As detailed in this blog ad nauseam, the Securities and Exchange Commission (“SEC”) has adopted amendments to the custody rules under the Investment Advisers Act of 1940 (“Advisers Act”). The most onerous of these changes is the requirement that investment advisers with custody of client funds or assets obtain a surprise examination from an independent public accountant.

As part of these wholesale revisions, the SEC also published interpretive guidance for independent public accountants. This guidance provides direction with respect to the independent verification and internal control report as required under the rule. For a sample of client accounts, the accountant is required to obtain records of the purchases, sales, contributions, withdrawals and any other debits or credits to each selected client’s account occurring since the date of the last examination. In order for the accountant’s procedures to meet the objective of the examination, it should include the following with respect to each selected client account:

1. Confirmation with the qualified custodian(s) of client funds and securities as of the date of the examination and that the client’s funds and securities are held in either a separate account under the client’s name or in accounts under the name of the investment adviser as agent or trustee for clients;
2. Confirmation with the client of funds and securities held in the account as of the date of the examination and contributions and withdrawals of funds and securities to and from the account since the date of the last examination; where confirmation replies are not received, the accountant should perform alternative procedures; and
3. Reconciliation of confirmations received and other evidence obtained to the investment adviser’s records.

Rule 206(4)-2(a)(6) establishes additional requirements for an investment adviser that itself, or its related person, maintains client funds or securities as a qualified custodian in connection with advisory services provided to clients. Such an investment adviser must at least once each calendar year obtain or receive from its related person an internal control report related to its or its affiliates’ custody services, including the safeguarding of funds and securities, prepared by an independent public accountant that is registered with, and subject to inspection by, the PCAOB.

The internal control report objectives should include:

• Documentation for the opening and modification of client accounts is received, authenticated, and established completely, accurately, and timely on the applicable system.
• Client transactions, including contributions and withdrawals, are authorized and processed in a complete, accurate, and timely manner.
• Trades are properly authorized, settled, and recorded completely, accurately, and timely in the client account.
• New securities and changes to securities are authorized and established in a complete, accurate and timely manner.
• Securities income and corporate action transactions are processed to client accounts in a complete, accurate, and timely manner.
• Physical securities are safeguarded from loss or misappropriation.
• Cash and security positions are reconciled completely, accurately and on a timely basis between the custodian and depositories.
• Account statements reflecting cash and security positions are provided to clients in a complete, accurate and timely manner.

The accountant’s internal control report should identify the control objectives included within the scope of the examination and include the accountant’s opinion as to whether controls have been placed in operation as of the specific date, and are suitably designed and are operating effectively to meet the identified control objectives during the specified period. The report should also describe the nature, timing, extent and results of the accountant’s procedures performed to verify that funds and securities are reconciled to depositories and other unaffiliated custodians.

Is anyone else surprised that the “new” SEC custody rule does not take into account current custodial practices (let alone future practices). It seems to have escaped the notice of the SEC that most custodians have gone green (okay, are trying to save money) by eliminating the delivery of paper account statements. At a recent CCOutreach session, a client asked a SEC official if would it be enough (e.g., would it constitute due inquiry) to call those clients that must access their account statements via the custodian’s web site to confirm that they did indeed access such statements? The SEC official responded:

“It is not clear how you would be able to derive a reasonable belief from this information. Just because the client says they were delivered the statements, how do you know they actually did receive them? Does the client know who all their custodians are, and do they remember receiving all of them at the time you are asking them?”

Of course, the same SEC official refused to say what would constitute due inquiry under these circumstances. Perhaps investment advisers need to have their clients take lie detector tests or better yet, perhaps advisers need to station an employee in each client’s home to confirm that the client accessed all their account statements.

Yesterday I had an informative discussion with Vivien Liu about one troubling aspect of the new SEC Custody Rule. Ms. Liu is Senior Counsel at the SEC and one of the primary drafters of the new rule.

Due Inquiry

Among the many new requirements under the Custody Rule, the one that will affect almost every SEC-registered investment adviser is the requirement that an adviser can only form a reasonable belief that the qualified custodian sends account statement directly to clients after “due inquiry”.

What then, as many of our client’s have asked, suffices as “due inquiry”?

Account Statements Sent by Mail

If the qualified custodian sends out paper copies of account statements to the client, the adviser can satisfy the “due inquiry” standard by receiving a duplicate account statement directly from the custodian.

Electronic Account Statements

It becomes a bit more problematic when custodians do not send paper copies of the account statement and either (1) email the statement to clients or (2) make the statement available to clients via the custodian’s web site (whether this is at the option of the client or the policy of the custodian).

Accordingly to Ms. Liu, if the custodian emails account statements, then “due inquiry” would be satisfied if the adviser was “cc’d” on any such email. In effect, this would be analogous to the adviser receiving a duplicate paper copy via regular mail.

It is the second scenario - where the client must access the account statement via the custodian’s web site - that prompted my call to the SEC. This is because a footnote in the new rule states that:

“Advisers are not permitted to satisfy the requirement of forming a reasonable belief after “due inquiry” by accessing qualified custodian account statements through the custodian’s website. Accessing account statements through the website merely confirms that they are available. If an adviser does not take additional steps to determine whether account statements were sent to clients, or that clients obtained statements through the website, the adviser would have an inadequate basis for forming a reasonable belief, after due inquiry, that the qualified custodian sends account statements to clients.”

When the question of what “additional steps” an adviser must take in this situation was put to Ms. Liu, she agreed that there was no obvious solution. Hardly encouraging. However, Ms. Liu did state that the SEC would probably issue a clarification in the coming weeks which, of course, will prompt yet another Client Alert! Our view on the matter - beyond surprise that the SEC did not seem to take current custodial reporting practices into account when formulating the new rule - is that the “additional step” that an adviser must take is follow-up phone calls to clients to confirm that they actually accessed their account statements.

I know, I know . . . outrageously time-consuming, onerous and unfairly burdensome. Guilty on all three counts. However, until the SEC issues some clarification, this seems to be the only way to satisfy the due inquiry requirement in this situation. Though many of you think us infallible (and rightly so) we are certainly open to other suggestions as to how to best handle this troubling scenario.

The new SEC custody rule requires that an investment adviser have a reasonable belief that the qualified custodian sends account statements directly to clients must be formed by the adviser after “due inquiry.”  One adviser asked whether calling their clients on a quarterly basis to “inquire” whether or not they are receiving statements from the qualified custodian would constitute ‘due inquiry”. Absolutely.

When first released, the SEC Final Rule: Custody of Funds or Securities of Clients by Investment Advisers had an uncertain effective date. As stated in the Final Rule, ”the effective date of the amendments to rules 206(4)-2, 204-2 and Forms ADV and ADV-E is 60 days after publication in the Federal Register.”

The Final Rule was published in the Federal Register on January 11, 2010 which makes the effective date March 11, 2010.

Therefore, starting on March 11, 2010:

1. Advisers that elect to send their own account statements to clients must include a legend in the notice urging clients to compare the account statements they receive from the custodian with those they receive from the adviser; and
2. Advisers that send their own account statements to clients, in any subsequent statements they deliver to clients after the initial notice, must urge clients to compare the adviser’s statements with the account statements they receive from the custodian.

Other actions that should be taken by investment advisers by the effective date include adopting the following policies and procedures as part of their compliance program:

1. Conducting background and credit checks on employees of the investment adviser who will have access (or could acquire access) to client assets to determine whether it would be appropriate for those employees to have such access;
2. Requiring the authorization of more than one employee before the movement of assets within, and withdrawals or transfers from, a client’s account, as well as before changes to account ownership information;
3. Limiting the number of employees who are permitted to interact with custodians with respect to client assets and rotating them on a periodic basis; and
4. If the adviser also serves as a qualified custodian for client assets, segregating the duties of its advisory personnel from those of custodial personnel to make it difficult for any one person to misuse client assets without being detected.

Advisers should also consider:

1. Including in their policies and procedures a requirement that any problems be brought to the immediate attention of the management of the adviser.
2. Developing policies regarding the ability of individual employees to acquire custody of client assets (i.e., as trustees for client assets), because their custody may be attributable to the firm, which will thereby acquire responsibility for those assets under the rule.
3. Developing procedures by which the CCO periodically tests the effectiveness of the firm’s controls over the safekeeping of client assets, including:

• Periodically testing the reconciliation of account statements prepared by advisers with account statements as reported by qualified custodians; and
• Comparing, on a sample basis, client addresses obtained from the clients’ qualified custodians to which the custodian sends client statements, with client addresses maintained by the adviser, to look for inconsistencies or patterns that suggest possible manipulation of address information as a means for concealing misappropriation from these accounts by advisory personnel.

Compliance Dates

Also, remember that in addition to the effective date, the Final Rule carried with it specific compliance dates as follows:

Notice Requirement

Immediately upon the effective date advisers that have custody of client assets must promptly upon opening a custodial account on a client’s behalf, and following any changes to the custodial account information, as specified in rule 206(4)-2(a)(2) send a notification to the client, including a legend urging the client to compare the account statements the client receives from the custodian with those the client receives from the adviser. Such legend should also be included in any account statements that advisers send to these clients after they are required to send the notification discussed above. In addition, immediately upon the effective date, each adviser that has custody of client assets must have a reasonable belief (except with respect to pooled investment vehicles the financial statements of which are audited and delivered to investors) that a qualified custodian sends account statements directly to clients at least quarterly.

Surprise Examination Requirement

An investment adviser required to obtain a surprise examination must enter into a written agreement with an independent public accountant that provides that the examination will take place by December 31, 2010 or, for advisers that become subject to the rule after the effective date, within six months of becoming subject to the requirement. If the adviser itself maintains client assets as qualified custodian, however, the agreement must provide for the first surprise examination to occur no later than six months after obtaining the internal control report.

Internal Control Reports Requirement

An investment adviser also required to obtain or receive an internal control report because it or a related person maintains client assets as a qualified custodian must obtain or receive an internal control report within six months of becoming subject to the requirement.

Audit of Pooled Investment Vehicles

An investment adviser to a pooled investment vehicle may rely on the annual audit provision if the adviser (or a related person) becomes contractually obligated to obtain an audit of the financial statements of the pooled investment vehicle for fiscal years beginning on or after January 1, 2010.

Amended Form ADV Requirement

Investment advisers registered with the SEC must provide responses to the revised Form ADV in their first annual amendment after January 1, 2011.

Just to drill down a bit on one aspect of the new custody rule:

As amended, rule 206(4)-2 imposes additional requirements when advisory client assets are maintained by the adviser itself or by a related person rather than with an independent qualified custodian. As proposed, the amended rule requires, in addition to the surprise examination,  that when an adviser or its related person serves as a qualified custodian for advisory client funds or securities under the rule, the adviser obtain, or receive from its related person, no less frequently than once each calendar year, a written report, which includes an opinion from an independent public accountant with respect to the adviser’s or related person’s controls relating to custody of client assets

The internal control report should address control objectives and associated controls related to the areas of client account setup and maintenance, authorization and processing of client transactions, security maintenance and setup, processing of income and corporate action transactions, reconciliation of funds and securities to depositories and other unaffiliated custodians, and client reporting. Control objectives addressing these areas should include –

1. Documentation for the opening and modification of client accounts is received, authenticated, and established completely, accurately, and timely on the applicable system.
2. Client transactions, including contributions and withdrawals, are authorized and processed in a complete, accurate, and timely manner.
3. Trades are properly authorized, settled, and recorded completely, accurately, and timely in the client account.
4. New securities and changes to securities are authorized and established in a complete, accurate and timely manner.
5. Securities income and corporate action transactions are processed to client accounts in a complete, accurate, and timely manner.
6. Physical securities are safeguarded from loss or misappropriation.
7. Cash and security positions are reconciled completely, accurately and on a timely basis between the custodian and depositories.
8. Account statements reflecting cash and security positions are provided to clients in a complete, accurate and timely manner.

Please find below a copy of our recent client alert regarding the issuance by the SEC of the revised custody rules.

CUSTODY OF FUNDS OR SECURITIES OF CLIENTS BY INVESTMENT ADVISERS

SUMMARY OF KEY PROVISIONS

By Scott Gottlieb, President, U.S. Compliance Consultants, LLC

Overview

The Securities and Exchange Commission (“SEC”) has adopted amendments to the custody and recordkeeping rules under the Investment Advisers Act of 1940 (“Advisers Act”). The changes are designed to provide additional safeguards when a registered advisor has custody of client funds or securities by requiring such an adviser, among other things, to undergo an annual surprise examination by an independent public accountant to verify client assets; to have the qualified custodian maintaining client funds and securities send account statements directly to the advisory clients; and unless client assets are maintained by an independent custodian (i.e., a custodian that is not the adviser itself or a related person), to obtain, or receive from a related person, a report of the internal controls relating to the custody of those assets from an independent public accountant that is registered with and subject to regular inspection by the Public Company Accounting Oversight Board.

Notice to Client

Rule 206(4)-2 currently requires investment advisers to notify their clients promptly upon opening a custodial account on their behalf and when there are changes to the information required in that notification. The amended rule requires:

1. Advisers that elect to send their own account statements to clients to include a legend in the notice urging clients to compare the account statements they receive from the custodian with those they receive from the adviser; and
2. Advisers that send their own account statements to clients, in any subsequent statements they deliver to clients after the initial notice, to urge clients to compare the adviser’s statements with the account statements they receive from the custodian

Delivery of Account Statements

Rule 206(4)-2 currently requires advisers that have custody, with certain limited exceptions, to maintain client funds or securities with a “qualified custodian,” which the adviser must have a reasonable basis for believing sends an account statement, at least quarterly, to each client for which the qualified custodian maintains funds or securities. Rule 206(4)-2 has been amended to eliminate an alternative to the requirement under which an adviser can send quarterly account statements to clients if it undergoes a surprise examination by an independent public accountant at least annually. The amended rule requires that an adviser’s reasonable belief that the qualified custodian sends account statements directly to clients must be formed by the adviser after “due inquiry”.

Advisers could form a reasonable belief after “due inquiry” if the qualified custodian provides the adviser with a copy of the account statement that was delivered to the client. Advisers are not permitted to satisfy the requirement of forming a reasonable belief after “due inquiry” by accessing qualified custodian account statements through the custodian’s website. Accessing account statements through the website merely confirms that they are available. If an adviser does not take additional steps to determine whether account statements were sent to clients, or that clients obtained statements through the website, the adviser would have an inadequate basis for forming a reasonable belief, after due inquiry, that the qualified custodian sends account statements to clients.

Annual Surprise Examination of Client Assets

Subject to limited exceptions, the amendments to Rule 206(4)-2 requires registered advisers with custody of client assets to undergo a surprise examination (or an audit, if applicable) of those assets by an independent public accountant. The surprise examination requirement applies even when assets are maintained by an independent qualified custodian.

Applicability of Surprise Examination

Advisers with Limited Custody Due to Fee Deduction

An adviser that has custody of client assets solely because of its authority to deduct advisory fees from client accounts does not need to have a surprise examination. Such advisers should have appropriate controls that address the risk that the adviser or its personnel could deduct fees to which the adviser is not entitled under the terms of the advisory contract. The adviser’s policies and procedures should take into account:

• How and when clients will be billed;
• Be reasonably designed to ensure that the amount of assets under management on which the fee is billed is accurate and has been reconciled with assets under management reflected on statements of the client’s qualified custodian; and
• Be reasonably designed to ensure that clients are billed accurately in accordance with the terms of their advisory contracts.

Examples of policies and procedures such an adviser should consider include:

• Periodic testing on a sample basis of fee calculations for client accounts to determine their accuracy;
• Testing of the overall reasonableness of the amount of fees deducted from all client accounts for a period of time based on the adviser’s aggregate assets under management; and
• Segregating duties between those personnel responsible for processing billing invoices or listings of fees due from clients that are provided to and used by custodians to deduct fees from clients’ accounts and those personnel responsible for reviewing the invoices and listings for accuracy, as well as the employees responsible for reconciling those invoices and listings with deposits of advisory fees by the custodians into the adviser’s proprietary bank account to confirm that accurate fee amounts were deducted.

Pooled Investment Vehicle Audit

Advisers to pooled investment vehicles (e.g., hedge funds, etc.) have custody of client assets because their capacity as general partner of a limited partnership, managing member of a limited liability company or trustee of a trust gives them legal ownership of or access to client funds or securities.

Under amended rule 206(4)-2, advisers to pooled investment vehicles may be deemed to comply with the surprise verification requirements of the rule by obtaining an audit of the pool and delivering the audited financial statements to pool investors within 120 days of the pool’s fiscal year-end. The audit must be conducted by an accounting firm registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board (“PCAOB”). If the pooled investment vehicle does not distribute audited financial statements to its investors, the adviser must obtain an annual surprise examination and must have a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement of the pooled investment vehicle to its investors in order to comply with the custody rule.

The rule requires the accounting firm performing the surprise examination to verify privately offered securities, along with other funds and securities, held by a pool that is not subject to a financial statement audit. Regardless of whether an adviser to a pooled investment vehicle obtains a surprise examination or satisfies that requirement by obtaining an audit, if the pooled investment vehicle’s assets are maintained with a qualified custodian that is either the adviser to the pool or a related person of the adviser, the adviser to the pool would have to obtain, or receive from the related person, an internal control report (see discussion below). Finally, the rule requires advisers to pools complying with the rule by distributing audited financial statements to investors to also obtain an audit upon liquidation of the pool when the liquidation occurs prior to the fund’s fiscal year-end (see discussion below).

Commission Reporting

Under amended rule 206(4)-2, each investment adviser subject to the surprise examination requirement must enter into a written agreement with an independent public accountant to conduct the surprise examination. The agreement must require the accountant, among other things:

1. To notify the SEC within one business day of finding any material discrepancy during the course of the examination;
2. To submit Form ADV-E via the IARD system to the SEC accompanied by the accountant’s certificate within 120 days of the time chosen by the accountant for the surprise examination, stating that the accountant has examined the funds and securities and describing the nature and extent of the examination; and
3. To file via the IARD system, upon dismissal or resignation within four business days a statement regarding the termination along with Form ADV-E.

Note that the requiring the accountant to file the Form ADV-E via the IARD system makes the report available to the public.

Privately Offered Securities

Advisers that maintain custody of privately offered securities on behalf of clients will be subject to the surprise examination requirement. Prior to the amendment, an accountant conducting the annual verification of client assets was permitted to forgo examining privately offered securities. The amended rule retains the current definition of “privately offered securities” as securities that are (i) acquired from the issuer in a transaction or chain of transactions not involving any public offering, (ii) uncertificated, and ownership thereof is recorded only on the books of the issuer or its transfer agent in the name of the client, and (iii) transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.

Custody by Adviser and Related Person

The amended rule requires, in addition to the surprise examination discussed above, that when an adviser or its related person serves as a qualified custodian for advisory client funds or securities, that the adviser obtain, or receive from its related person, no less frequently than once each calendar year, a written report, which includes an opinion from an independent public accountant with respect to the adviser’s or related person’s controls relating to custody of client assets.

The amended rule also requires, in these circumstances, that the accountant issuing the internal control report, as well as the accountant performing the surprise examination, be registered with, and subject to regular inspection by, the PCAOB.

Internal Control Report

The internal control report must include the accountant’s opinion as to whether:

1. The qualified custodian’s internal controls have been placed in operation as of a specific date;
2. Are suitably designed; and
3. Are operating effectively to meet control objectives related to custodial services, including the safeguarding of funds and securities of advisory clients during the year.

In order for the accountant to be able to form this opinion, the internal control report should address:

• Control objectives and associated controls related to the areas of client account setup and maintenance;
• Authorization and processing of client transactions;
• Security maintenance and setup;
• Processing of income and corporate action transactions; and
• Reconciliation of funds and security positions to depositories and other unaffiliated custodians, and client reporting.

Related Persons

Under the amended rule, an adviser has custody of any client securities or funds that are directly or indirectly held by a “related person” in connection with advisory services provided by the adviser to its clients. A related person is defined by the rule as a person directly or indirectly controlling or controlled by the adviser and any person under common control with the adviser.

There is, however, a limited exception from the surprise examination requirements in circumstances when the adviser is deemed to have custody solely as a result of a related person having custody. The exception is available to an adviser that is (i) deemed to have custody solely as a result of certain of its related persons holding client assets, and (ii) “operationally independent” of the custodian.

Note that an adviser whose client assets are held by a related person, but does not undergo a surprise examination, is required to make and keep a memorandum describing the relationship with the related person in connection with advisory services the adviser provides to clients and include an explanation of the adviser’s basis for determining that it has overcome the presumption that it is not operationally independent of the related person with respect to the related person’s custody of client assets.

PCAOB Registration and Inspection

Under the amendments, the surprise examination and internal control report required when the adviser or its related person serves as qualified custodian for client assets may be satisfied only when performed or prepared by an independent public accountant that is registered with, and subject to regular inspection by, the PCAOB.

Liquidation Audit

The amended rule requires that advisers to pooled investment vehicles that distribute the pool’s audited financial statements to investors under the rule’s annual audit provision must, in addition to obtaining an annual audit, obtain a final audit of the pool’s financial statements upon liquidation of the pool and distribute the financial statements to pool investors promptly after the completion of the audit.

Delivery to Related Persons

Revised rule 206(4)-2 precludes advisers from using layers of pooled investment vehicles to avoid meaningful application of the protections of the Custody Rule. The amended rule provides that sending an account statement or distributing audited financial statements will not meet the requirements of the rule if all of the investors in a pooled investment vehicle to which the statements are sent are themselves pooled investment vehicles that are related persons of the adviser.

Compliance Policies and Procedures

Pursuant to Rule 206(4)-7 under the Advisers Act (e.g., the Compliance Rule) advisers are required to adopt written policies and procedures that must address the safeguarding of client assets from conversion or inappropriate use by advisory personnel.

Pursuant to SEC guidance, advisers with custody of client assets should consider instituting the following policies and procedures as part of their compliance program:

1. Conducting background and credit checks on employees of the investment adviser who will have access (or could acquire access) to client assets to determine whether it would be appropriate for those employees to have such access;
2. Requiring the authorization of more than one employee before the movement of assets within, and withdrawals or transfers from, a client’s account, as well as before changes to account ownership information;
3. Limiting the number of employees who are permitted to interact with custodians with respect to client assets and rotating them on a periodic basis; and
4. If the adviser also serves as a qualified custodian for client assets, segregating the duties of its advisory personnel from those of custodial personnel to make it difficult for any one person to misuse client assets without being detected.

Advisers should also consider including in their policies and procedures a requirement that any problems be brought to the immediate attention of the management of the adviser. Advisers also should consider developing policies regarding the ability of individual employees to acquire custody of client assets (i.e., as trustees for client assets), because their custody may be attributable to the firm, which will thereby acquire responsibility for those assets under the rule.

Advisers should also consider developing procedures by which the CCO periodically tests the effectiveness of the firm’s controls over the safekeeping of client assets, including:

1. Periodically testing the reconciliation of account statements prepared by advisers with account statements as reported by qualified custodians; and
2. Comparing, on a sample basis, client addresses obtained from the clients’ qualified custodians to which the custodian sends client statements, with client addresses maintained by the adviser, to look for inconsistencies or patterns that suggest possible manipulation of address information as a means for concealing misappropriation from these accounts by advisory personnel.

Amendments to Form ADV

The amendments require registered advisers to report to the SEC more detailed information about their custody practices in their registration form.

Item 7 of Form ADV Part 1A

Advisers are required to report all related persons who are broker-dealers and to identify which, if any, serve as qualified custodians with respect to the adviser’s clients’ funds or securities. Section 7.A. of Schedule D has also been amended to require an adviser to report whether it has determined whether it has overcome the presumption that it is not operationally independent from a related person broker-dealer qualified custodian, and thus is not required to obtain a surprise examination for the clients’ assets maintained at that custodian.

Item 9 of Form ADV Part 1A

Amendments to Item 9 to require each registered adviser to report to the SEC:

1. Whether the adviser or a related person has custody of client assets, and if so, both the total U.S. dollar amount of those assets as well as the number of clients for whose accounts the adviser or its related person has custody;
2. If the adviser, or a related person, acts as an adviser to a pooled investment vehicle, whether (a) the pool is audited, and (b) the qualified custodians send account statements to pool investors;
3. Whether an independent public accountant conducts an annual surprise examination of client assets;
4. Whether an independent public accountant prepares an internal control report with respect to the adviser or its related person; and
5. Whether the adviser or a related person serves as qualified custodian for the adviser’s clients.

Schedule D has been amended to require that advisers (i) identify and provide certain information about the accountants that perform audits or surprise examinations and that prepare internal control reports; and (ii) to identify related persons, such as banks, that serve as qualified custodians with respect to their clients’ funds or securities, but are not otherwise reported in Item 7. Schedule D has also been amended to require an adviser to report whether it has determined that it has overcome the presumption that it has determined that is have overcome the presumption that it is not operationally independent from a related person qualified custodian and therefore, not required to obtain a surprise examination for the clients’ assets maintained at that custodian.

Required Records

Under the revised book and recordkeeping rules, advisers are required to maintain a copy of (i) the internal control report that such adviser is required to obtain or receive from its related person and (ii) the memorandum describing the basis upon which the adviser determined that the presumption that any related person is not operationally independent has been overcome, for five years from the end of the fiscal year in which, as applicable, the internal control report or memorandum is finalized.

Effective and Compliance Dates

Effective Date

The effective date of the amendments to rules 206(4)-2, 204-2 and Forms ADV and ADV-E is 60 days after publication in the Federal Register.

Compliance Dates

Notice Requirement

Immediately upon the effective date advisers that have custody of client assets must promptly upon opening a custodial account on a client’s behalf, and following any changes to the custodial account information, as specified in rule 206(4)-2(a)(2) send a notification to the client, including a legend urging the client to compare the account statements the client receives from the custodian with those the client receives from the adviser. Such legend should also be included in any account statements that advisers send to these clients after they are required to send the notification discussed above. In addition, immediately upon the effective date, each adviser that has custody of client assets must have a reasonable belief (except with respect to pooled investment vehicles the financial statements of which are audited and delivered to investors) that a qualified custodian sends account statements directly to clients at least quarterly.

Surprise Examination Requirement

An investment adviser required to obtain a surprise examination must enter into a written agreement with an independent public accountant that provides that the examination will take place by December 31, 2010 or, for advisers that become subject to the rule after the effective date, within six months of becoming subject to the requirement. If the adviser itself maintains client assets as qualified custodian, however, the agreement must provide for the first surprise examination to occur no later than six months after obtaining the internal control report.

Internal Control Reports Requirement

An investment adviser also required to obtain or receive an internal control report because it or a related person maintains client assets as a qualified custodian must obtain or receive an internal control report within six months of becoming subject to the requirement.

Audit of Pooled Investment Vehicles

An investment adviser to a pooled investment vehicle may rely on the annual audit provision if the adviser (or a related person) becomes contractually obligated to obtain an audit of the financial statements of the pooled investment vehicle for fiscal years beginning on or after January 1, 2010.

Amended Form ADV Requirement

Investment advisers registered with the SEC must provide responses to the revised Form ADV in their first annual amendment after January 1, 2011.