§ 275.206(4)-2 — Investment adviser custody rule.

Rule 206(4)-2 applies to every investment adviser registered or required to be registered under the Act that has custody of client funds or securities. The Commission proposed comprehensive amendments to the custody rule in 2023 (the "safeguarding proposal") that would, if adopted, substantially expand and rename the rule. As of the retrieval date, the 2023 amendments have not been adopted, and the current rule remains in force.

(a) Safekeeping required.

If you are an investment adviser registered or required to be registered with the Commission, it is a fraudulent, deceptive, or manipulative act, practice, or course of business within the meaning of section 206(4) for you to have custody of client funds or securities unless:

1. **Qualified custodian.** A qualified custodian maintains those funds and securities: - In a separate account for each client under that client's name; or - In accounts that contain only your clients' funds and securities, under your name as agent or trustee for the clients. 2. **Notice to clients.** If you open an account with a qualified custodian on your client's behalf, either under the client's name or under your name as agent, you promptly notify the client in writing of the qualified custodian's name, address, and the manner in which the funds or securities are maintained, and promptly notify the client in writing of any changes to this information. 3. **Account statements.** You have a reasonable basis, after due inquiry, for believing that the qualified custodian sends an account statement, at least quarterly, to each of your clients for which it maintains funds or securities, identifying the amount of funds and of each security in the account at the end of the period and setting forth all transactions in the account during that period. 4. **Surprise examination.** The client funds and securities of which you have custody are verified by actual examination at least once during each calendar year by an independent public accountant, pursuant to a written agreement between you and the accountant, at a time chosen by the accountant without prior notice or announcement to you and that is irregular from year to year. 5. **Internal control report.** If you or a related person maintains client funds or securities as a qualified custodian, you obtain or receive from the qualified custodian no less than annually a written internal control report that includes an opinion of an independent public accountant as to whether controls have been placed in operation as of a specific date, are suitably designed, and are operating effectively.

(b) Exceptions.

Paragraph (a)(4) (the surprise examination) does not apply if:

1. **Operational custody** arising solely from the deduction of advisory fees from the client's account is exempt from the surprise exam, provided the qualified custodian sends statements directly to the client at least quarterly; 2. **Pooled investment vehicles** subject to an annual audit and distribution of audited financial statements to all investors within 120 days (or 180 days for a fund of funds) of fiscal year-end; 3. **Custody solely by virtue of standing letters of authorization** that meet the specific conditions outlined in Commission staff guidance (the 2017 IM Guidance Update No. 2017-01); 4. **Privately offered securities** held by the adviser if (i) the securities are acquired from the issuer in a transaction or chain of transactions not involving any public offering; (ii) the securities are uncertificated and ownership is recorded only on the books of the issuer or its transfer agent in the name of the client; and (iii) the securities are transferable only with prior consent of the issuer or holders of the outstanding securities of the issuer.

(c) Definitions.

Custody.

"Custody" means holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. You 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 you provide to clients. Examples of custody include:

1. Possession of client funds or securities; 2. Any arrangement (including a general power of attorney) under which you are authorized or permitted to withdraw client funds or securities maintained with a custodian upon your instruction to the custodian; and 3. Any capacity (such as general partner of a limited partnership, managing member of a limited liability company, or a comparable position for another type of pooled investment vehicle, or trustee of a trust) that gives you or your supervised person legal ownership of or access to client funds or securities.

Qualified custodian.

Means:

1. A bank as defined in section 202(a)(2) of the Advisers Act or a savings association as defined in section 3(b)(1) of the FDIA; 2. A broker-dealer registered under section 15(b)(1) of the Securities Exchange Act of 1934 holding client assets in customer accounts; 3. A futures commission merchant registered under the Commodity Exchange Act, holding client assets in customer accounts, but only with respect to clients' funds and security futures, or other securities incidental to transactions in contracts for the purchase or sale of a commodity for future delivery and options thereon; or 4. A foreign financial institution that customarily holds financial assets for its customers, provided that the foreign financial institution keeps the advisory clients' assets in customer accounts segregated from its proprietary assets.

(d) Surprise examination timing.

The surprise examination must occur no less than once per calendar year at a time chosen by the accountant without prior notice to the adviser, and the examination date must be irregular from year to year. The accountant must, within 120 days of the examination, file Form ADV-E with the Commission describing the examination and its results.