| ARLINGTON, Va., March 8
ARLINGTON, Va., March 8 The failure by some
advisers to follow a rule aimed at curbing their access to
clients' funds may be weakening efforts to prevent fraud, a top
U.S. securities regulator said.
An investor risk alert announced by the Securities and
Exchange Commission on Monday revealed that many advisers were
not following mandatory procedures when they held client funds
directly through their firms or when they could conduct certain
transactions in customers' accounts.
"It's a big worry," said Carlo di Florio, director of the
SEC's Office of Compliance, Inspections and Examinations, which
regularly examines advisers to ensure they are complying with
securities industry rules.
Lapses in advisers' efforts to comply with the rule, which
is aimed at curbing unfettered access to client funds, could
make investors more vulnerable to fraud, di Florio told
reporters on Thursday after speaking at the Investment Adviser
Association's compliance conference in Arlington, Virginia.
The SEC ramped up its "custody rule" in 2010 as a result of
Bernard Madoff's $65 billion Ponzi scheme.
While many advisers rely on outside companies, such as units
of Charles Schwab Corp. and TD Ameritrade Holding Corp
, to hold client assets, Madoff's firm held his clients'
money in-house. That made it easier to conceal actions that an
outside company may have uncovered, such as fabricating trades.
The custody rule changes include numerous safeguards, such
as a requirement that outside custodians send quarterly account
statements directly to clients, not just to the adviser.
But a recent review by the SEC showed some advisers did not
know that they were deemed custodians. That is because they
missed, or did not follow, some finer points of the rule.
Advisers, even when they park client assets with outside
firms, are still deemed custodians by the SEC if they can access
the funds through an online bill-paying service, or sign checks
as trustees, among other actions.
Being labeled a custodian triggers other measures of the
rule, such as being subject to surprise examinations. That means
the adviser must hire an outside accountant whose role is to
make unannounced inspections to verify that clients' funds
But the "surprise exam" requirement for certain advisers has
led to other problems, the SEC said. Some advisers, for example,
scheduled the exams so that they were not a surprise at all.
"The rule is there to say that if you don't have these
controls in place, the risk that customer assets will be lost is
greater," di Florio told reporters.
The SEC's analysis was based on a review of recent
examinations that contained "significant deficiencies,"
according to the alert on Monday. About one-third of those -
more than 140 - included custody problems. The SEC oversees
about 11,000 investment advisers.
who violated the rule must now fix the problems, including
developing new custody procedures at their firms, the SEC said.
The SEC's exam unit also referred some more-serious cases to SEC
"I was surprised about the widespread number of
deficiencies," David Tittsworth, executive director of the
Washington-based Investment Adviser Association, told Reuters.
"At the minimum, we will have to do a better job about educating
advisers about what their obligations are."
Many advisers were confused by the custody rule requirements
when they took effect in 2010. Some complained about not knowing
whether they applied to their business situations.
The inability of some advisers to grasp whether they are
even covered by the rule may result from both how the SEC
drafted it and problems at the advisory firms themselves, di
Florio said. The SEC may need to clarify the rule beyond a
series of questions and answers from its staff published in 2010
and 2011, he added.
"Clearly people are struggling with the custody rule and
different dimensions of the custody rule," di Florio said in his
remarks to compliance professionals.