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Surprise examinations: Valuable services for investment advisers

04.16.21

To verify compliance with Rule 206(4)-2 of the Investment Advisers Act of 1940, surprise examinations help financial advisers meet the requirement of the rule.

Who benefits from this service?
Investment advisers that maintain custody of client funds and securities.

What is the service we provide?
Perform independent verification of client funds of which an investment adviser has custody. Provide report as required under Rule 206(4)-2 under the Investment Advisers Act of 1940 (the Custody Rule).

When is this service provided?
A time chosen by the independent accountant. As the name implies, surprise examinations are to be performed without prior notice or announcement at irregular intervals each year. The first examination must occur within six months of becoming subject to independent verification.

Why is this service required? 
This Rule provides that it is a fraudulent, deceptive or manipulative act, practice, or course of business within the meaning of Section 206(4)-2 of the Act for an investment adviser to have custody of client funds or securities unless:

  1. The qualified custodian maintains those funds in a separate account for each client under the client’s name or in an account that contains only the client’s funds under the investment adviser’s name as agent or trustee for the client.
  2. Clients are notified promptly in writing of the qualified custodian’s name, address, and the manner in which the funds are maintained
  3. The investment adviser has a reasonable basis to believe the qualified custodian sends account statements at least quarterly to clients for which the investment adviser maintains funds or the investment adviser sends quarterly account statements to those clients and an independent public accountant verifies all the funds and securities by surprise examination once during each calendar year

How do we provide this service?
We obtain a listing of all clients for which the investment adviser has custody of and perform various procedures such as:

  • Reading contract provisions with qualified custodians;
  • Confirming balances with the qualified custodians and clients of the investment adviser as of date chosen at random;
  • Reviewing reconciliations of cash and securities from qualified custodians to books and records of investment adviser

Additional requirement
The independent verification procedures must be performed by an independent public accounting firm that is registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board.

An additional requirement that we handle is to file a certificate on Form ADV-E with the Commission within 120 days of date chosen, stating that we have examined the funds and securities and describing the nature and extent of the examination.

Definitions
Custody means holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. An entity is considered to have custody if a related person holds, directly or indirectly, client funds or securities, or has any authority to obtain possession of them, in connection with advisory services provided to clients.

Related person means any person, directly or indirectly, controlling or controlled by the entity, and any person that is under common control with the entity.

Contact
Please contact Janice Latulippe in our Financial Services Group for more information about surprise examinations.

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