The SEC has published the final release for rules and form amendment intended to better protect investors from fraud and theft by investment advisers by ensuring that investment advisers who have custody of clients’ funds and securities are handling those assets properly.

As we summarized in our May 20, 2009 post, SEC Proposes Rules on Investor Funds Controlled by Investment Advisers, the rules proposed in May require:

that investment advisers have an annual “surprise exam” by an independent accounting firm. To help prevent advisers from rigging their own “surprise” by a friendly or unqualified accountant, in the case of advisers or affiliates of the adviser holding clients’ assets directly, the “surprise exam” would have to be conducted by a PCAOB-registered and inspected accountant.

Another aspect of these proposals would apply to investment advisers whose client assets are not held or controlled by a firm independent of the adviser, requiring them to obtain a written report prepared by a PCAOB-registered and inspected accountant that, “among other things, describes the controls in place, tests the operating effectiveness of those controls, and provides the results of those tests” (i.e., their SAS-70 reports).

In addition to these “surprise exam” provisions, the proposed amendments also would require that custodians holding the assets of advisory clients deliver the custodial statements directly to the individual advisory clients rather than sending them through the investment adviser. Advisory clients would be encouraged to compare the statements they receive from the adviser with those they obtain from the custodian, making it more difficult for an adviser to prepare false account statements, and making it possible for clients to find discrepancies.

The final rules do differ in some respects from the proposing release.  In particular, the under the new rules,  an adviser to a pooled investment vehicle that is subject to an annual financial statement audit by an independent public accountant, and that distributes the audited financial statements prepared in accordance with generally accepted accounting principles to the pool's investors, will be deemed to have satisfied the annual surprise examination requirement. Under the proposed rules, such an adviser would have been subject to surprise audit.  In addition, the Commission tightened the rules to require that these surprise exams, as with surprise exams of other advisers under the rules, be performed by an independent public accountant registered with, and subject to regular inspection by, the PCAOB.

The full text of the final rule release is available at:   http://sec.gov/rules/proposed/2009/ia-2876.pdf

The full text of the proposing release is available at:  http://sec.gov/rules/final/2009/ia-2968.pdf