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What "custody" means under the rule
Custody includes any arrangement that gives the adviser direct or indirect access to client funds or securities. The clearest case is physical possession. The trickier cases — and the ones that cause inadvertent custody findings — are these:
- Authority to deduct fees directly from client accounts.
- Authority to disburse funds to third parties (a standing letter of authorization structured incorrectly).
- Acting as trustee on a client's trust.
- General partner or managing member roles in pooled vehicles.
- Login credentials that allow movement of assets, even if not used.
The required safeguards
- Qualified custodian — assets must be held by a qualified custodian (typically a bank or broker-dealer) in a separate account in the client's name.
- Account statements — the qualified custodian must deliver account statements to the client at least quarterly.
- Surprise examination — for advisers with custody beyond fee deduction, an independent accountant must conduct an annual surprise verification of the assets and file Form ADV-E.
- Internal controls report — for advisers serving as qualified custodian, an annual SOC-1 type report.
Inadvertent custody — the most common finding
An adviser can have custody without intending to. The classic example is a standing letter of authorization that names the third party in a way that creates discretion for the adviser, or fee-deduction authority structured in a way that lets the adviser instruct the custodian to move money beyond fees. The SEC has issued guidance clarifying these cases; firms that haven't reviewed their custody footprint against current guidance are exposed.
Reporting custody on Form ADV
Custody status — and the specific custody arrangements — must be disclosed on Form ADV. Discrepancies between the form's disclosed custody position and the firm's actual practice are among the highest-impact examination findings.
How StratiFi thinks about the custody rule
Custody is a binary fact pattern with non-binary controls. The firms that get it right map every authority they have over client funds — fee deduction, SLOA, trustee role, login access — against the current SEC guidance, document the conclusion, and revisit the analysis whenever a new authority is added or the rules change.
Frequently asked questions
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Does fee deduction count as custody?
Technically yes, but the SEC's "fee-deduction-only" exception means a surprise examination is not required if the adviser's only custody is direct fee deduction with proper safeguards. The custody disclosure on Form ADV is still required. -
What's a qualified custodian?
A bank, registered broker-dealer, registered futures commission merchant, or certain foreign financial institutions that meet SEC-defined criteria. Most large brokerages and trust companies qualify. -
How often is the surprise exam?
Annual, on a date that varies year to year and is not disclosed to the adviser in advance. The accountant files Form ADV-E within 120 days of the exam date.