What is the Custody Rule Audit Exemption?

The Securities and Exchange Commission (SEC) requires regular surprise audits of registered investment advisers (RIAs) to ensure compliance with the Investment Advisers Act 1940. But you might meet the requirements of the custody rule audit exemption.

Let’s briefly define a custody rule audit and review the rule’s exemption.

What is the Custody Rule Audit?

Any RIA found to hold custody of clients’ funds or assets is subject to a custody rule audit. The custody rule requires RIAs to maintain clients’ funds and investments with a qualified custodian, disclose information about their qualified custodian to their client, and ensure that clients receive quarterly account statements from their qualified custodian.

A surprise audit conducted by a PCOAB-registered public accounting firm ensures that RIAs comply with federal regulations and can detect fraud and misuse of clients’ funds. While surprise examinations are required, there is an exemption to the custody rule.

What You Should Know About the Custody Rule Audit Exemption

A few criteria allow a custody rule audit exemption to be granted. Those criteria are:

Fee deductions: If an RIA holds a client’s funds exclusively to deduct advisory fees, there is no requirement for a surprise examination.
Pooled investment vehicles: Pooled Investment Vehicles, such as hedge funds and venture capital funds, can be exempt from the custody rule audit if an adviser distributes an audited financial statement to investors within 120 of the end of the fiscal year. A PCOAB-registered public accounting firm must conduct an audit of financial statements.
Related Person: A custody rule audit exemption is granted if an RIA holds custody of clients’ assets and a related person can hold or obtain possession (and they are operationally independent of the RIA).

If you meet these three criteria, you may qualify for the custody rule audit exemption. However, it is a good idea to ask your audit firm to double-check your eligibility before claiming the exemption. Claiming the exemption when you do not qualify can result in hefty fines.

Conclusion

Every registered investment advisor should take the time to understand the ins and outs of the custody rule. If you’re unsure if you meet exemption criteria, talk with your audit team. They will help you better understand the exceptions and help you prepare for your audit.

As a PCOAB-registered firm, Assurance Dimensions and its auditors have performed countless audits required by the SEC. When you partner with us, you can be sure your custody audit is accurate and complete.