March 7, 2018

Dalia Blass
Director
Division of Investment Management

Peter B. Driscoll
Director
Office of Compliance Inspections and Examinations

U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549

Re: IM Guidance Update No. 2017-01 – Inadvertent Custody: Advisory Contract Versus Custodial Contract Authority (the “February 2017 Guidance” or the “Guidance”)1

Dear Ms. Blass and Mr. Driscoll:

The undersigned associations (the “Associations”)2 appreciate the Staff’s active dialogue over the past year regarding our members’ concerns and questions related to the February 2017 Guidance. Following our most recent meeting with Staff from the Division of Investment Management (“IM”) and Office of Compliance Inspections and Examinations (“OCIE”), we believe that it would be helpful to set forth (I.) our members’ understanding of Rule 206(4)-2 (the “Custody Rule”) promulgated by the Commission under the Investment Advisers Act of 1940 (the “Advisers Act”); (II.) the changes in interpretation of the Custody Rule raised by the Guidance, and resulting negative consequences; and (III.) the types of controls investment advisers already have in place that are reasonably designed to address the risk of misappropriation. We are firmly committed to continuing to work with the Staff to find a solution to issues raised by the Guidance and hope that this letter is helpful in moving forward.

I. Investment Advisers’ Understanding of the Custody Rule

A. The “authorized” scope of an investment adviser to obtain possession of client funds or securities is restricted by the IMA between the client and investment adviser

An investment adviser defines the scope of its relationship with its advisory clients, including the extent to which the investment adviser can transfer client funds and securities, through the
Investment Management Agreement (“IMA”)3 it enters into with the client. The investment adviser’s investment authority is established by the IMA itself and, in many cases, through related investment guidelines. IMAs commonly include a provision expressly providing that the investment adviser does not have custody of client assets, nor any authority to transfer securities and funds to themselves (other than due to the deduction of advisory fees from client accounts). These clients, in turn, establish a custody account and grant investment advisers authority to transfer assets held in the custody account through a custody agreement (“Custody Agreement”). 4 As such, the custodian holds the client’s cash and securities and transfers them upon instruction by an investment adviser who is bound by the authority granted in its IMA. Many of these same clients in their IMAs and related investment guidelines grant investment advisers authority to trade in a wide variety of asset classes and instruments—including those that do not settle “delivery-versus-payment” (“DVP”).

Investment advisers have determined that, for the advisory client relationship described above, they do not have custody of client funds or securities under the Custody Rule. This view is grounded in the Custody Rule’s definition of “custody” as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.”5 The definition of custody also includes “[a]ny arrangement (including a general power of attorney) under which you are authorized or permitted to withdraw client funds or securities maintained with a custodian upon your instruction to the custodian.” Investment advisers are not “authorized or permitted” to take actions that would violate the terms of their IMAs. As such, an investment adviser would not view itself as being “authorized” to obtain possession of client funds or securities pursuant to a Custody Agreement to which it is not a party when the exercise of authority under that Custody Agreement would violate the investment adviser’s IMA.

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1 The February 2017 Guidance is available at: https://www.sec.gov/investment/im-guidance-2017-01.pdf.

2 See end of letter for descriptions of the Asset Management Group of the Securities Industry and Financial Markets Association (“SIFMA AMG”) and the Investment Adviser Association (“IAA”).

3 The term IMA used herein refers broadly to arrangements between investment advisers and their clients to provide discretionary advisory services.

4 The term Custody Agreement as used herein refers broadly to any agreements or other documents that form the relationship between a client and custodian.

5 Rule 206(4)-2(d)(2) (emphasis added).