 946-210-50-4 through
6.
3.a listing of all additions to
and withdrawals from the fund by the investor, the total value of the
investor's interest in the fund at the end of the quarter.
(B) The investment adviser:
1.Enters into a written agreement with an
independent party who is obliged to act in the best interest of the limited
partners, members, or other beneficial owners to review all fees, expenses and
capital withdrawals from the pooled accounts.
2.Sends all invoices or receipts to the
independent party, detailing the amount of the fee, expenses or capital
withdrawal and the method of calculation such that the independent party can:
a.determine that the payment is in accordance
with the pooled investment vehicle standards (generally the partnership or
membership agreement), and
b.forward to the qualified custodian approval
for payment of the invoice, with a copy to the investment adviser.
(C) Waiver of Net Worth
and Audited Financial Statements. An investment adviser having custody solely
because it meets the definition of custody as defined in subparagraph (d)(2)(C)
of this section and who otherwise complies with this section will not be
required to meet the custodial requirements as set forth in Section 260.237.2
and Section 260.241.2 of these rules.
(6) Independent Verification. The client
funds and securities of which the investment adviser has custody are verified
by actual examination at least once during each calendar year, by an
independent certified public accountant, pursuant to a written agreement
between the investment adviser and the independent certified public accountant,
at a time that is chosen by the independent certified public accountant without
prior notice or announcement to the investment adviser and that is irregular
from year to year. The written agreement must provide for the first examination
to occur within six months of becoming subject to this paragraph, except that,
if the investment adviser maintains client funds or securities pursuant to this
section as a qualified custodian, the agreement must provide for the first
examination to occur no later than six months after obtaining the internal
control report required by paragraph (a)(7)(B). The written agreement must
require the independent certified public accountant to:
(A) File a certificate on Form ADV-E, Expires
January 31, 2016, hereby incorporated by reference, with the Commissioner
within 120 days of the time chosen by the independent certified public
accountant in section (a)(6) of this section, stating that it has examined the
funds and securities and describing the nature and extent of the examination;
(B) Upon finding any material
discrepancies during the course of the examination, notify the Commissioner
within one business day of the finding, by means of a facsimile transmission or
electronic mail, followed by first class mail, directed to the attention of the
Commissioner; and
(C) Upon
resignation or dismissal from, or other termination of, the engagement, or upon
removing itself or being removed from consideration for being reappointed, file
within four business days Form ADV-E accompanied by a statement that includes:
1.The date of such resignation, dismissal,
removal, or other termination, and the name, address, and contact information
of the independent certified public accountant; and
2.An explanation of any problems relating to
examination scope or procedure that contributed to such resignation, dismissal,
removal, or other termination.
(7) Investment advisers acting as qualified
custodians. If the investment adviser maintains, or if the investment adviser
has custody because a related person maintains, client funds or securities
pursuant to this section as a qualified custodian in connection with advisory
services the investment adviser provides to clients:
(A) The independent certified public
accountant the investment adviser retains to perform the independent
verification required by paragraph (a)(6) of this section must be registered
with, and subject to regular inspection as of the commencement of the
professional engagement period, and as of each calendar year-end, by the Public
Company Accounting Oversight Board in accordance with its rules; and
(B) The investment adviser must obtain, or
receive from its related person, within six months of becoming subject to this
paragraph and thereafter no less frequently than once every calendar year, a
written internal control report prepared by an independent certified public
accountant:
1.The internal control report
must include an opinion of an independent certified public accountant as to
whether controls have been placed in operation as of a specific date, and are
suitably designed and are operating effectively to meet control objectives
relating to custodial services, including the safeguarding of funds and
securities held by either the investment adviser or a related person on behalf
of the investment adviser's clients, during the year;
2.The independent certified public accountant
must verify that the funds and securities are reconciled to a custodian other
than the investment adviser or the investment adviser's related persons; and
3.The independent certified public
accountant must be registered with, and subject to regular inspection as of the
commencement of the professional engagement period, and as of each calendar
year-end, by the Public Company Accounting Oversight Board in accordance with
its rules.
(8) Independent representative. A client may
designate an independent representative to receive, on his or her behalf,
notices and account statements as required under paragraphs (a)(3) and (a)(4)
of this section.
(b)
Exceptions
(1) Shares of mutual funds. With
respect to shares of an open-end company as defined in Section 5(a)(1) of the
Investment Company Act of 1940 ( "mutual fund"), an investment adviser may use
the mutual fund's transfer agent in lieu of a qualified custodian for purposes
of complying with paragraph (a) of this section.
(2) Certain privately offered securities.
(A) An investment adviser is not required to
comply with subsection (a)(2) of this section with respect to securities that
are:
1.acquired from the issuer in a
transaction or chain of transactions not involving any public offering;
2.uncertificated, and ownership
thereof is recorded only on books of the issuer or its transfer agent in the
name of the client; and
3.transferable only with prior consent of the
issuer or holders of the outstanding securities of the issuer.
(B) Notwithstanding subparagraph
(b)(2)(A), the provisions of subsection (b)(2) are available with respect to
securities held for the account of a limited partnership (or limited liability
company, or other type of pooled investment vehicle) only if the limited
partnership is audited, the audited financial statements are distributed to the
limited partners, as described in subsection (b)(4) of this section, and the
investment adviser notifies the Commissioner in writing that the investment
adviser intends to provide audited financial statements to the limited partners
as described in this subparagraph. Such notification is required to be given on
Form ADV.
(3) Fee
Deduction. Notwithstanding paragraph (a)(6) of this section, an investment
adviser is not required to obtain an independent verification of client funds
and securities maintained by a qualified custodian, and will not be required to
meet the custodial requirements set forth in Section 260.237.2 and Section
260.241.2 of these rules if all of the following are met:
(A) The investment adviser has custody of the
funds and securities solely as a consequence of its authority to make
withdrawals from client accounts to pay its advisory fee.
(B) The investment adviser has written
authorization from the client to deduct advisory fees from the account held
with the qualified custodian.
(C)
Each time a fee is directly deducted from a client account, the investment
adviser concurrently:
1.Sends the qualified
custodian an invoice or statement of the amount of the fee to be deducted from
the client's account; and
2.Sends
the client an invoice or statement itemizing the fee. Itemization includes the
formula used to calculate the fee, the value of the assets under management on
which the fee is based, and the time period covered by the fee.
(D) The investment adviser
notifies the Commissioner in writing that the investment adviser intends to use
the safeguards provided in this paragraph (b)(3). Such notification is required
to be given on Form ADV.
(4) Limited partnerships subject to annual
audit. An investment adviser is not required to comply with paragraphs (a)(3),
(a)(4), and (a)(5)(B) of this section and shall be deemed to have complied with
paragraph (a)(6) of this section with respect to the account of a limited
partnership (or limited liability company, or another type of pooled investment
vehicle) if each of the following conditions are met:
(A) Account statements required by paragraph
(a)(5)(A).
(B) At least annually
the fund is subject to an audit and distributes its audited financial
statements prepared in accordance with generally accepted accounting principles
to all limited partners (or members or other beneficial owners) and the
Commissioner within 120 days of the end of its fiscal year.
(C) The audit is performed by an independent
certified public accountant that is registered with, and subject to regular
inspection as of the commencement of the professional engagement period, and as
of each calendar year-end, by the Public Company Accounting Oversight Board in
accordance with its rules.
(D)
Upon liquidation, the adviser distributes the fund's final audited financial
statements prepared in accordance with generally accepted accounting principles
to all limited partners (or members or other beneficial owners) and the
Commissioner promptly after the completion of such audit.
(E) The written agreement with the
independent certified public accountant must require the independent certified
public accountant to, upon resignation or dismissal from, or other termination
of, the engagement, or upon removing itself or being removed from consideration
for being reappointed, notify the Commissioner within four business days by the
filing of Form ADV-E accompanied by a statement that includes:
1.The date of such resignation, dismissal,
removal, or other termination, and the name, address, and contact information
of the independent certified public accountant; and
2.An explanation of any problems relating to
examination scope or procedure that contributed to such resignation, dismissal,
removal, or other termination.
(F) The investment adviser must also notify
the Commissioner in writing that the investment adviser intends to employ the
use of the statement delivery and audit safeguards described above in this
paragraph (b)(4). Such notification is required to be given on Form ADV.
(5) The investment
adviser is not required to comply with this section with respect to the account
of an investment company registered under the Investment Company Act of 1940.
(c) Delivery to Related
Persons. Sending an account statement under paragraph (a)(5) of this rule or
distributing audited financial statements under paragraph (b)(4) of this rule
shall not satisfy the requirements of this rule if such account statements of
financial statements are sent solely to limited partners (or members or other
beneficial owners) that themselves are limited partnerships (or other limited
liability companies, or another type of pooled investment vehicle) and are
related persons of the investment adviser.
(d) Definitions. For purposes of this
section:
(1) "Control" means the power,
directly or indirectly, to direct the management or policies of a person,
whether through ownership of securities, by contract, or otherwise. For
purposes of this definition:
(A) Each of the
investment adviser's officers, partners, or directors exercising executive
responsibility (or persons having similar status or functions) is presumed to
control the investment adviser;
(B) A person is presumed to control a
corporation if the person:
1.Directly or
indirectly has the right to vote 25 percent or more of a class of the
corporation's voting securities; or
2.Has the power to sell or direct the sale of
25 percent or more of a class of the corporation's voting securities;
(C) A person is
presumed to control a partnership if the person has the right to receive upon
dissolution, or has contributed, 25 percent or more of the capital of the
partnership;
(D) A person is
presumed to control a limited liability company if the person:
1.Directly or indirectly has the right to
vote 25 percent or more of a class of the interests of the limited liability
company;
2.Has the right to
receive upon dissolution, or has contributed, 25 percent or more of the capital
of the limited liability company; or
3.Is an elected manager of the limited
liability company; and
(E) A person is presumed to control a trust
if the person is a trustee or managing agent of the trust.
(2) "Custody" means holding,
directly or indirectly, client funds or securities, or having any authority to
obtain possession of them, or having the ability to appropriate them. An
investment adviser has custody if a related person holds, directly or
indirectly, client funds or securities, or has any authority to obtain
possession of them, or has the ability to appropriate them, in connection with
advisory services the investment adviser provides to clients. Custody includes:
(A) Possession of client funds or securities
unless received inadvertently and returned to the sender promptly, but in any
case within three business days of receiving them.
(B) Any arrangement (including a general
power of attorney) under which the investment adviser is authorized or
permitted to withdraw client funds or securities maintained with a custodian
upon the investment adviser's instruction to the custodian.
(C) Any capacity (such as general partner of
a limited partnership, managing member of a limited liability company or a
comparable position for another type of pooled investment vehicle, or trustee
of a trust) that gives the investment adviser or the investment adviser's
representative legal ownership of or access to client funds or securities.
(D) Receipt of checks drawn by
clients and made payable to unrelated third parties will not meet the
definition of custody if forwarded to the third party within three business day
of receipt and the adviser maintains the records required under Section
260.241.3 of these rules.
(3) "Independent Certified Public Accountant"
means a certified public accountant that meets the standards of independence
described in Rule 2-01(b) and (c) of Regulations S-X (
17 CFR
210.2-01(b) and (c) ),
effective March 8, 2005.
(4)
"Independent party" means a person that:
(A)
Is engaged by the investment adviser to act as a gatekeeper for the payment of
fees, expenses and capital withdrawals from the pooled investment;
(B) Does not control, is not controlled by,
and is not under common control with the investment adviser;
(C) Does not have, and has not had within the
past two years, a material business relationship with the investment adviser;
and
(D) Does not negotiate or
agree to have material business relations or commonly controlled relations with
an investment adviser for a period of two years after serving as the person
engaged in an independent party agreement.
(5) "Independent designee" means a person
who:
(A) Acts as agent for an advisory
client, including in the case of a pooled investment vehicle, for limited
partners of a limited partnership, members of a limited liability company, or
other beneficial owners of another type of pooled investment vehicle, and by
law or contract is obliged to act in the best interest of the advisory client
or the limited partners, members, or other beneficial owners;
(B) Does not control, is not controlled by,
and is not under common control with the investment adviser; and
(C) Does not have, and has not had within the
past two years, a material business relationship with the investment adviser.
(6) "Qualified
custodian" means any of the following:
(A) A
bank or savings association that has deposits insured by the Federal Deposit
Insurance Corporation under the Federal Deposit Insurance Act.
(B) A broker-dealer registered with the
Commissioner and with the Securities and Exchange Commission holding the client
assets in customer accounts insured by the Securities Investor Protection
Corporation (SIPC).
(C) A
registered futures commission merchant registered under Section 4f(a) of the
Commodity Exchange Act ( 7
U.S.C. 6 f(a) ), holding the client assets in
customer accounts, but only with respect to clients' funds and security
futures, or other securities incidental to transactions in contracts for the
purchase or sale of a commodity for future delivery and options thereon.
(D) A foreign financial
institution that customarily holds financial assets for its customers, provided
that the foreign financial institution keeps the advisory client's assets in
customer accounts segregated from its proprietary assets.
(7) "Related person" means any person,
directly or indirectly, controlling or controlled by the investment adviser,
and any person that is under common control with the investment adviser.
Notes
Note: Authority cited: Sections 25235, 25237 and 25610, Corporations Code. Reference: Sections 25235 and 25237, Corporations Code.
2. Repealer and new section filed 12-30-2013; operative 4-1-2014 (Register 2014, No. 1).
State regulations are updated quarterly; we currently have two versions available. Below is a comparison between our most recent version and the prior quarterly release. More comparison features will be added as we have more versions to compare.
No prior version found.