On April 25, 2016, the SEC issued a no-action letter to the Investment Advisers Association clarifying its views on the application of Rule 206(4)-2 under the Advisers Act (the Custody Rule) to situations involving a sub-adviser in an investment advisory program for which a related person qualified custodian is the primary adviser and the primary adviser is responsible for Custody Rule compliance. Typically, an adviser that has custody of client assets generally must undergo an annual surprise examination by an independent public accountant to verify the client funds and securities.  However, certain sub-advisers that technically have custody may be able to avoid obtaining a separate surprise examination by an accountant under the Custody Rule based on this relief.

The SEC’s relief from having a separate surprise examination is conditioned on the sub-adviser having custody solely because of its affiliation with the qualified custodian and primary adviser (i.e., the sub-adviser does not hold funds or securities itself, has no authority to obtain possession of funds or securities, and has no authority to deduct fees from clients’ accounts).  The primary adviser must of course continue to comply fully with the Custody Rule.  Finally, in order to avail itself of this relief, the sub-adviser must still obtain from the primary adviser the written internal control report from the accounting firm performing the surprise exam.

A copy of the no-action letter is available here.