IM Guidance Update

FEBRUARY 2017 | No. 2017-01

INADVERTENT CUSTODY: 

ADVISORY CONTRACT VERSUS CUSTODIAL CONTRACT AUTHORITY

The staff of the Division of Investment Management has determined that under the 

Investment Advisers Act of 1940 custody rule, Rule 206(4)-2, an investment adviser 

may inadvertently have custody of client funds or securities because of provisions in a 

separate custodial agreement entered into between its advisory client and a qualified 

custodian. This guidance update discusses, among other things, some circumstances 

the staff has encountered where such inadvertent custody could arise.

The staff cautions advisers to be aware that they may have custody due to the authority 

resulting from various agreements that may be in place in connection with relevant 

custodial and advisory agreements. The custodial agreement between a client and 

custodian may grant an adviser broader access to client funds or securities than the 

adviser’s own agreement with the client contemplates. Depending on the wording of 

or rights conferred by these custodial agreements, an adviser may have custody, and 

may also be subject to the surprise examination requirement, even though it did not 

otherwise intend to have such access.

The staff has observed that, in some cases, the terms of an agreement between a client 

and qualified custodian might permit the client’s adviser to instruct the custodian to 

disburse, or transfer, funds or securities.1

 Examples of such agreements between clients 

and qualified custodians include:

• A custodial agreement that grants the client’s adviser the right to “receive money, 

securities, and property of every kind and dispose of same.” 

• A custodial agreement under which a custodian “may rely on [adviser’s] 

instructions without any direction from you. You hereby ratify and confirm any and 

all transactions with [the custodian] made by [adviser] for your account.” 

• A custodial agreement that provides authorization for the client’s adviser to 

“instruct us to disburse cash from your cash account for any purpose . . . .”

US Securities and Exchange Commission

 Division of Investment Management
IM GUIDANCE UPDATE 2

The definition of custody turns on whether the adviser is permitted to “withdraw” 

client funds or securities “upon [the adviser’s] instruction to the qualified custodian.”2

The staff believes that an adviser would have custody where the custodial agreement 

enables the adviser to withdraw, or transfer, client funds or securities upon instruction 

to the custodian. An adviser could also have custody when provisions in a custodial 

agreement and advisory agreement conflict as to an adviser’s authority to withdraw, 

or transfer, client funds or securities upon instruction to the custodian. For example, 

the staff believes an adviser would have custody if the custodial agreement authorizes 

the adviser to withdraw client funds or securities, notwithstanding a provision in the 

advisory agreement to the contrary. Moreover, a separate bilateral restriction between 

the adviser and the client would be insufficient to prevent the adviser from having 

custody where the custodial agreement enables the adviser to withdraw or transfer 

client funds or securities upon instruction to the custodian.3 An adviser would have 

custody, in either case, because from the qualified custodian’s perspective the client has 

authorized the adviser to withdraw the client’s funds or securities. While there may be 

constraints contained in the advisory agreement between the adviser and its client(s), 

the custodian may not be aware of them; accordingly, if, for example, the adviser 

attempted to withdraw funds from the account, the custodian would view the adviser 

as authorized to do so and would release those funds. In this regard, however, where 

a custodial agreement is structured narrowly to permit the deduction of advisory fees 

(without granting any other rights that would impute custody), an adviser may have 

custody but not need a surprise examination, provided it otherwise complies with the 

exception under Rule 206(4)-2(b)(3) available to advisers with limited custody due to 

fee deduction.4

Accordingly, depending on the facts and circumstances, custodial agreements could 

impute advisers with custody they otherwise did not intend to have. The staff cautions 

advisers to be aware of this possibility and, if applicable, take steps to ensure they 

comply with the custody rule. One way for an adviser to avoid such inadvertent custody 

would be to draft a letter (or other form of document) addressed to the custodian that 

limits the adviser’s authority to “delivery versus payment,” notwithstanding the wording 

of the custodial agreement, and to have the client and custodian provide written 

consent to acknowledge the new arrangement.5
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Endnotes

1 An adviser’s authority to issue instructions to a broker-dealer or a custodian to 

effect or to settle trades does not constitute “custody.” Clients’ custodians are 

generally under instructions to transfer funds (or securities) out of a client’s account 

only upon corresponding transfer of securities (or funds) into the account. This 

“delivery versus payment” arrangement minimizes the risk that an adviser could 

withdraw or misappropriate the funds or securities in its client’s custodial account. 

This guidance update contemplates custody arising from authority that goes 

beyond such arrangements.

2 Rule 206(4)-2 defines “custody,” in part, to mean “holding, directly or indirectly, 

client funds or securities, or having any authority to obtain possession of them. . . .” 

Custody includes “[a]ny arrangement (including a general power of attorney) under 

which [an adviser is] authorized or permitted to withdraw client funds or securities 

maintained with a custodian upon [its] instruction to the custodian.” 

3 Such a restriction might appear in account agreements or powers of attorney 

with the adviser. For example, the staff has observed wording seeking to limit 

an adviser’s authority in a power of attorney stating that it “implies no power to 

personally obtain custody or possession of any securities.”

4 For example, such a custodial agreement might provide “(1) [Custodian name] 

is permitted to rely upon the authority of the [adviser] to provide instructions to 

disburse cash from your cash account if [custodian] in good faith believes such 

instructions to be given in connection with or in accordance with: (a) securities 

trading activity; or (b) the payment of fees that you owe [adviser]. (2) Any other 

instructions to disburse cash from your accounts must come from you or other 

persons whom you have authorized to do so in accordance with the agreement, but 

excluding your [adviser]. (3) Your [adviser] will not have the authority to provide us 

with any instruction to disburse cash from your accounts on your behalf except as 

contemplated above.”

5 Without written consent, the adviser would retain the authority conferred under the 

original agreement, and the adviser would continue to have custody.
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IM Guidance Updates summarizes the views of the Division of Investment Management 

regarding various requirements of the federal securities laws. Future changes in laws 

or regulations may supersede some of the discussion or issues raised herein. This IM 

Guidance Update is not a rule, regulation or statement of the Commission, and the 

Commission has neither approved nor disapproved of this IM Guidance Update.

The mission of the Securities and Exchange Commission is to protect investors; maintain fair, 

orderly, and efficient markets; and facilitate capital formation.

If you have any questions about this IM Guidance Update, please contact:

AARON T. GILBRIDE

Chief Counsel’s Office/Public Inquiry

Phone: 202.551.6825

Email: IMOCC@sec.gov