Compliance with the rules of the Securities and Exchange Commission (SEC) is difficult. It often requires weeks of work, not simply to fill out the forms but also to understand what the forms are asking.
Item 9 Custody, offers perhaps some of the most confusing and most often changed compliance questions. I have covered this item before in “Answering SEC ADV Part 1 Item 9 Custody is Representative of a Larger Compliance Problem.”
Toward the end of Item 9 Custody, question F asks:
“If you or your related persons have custody of client funds or securities, how many persons, including, but not limited to, you and your related persons, act as qualified custodians for your clients in connection with advisory services you provide to clients?”
The wording of this compliance question is confusing.
At first glance, you’d think you should skip this question if you don’t have real custody of client accounts.
However, many advisors have custody only in the limited sense that they can move money between two different client accounts or distribute their management fee. With that interpretation of “have custody,” you would be tempted to add up the number of staff (people) who have this ability and put that number in this answer.
However, the question is asking for how many “persons … act as qualified custodians.” If people means “staff,” then you’d think that you should answer zero, meaning that none of your staff acts as a qualified custodian. However, that is not what they mean when they say “people.”
Each of the words in italics offers a link to a provided glossary of terms. In this case the important definition is provided by the definition of the word “person”:
“Person: A natural person (an individual) or a company. A company includes any partnership, corporation, trust, limited liability company (“LLC”), limited liability partnership (“LLP”), sole proprietorship, or other organization. [Used throughout Form ADV and Form ADV-W]”
Person could mean a natural person, meaning a real human being, but it could also mean a company.
Inserting this definition into the original question, the paraphrase would be:
“If you have custody of client funds or securities, how many companies (or natural people) act as qualified custodians for the accounts with your advisory services?”
This implies that the SEC is asking how many companies act as qualified custodians for accounts with advisory services and if you have custody, you answer this question and if you don’t have custody, then you don’t answer it. However, the answer box requires an integer and is marked as incomplete if you do not answer it.
This eliminates the option that the conditional phrase at the start governs whether or not you answer the question.
Therefore, either the conditional phrase — “If you have custody of client funds or securities,” — is irrelevant and you simply reply with the number of qualified custodians for accounts with advisory services or the first part of the question means something other than what it explicitly says.
Because of the conditional phrase at the beginning, it seems that the SEC wants the number of companies that act as qualified custodians for accounts with custody. However, they didn’t say that. They said accounts “in connection with advisory services you provide to clients.”
From this, we had a fierce internal debate over the grammar of this question. How are you supposed to answer it?
We have several companies that act as qualified custodians for accounts with our advisory services. However, we only have one company acting as a qualified custodian for the accounts where our staff has the ability to move money between accounts not identically named (also known as third party transfers). That company is Charles Schwab.
In the end, we interpreted the conditional phrase to govern the entire sentence (Otherwise, why is it there?) and assumed the question was asking for how many qualified custodians work with accounts where you have custody.
As a result, we answered “1” to Item 9 Custody, F. The one is Charles Schwab.
I’m not sure why they phrased the question the way that they did. At first, second, third, or even twentieth read, it is not clear what specifically they are asking.
Read the full article here
