Quick Answer
Custody is about authority, not just physical possession: an adviser has custody if it can obtain client funds or securities, even just by deducting fees. The Uniform Securities Act requires an adviser with custody to at least notify the Administrator; NASAA's custody rule for investment advisers adds a qualified custodian, client notice, quarterly statements, and an annual surprise examination.
This section covers who is allowed to hold client assets, what counts as having custody, and the safeguards NASAA requires when an investment adviser does.
When Is an Adviser's Custody Unlawful?
Under the Uniform Securities Act's custody provision, it is unlawful for an investment adviser to take or have custody of client securities or funds if:
- The Administrator by rule prohibits custody, or
- In the absence of such a rule, the adviser fails to notify the Administrator that it has or may have custody
This gives the Administrator two regulatory options: ban IA custody outright, or require notification. If a state has not adopted a specific custody rule, the default is that the adviser must at minimum notify the Administrator. The Administrator may also adopt rules, such as NASAA's custody rule for investment advisers, that impose additional safeguards beyond this baseline.
What Counts as "Custody"?
An investment adviser has custody when it holds, directly or indirectly, client funds or securities, or has the authority to obtain possession of them. The adviser also has custody if a related person holds client funds or securities, or has authority to obtain them, in connection with the advisory services the adviser provides. Custody includes:
- Physical possession of client funds or securities (for example, holding stock certificates or checks)
- Authority to withdraw funds or securities from a client's account, such as deducting advisory fees directly
- Legal ownership or access to client funds through any arrangement that lets the adviser obtain them, including acting as trustee for a client trust or holding signatory authority over a client's bank account
Two narrow situations do not count as custody, even though the adviser briefly holds something belonging to a client, provided the adviser also keeps the required records of the transfer:
- Inadvertent receipt: the adviser receives client funds or securities by mistake and returns them to the sender within three business days
- Third-party checks: a client's check is made payable to a third party, and the adviser forwards it to that third party within three business days of receipt
Is Discretionary Authority the Same as Custody?
No. Discretionary authority by itself is not custody. The two powers answer different questions:
| Power | What it lets the adviser do |
|---|---|
| Discretion | Decide the security, the amount, or the action in a client's account without asking first |
| Custody | Hold client funds or securities, or obtain them |
An adviser that places trades in a client account held at a qualified custodian, but cannot withdraw cash or securities from that account, has discretion without custody. It owes none of the custody safeguards on this page.
The two often appear together, and the Administrator may require a bond for either one. That shared consequence is what makes students merge them. They remain separate determinations, and a fact pattern can give an adviser one, both, or neither.
Exam Tip: Gotchas
"Custody" does not require the adviser to physically hold the assets. If the adviser has the authority to access or withdraw client funds, even only through automatic fee deductions, that is custody. It also does not require the adviser itself to hold anything: a related person with that authority gives the adviser custody too. The narrow three-business-day exceptions (inadvertent receipt, forwarding third-party checks) are the only carve-outs from "possession equals custody." Discretion is a separate question, not a carve-out. Authority to choose trades is not authority to obtain assets, so an adviser with discretion alone never triggers the custody rule.
What Does NASAA's Custody Rule Require?
NASAA's custody rule for investment advisers gives state-registered advisers (and advisers required to be state-registered) with custody a detailed set of safeguards:
| Requirement | Details |
|---|---|
| Qualified custodian | Client funds and securities must be maintained with a qualified custodian (bank, savings association, broker-dealer, futures commission merchant, or a foreign financial institution meeting specified conditions) |
| Notice to Administrator | An adviser with custody must promptly notify the Administrator on Form ADV |
| Account-opening notice | The adviser promptly tells the client the custodian's name and address and how assets are maintained, and updates the notice after any change |
| Quarterly statements | The adviser has a reasonable basis for believing the qualified custodian sends clients statements at least quarterly |
| Surprise examination | An adviser with custody generally undergoes an annual surprise examination by an independent certified public accountant |
| Account structure | Assets may sit in separate client accounts, or in client-only omnibus or pooled accounts under the adviser as agent or trustee; they may never mix with the adviser's proprietary assets |
Who Qualifies as a Custodian?
Client assets must be held by a qualified custodian:
- Banks and savings associations
- Registered broker-dealers
- Futures commission merchants
- Foreign financial institutions that meet specified conditions
An adviser (or a related person) that independently qualifies may act as its own clients' custodian, subject to extra safeguards beyond the standard surprise examination.
Account statements from the qualified custodian go directly to the client, not through the adviser, to prevent misappropriation. If the adviser also sends its own account statements to that client, the adviser must include a notice urging the client to compare the custodian's statements against the adviser's.
Are There Exceptions to the Custody Safeguards?
- Mutual fund shares: the adviser may use the fund's own transfer agent in place of a qualified custodian
What Does the Annual Surprise Examination Require?
If an adviser has custody of client assets, it generally must engage an independent certified public accountant to conduct an annual surprise examination to verify that client assets are present and properly accounted for.
When Is the Surprise Examination Not Required?
An adviser whose only form of custody is deducting advisory fees can be relieved of the independent-verification (surprise-examination) requirement if it meets NASAA's conditions for fee-deduction custody. The exception removes independent verification only; every other custody safeguard (qualified custodian, quarterly statements, and so on) still applies.
What Should You Check on Exam Day?
- Under the Uniform Securities Act, IA custody is unlawful unless a rule permits it or the adviser notifies the Administrator.
- Custody is about authority to obtain funds or securities, not just physical possession; fee-deduction authority alone is custody, and a related person's authority counts too.
- Discretion alone is not custody. Choosing the security, amount, or action is not the same as being able to obtain the assets. An adviser can hold one power, both, or neither.
- The narrow exceptions are inadvertent receipt and forwarding a third-party check, each within three business days with the required records kept.
- NASAA's custody rule requires a qualified custodian (banks/savings associations, registered broker-dealers, futures commission merchants, or qualifying foreign institutions; mutual fund shares may use the fund's transfer agent), Form ADV notice, client notice, quarterly statements, and an annual surprise examination.