Custody Definition and Obligations

This section reinforces the custody rules covered in Client Funds and Securities. The exam outline lists this as a separate topic to emphasize how frequently custody concepts are tested.

Key Reinforcement

An adviser with custody must:

• Maintain client assets with a qualified custodian (bank, broker-dealer (BD), trust company, futures commission merchant (FCM))
• Ensure the custodian sends quarterly statements directly to clients
• Report custody status on Form ADV
• Submit to an annual surprise examination by an independent certified public accountant (CPA), registered with the Public Company Accounting Oversight Board (PCAOB)

Surprise Examination Details

• Must be conducted at an irregular time chosen by the accountant without prior notice to the adviser
• CPA has 120 days from the surprise date to file Form ADV-E with the Securities and Exchange Commission (SEC)

Think of it this way: The entire point is independence. The accountant picks the date, the accountant contacts clients directly, and the accountant reports to the regulator. The adviser is kept out of the loop so it cannot prepare or conceal problems.

Audit exception: A pooled investment vehicle is exempt from the surprise examination if it undergoes an annual Generally Accepted Accounting Principles (GAAP) audit with results distributed to investors within 120 days of fiscal year-end.

Exam Tip: Gotchas

• Form ADV-E is not Form ADV. ADV-E is the cover page for the surprise examination report. Form ADV is the adviser's registration document.
• 120 days appears twice. The accountant has 120 days to file the surprise exam report. Pooled vehicles also have 120 days to distribute audited financials to investors.

Minimum Financial Requirements

Exam Tip: Gotchas

• Deducting advisory fees directly from a client's account = custody. If you can pull money from the account (even just your fee), you have custody and must comply with all custody requirements.