02-032 C.M.R. ch. 515, § 11 - Custody of client funds or securities by investment advisers

1. Sectional Definitions. For purposes of this section, the following definitions shall apply:

A. "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.

(1) 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 adviser's instruction to the custodian; and

(c) Any capacity (such as a 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, an owner of the investment adviser, or a supervised person of the investment adviser legal ownership of or access to client funds or securities.

(2) 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 24 hours of receipt and the adviser maintains the records required.

B. "Independent representative" means a person who:

(1) 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 obligated to act in the best interest of the advisory client or the limited partners, members, or other beneficial owners;

(2) Does not control, is not controlled by, and is not under common control with the adviser; and

(3) Does not have, and has not had within the past two years, a material business relationship with the adviser.

C. "Qualified custodian" means:

(1) A bank or savings association that has deposits insured by the Federal Deposit Insurance Corporation under the Federal Deposit Insurance Act;

(2) A licensed broker-dealer holding the client assets in customer accounts;

(3) A registered futures commission merchant under Section 4 f(a) of the Commodity Exchange Act, 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; and

(4) A foreign financial institution that customarily holds financial assets for its customers, provided that the foreign financial institution keeps the advisory clients' assets in customer accounts segregated from its proprietary assets.

D. "Supervised person" means any partner, officer, director (or other person occupying a similar status or performing similar functions), or employee of an investment adviser, or other person who provides investment advice on behalf of the investment adviser and is subject to the supervision and control of the investment adviser.

2. General Provision. It shall be unlawful and a fraudulent or deceptive act, practice, or course of business for any investment adviser licensed or required to be licensed in Maine to take or have custody of any securities or funds of any client unless the investment adviser complies with the provisions of this section.

3. Notice to Administrator. The investment adviser shall promptly notify the Administrator in writing that the investment adviser has or may have custody. Such notification is required to be given on Form ADV.

4. Qualified custodian. The funds and securities shall be maintained by a qualified custodian:

A. In a separate account for each client under that client's name; or

B. In accounts that contain only the funds and securities of the adviser's clients, under the adviser's name as agent or trustee for the clients.

5. Notice to clients. When the investment adviser opens an account with a qualified custodian for maintaining a client's funds or securities, the adviser shall notify the client promptly in writing of the qualified custodian's name and address and of the manner in which the funds and securities are maintained. The adviser shall notify the client promptly in writing of any changes to this information.

6. Account statements

A. Account statements must be sent to clients, either by:

(1) A qualified custodian. The investment adviser must have a reasonable basis 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 during that period; or

(2) The investment adviser.

B. If the investment adviser sends account statements to its clients, the adviser must comply with the following requirements:

(1) The investment adviser shall send an account statement, at least quarterly, to each client for whom the investment adviser has custody of funds or securities, identifying the amount of funds and of each security of which the investment adviser has custody at the end of the period and setting forth all transactions during that period;

(2) An independent certified public accountant shall verify all of those funds and securities by actual examination at least once during each calendar year at a time chosen by the accountant without prior notice or announcement to the adviser and that is irregular from year to year, and shall file a certificate on Form ADV-E [ 17 CFR 279.8] with the Administrator within 30 days after the completion of the examination, stating that it has examined the funds and securities and describing the nature and the extent of the examination; and

(3) The independent certified public accountant, upon finding any material discrepancies during the course of the examination, shall notify the Administrator 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 Administrator.

C. Limited partnerships and limited liability companies. If the investment adviser 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), the account statements required under this subsection must be sent to each limited partner (or member or other beneficial owner or their independent representative).

D. Revocable trusts. If an investment adviser, owner of an investment adviser, or supervised person of an investment adviser is serving as trustee of a revocable trust and the investment adviser acts as the investment adviser to that trust, the account statements required under this subsection must be sent to the grantor of the trust. If the trust assets are being maintained by a qualified custodian, the adviser shall instruct the custodian to send the statements directly to the grantor and must have a reasonable basis for believing the statements are being sent.

E. Irrevocable trusts

(1) If an investment adviser, owner of an investment adviser, or supervised person of an investment adviser is serving as trustee of an irrevocable trust and the investment adviser acts as the investment adviser to that trust, the investment adviser shall send a notice annually to every beneficiary entitled to receive the annual report of the trustee pursuant to 18-B M.R.S.A. §813(3). The investment adviser is not required to send this notice to beneficiaries for whom the trustee is also the legal guardian.

(2) The notice must state that:

(a) The investment adviser or one of its owners or supervised persons is serving as the trustee for the trust;

(b) The investment adviser is providing advisory services to the trust; and

(c) The beneficiary may receive, upon request, a copy of the account statements required by this subsection.

(3) The notice required by subparagraph (1) may be sent with the annual report of the trustee required by 18-B M.R.S.A. §813(3).

(4) The investment adviser shall arrange for the account statements to be sent to each beneficiary requesting statements. If the trust assets are being maintained by a qualified custodian, the adviser shall instruct the custodian to send the statements directly to the requesting beneficiaries and must have a reasonable basis for believing the statements are being sent. If more than three beneficiaries request statements, the custodian may charge a fee, reflecting its actual costs of copying and mailing the statements, to each beneficiary receiving them.

F. Co-trustees. Compliance with paragraphs D and E of this subsection is not required if the trust has at least one co-trustee who is neither a relative of, nor within the past three years has had a material business relationship with, the investment adviser or any of its owners or supervised persons, and the trust's assets are maintained by a qualified custodian who is sending a copy of the account statements required by paragraph A of this subsection directly to the co-trustee.

7. Independent representatives. A client may designate an independent representative to receive, on his behalf, notices and account statements as required under subsections 5 and 6 of this section.

8. Direct fee deduction

A. An adviser who has custody by virtue of having fees directly deducted from client advisory accounts must also provide the following safeguards:

(1) The investment adviser must have written authorization from the client to deduct advisory fees from the account with the qualified custodian.

(2) Each time a fee is directly deducted from a client account, the investment adviser must concurrently:

(a) Send the qualified custodian an invoice of the amount of the fee to be deducted from the client's account; and

(b) Send the client an invoice itemizing the fee. Itemization includes the formula used to calculate the fee, the amount of assets under management the fee is based on, and the time period covered by the fee. Invoices need not be sent more frequently than every quarter, provided that the invoice must show the calculation of each fee deducted during the quarter.

B. An investment adviser is not required to comply with paragraph A(2)(b) of this subsection for any client who waives in writing the right to receive an itemized invoice. The waiver must describe the right being waived and must be on a document that does not address any other matter.

C. Whenever account statements are required to be sent to a grantor or beneficiary of a trust pursuant to subsection 6(D) or (E), the adviser shall send to that person the itemized invoice required by paragraph A(2)(b) of this subsection unless the person has executed a waiver in accordance with this subsection.

D. The investment adviser must notify the Administrator in writing that the investment adviser intends to use the safeguards provided in paragraph A. Such notification is required to be given on the Form ADV.

E. An investment adviser having custody solely by virtue of having fees directly deducted from client advisory accounts and who complies with this subsection and with subsections 4-7 of this section is not required to:

(1) Meet the financial requirements for custodial advisers set forth in subsection 12(1) of this Chapter;

(2) Meet the bonding requirement set forth in section 13 of this Chapter; and

(3) File an audited balance sheet on Form ADV, Part II, Schedule G, unless required for some reason other than having custody of client assets.

9. Mutual fund shares. With respect to shares of an open-end investment company as defined in Section 5(a)(1) of the Investment Company Act of 1940 [ 15 U.S.C. 80a-5(a)(1)] ("mutual fund"), an investment adviser may use the mutual fund's transfer agent in lieu of a qualified custodian for purposes of complying with this section.

10. Certain privately offered securities

A. An investment adviser is not required to comply with 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. This subsection applies 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 and the audited financial statements are distributed as required by subsection 11 of this section.

11. Limited partnerships subject to annual audit. An investment adviser is not required to comply with subsection 6(C) of this section with respect to the account of a limited partnership (or limited liability company, or another type of pooled investment vehicle) that is subject to audit at least annually and distributes its audited financial statements prepared in accordance with generally accepted accounting principles to all limited partners (or members or other beneficial owners) within 120 days of the end of the fiscal year, or in the case of a fund of funds within 180 days of the end of the fiscal year.

12. Registered investment companies. An 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 [ 15 U.S.C. 80a-1 to 80 -a-64].

13. Client funds or securities not maintained with qualified custodian. An investment adviser who intends to have custody of client funds or securities but is not able to utilize a qualified custodian, as defined in this section, must:

A. First obtain the written approval of the Administrator, and

B. Comply with subsections 3 through 7 of this section, to the extent applicable, including performing those functions that would otherwise be performed by the qualified custodian.

14. Beneficial trusts. An investment adviser who has custody of client assets solely because the investment adviser, an owner of the investment adviser, or a supervised person of the investment adviser is a trustee for a beneficial trust and the beneficial owner of the trust is a parent, grandparent, spouse, sibling, child or grandchild of the trustee is not required to file an audited balance sheet on Form ADV, Part II, Schedule G if the investment adviser complies with this section. These relationships include "step" relationships.

Notes

02-032 C.M.R. ch. 515, § 11