Hawaii Administrative Rules › Title 16 - DEPARTMENT OF COMMERCE AND CONSUMER AFFAIRS › Chapter 39 - SECURITIES › Subchapter 4 - REGISTRATION OF BROKER-DEALERS, AGENTS, INVESTMENT ADVISERS, AND INVESTMENT ADVISER REPRESENTATIVES › C - Investment Advisers › Section 16-39-436 - Custody of client funds or securities by investment advisers

Current through June, 2024
(a) Safekeeping required. It shall be
				  unlawful and deemed to be a fraudulent, deceptive, or manipulative act,
				  practice, or course of business for an investment adviser that is registered or
				  required to be registered to have custody of client funds or securities unless:
(1) Notice to commissioner. The investment
				  adviser shall notify the commissioner promptly in writing that the investment
				  adviser has or may have custody. Such notification is also required to be given
				  on Form ADV through the IARD;
(2)
				  Qualified custodian. A qualified custodian maintains those funds and
				  securities:
(A) In a separate account for each
				  client under that client's name; or
(B) In accounts that contain only the
				  client's funds and securities, under the investment adviser's name as agent or
				  trustee for the client;
(3) Notice to clients. If the investment
				  adviser opens an account with a qualified custodian on the client's behalf,
				  either under the client's name or under the investment adviser's name as agent,
				  the investment adviser shall notify the client in writing of the qualified
				  custodian's name, address, and the manner in which the funds or securities are
				  maintained, promptly when the account is opened and following any changes to
				  this information;
(4) Account
				  statements shall be sent to clients, either:
(A) By a qualified custodian. The investment
				  adviser shall have a reasonable basis for believing that the qualified
				  custodian sends an account statement, at least quarterly, to each of the
				  investment adviser's 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; or
(B) By the investment
				  adviser.
(i) The investment adviser shall send
				  an account statement, at least quarterly, to each client for whom the
				  investment adviser has custody of funds or securities, identifying the amount
				  of funds and of each security of which the investment adviser has custody at
				  the end of the period and setting forth all transactions during that
				  period;
(ii) An independent
				  certified public accountant shall verify all client funds and securities by
				  actual examination at least once during each calendar year at a time chosen by
				  the accountant without prior notice or announcement to the investment adviser
				  and that is irregular from year to year, and shall file a copy of the auditors
				  report and financial statements with the commissioner within thirty calendar
				  days after the completion of the examination, along with a letter stating that
				  it has examined the funds and securities and describing the nature and extent
				  of the examination, and
(iii) The
				  independent certified public accountant, upon finding any material
				  discrepancies during the course of the examination, shall notify the
				  commissioner of the discrepancies within one business day of the finding, by
				  means of a facsimile transmission or electronic mail, followed by first class
				  mail, directed to the attention of the commissioner;
(C) Special rule for limited partnerships and
				  limited liability companies. If the investment adviser is a general partner of
				  a limited partnership or managing member of a limited liability company, or
				  holds a comparable position for another type of pooled investment vehicle, the
				  account statements required under paragraph (4) shall be sent to each limited
				  partner or member, or other beneficial owner or their independent
				  representative;
(5)
				  Independent representatives. A client may designate an independent
				  representative to receive, on the client's behalf, notices and account
				  statements as required under paragraphs (3) and (4);
(6) Direct fee deduction. An investment
				  adviser who has custody by having the authority to deduct fees directly
				  deducted from client accounts shall provide the following safeguards:
(A) Written authorization. The investment
				  adviser shall have written authorization from the client to deduct advisory
				  fees from the account held with the qualified custodian;
(B) Notice of fee deduction. Each time a fee
				  is directly deducted from a client account, the investment adviser shall
				  concurrently:
(i) Send the qualified custodian
				  an invoice of the amount of the fee to be deducted from the client's account;
				  and
(ii) Send the client an invoice
				  itemizing the fee. Such itemization shall include the formula used to calculate
				  the fee, the amount of assets under management the fee is based on, and the
				  time period covered by the fee;
(C) Notice of safeguards. The investment
				  adviser shall notify the commissioner in writing that the investment adviser
				  intends to use the safeguards required under this section. Such notification
				  shall be given on Form ADV;
(D)
				  Waiver of net worth, bonding and audited financial statement requirements. An
				  investment adviser having custody solely because the investment adviser meets
				  the definition of custody as defined under this section and who complies with
				  the safekeeping requirements in paragraphs (1) through (6) shall not be
				  required to meet the financial requirements for an investment adviser with
				  custody as provided in section
				  16-39-433, the bonding requirement
				  set forth in section
				  16-39-434, and the audited
				  financial statement requirement set forth in section
				  16-39-437;
(7) Pooled investments. An investment adviser
				  to pooled investment vehicles who has custody and who does not meet the
				  exception provided in subsection (b)(3) shall, in addition to the safeguards
				  set forth in paragraphs (1) through (5), comply with the following:
(A) Engage an independent party. Hire an
				  independent party to review all fees, expenses, and capital withdrawals from
				  the pooled investment accounts;
(B)
				  Review of fees. Send all invoices or receipts to the independent party,
				  detailing the amount of the fee, expenses or capital withdrawal, and the method
				  of calculation such that the independent party can:
(i) Determine that the payment is in
				  accordance with the pooled investment vehicle standards (generally, the
				  partnership agreement or membership agreement); and
(ii) Forward, to the qualified custodian,
				  approval for payment of the invoice with a copy to the investment
				  adviser;
(C) For purposes
				  of this section, an "independent party" means a person that:
(i) Is engaged by the investment adviser to
				  act as a gatekeeper for the payment of fees, expenses, and capital withdrawals
				  from the pooled investment;
(ii)
				  Does not control and is not controlled by, and is not under common control with
				  the investment adviser; and
(iii)
				  Does not have, and has not had within the past two years, a material business
				  relationship with the investment adviser;
(D) Notice of safeguards. The investment
				  adviser shall notify the commissioner in writing that the investment adviser
				  intends to use the safeguards required under this section. The notification
				  shall be given on Form ADV;
(E)
				  Waiver of net worth, bonding and audited financial statement requirements. An
				  investment adviser having custody solely because the investment adviser meets
				  the definition of custody as defined under this section and who complies with
				  the safekeeping requirements in paragraphs (1) through (5) and (7) shall not be
				  required to meet the financial requirements for an investment adviser with
				  custody as provided in section 16-39-433, the bonding requirement set forth in
				  section 16-39-434, and the audited
				  financial statement requirement set forth in section
				  16-39-437;
(8) Investment adviser or investment adviser
				  representative as trustee. When a trust retains an investment adviser,
				  investment adviser representative, or employee, director, or owner of an
				  investment adviser as trustee and the investment adviser acts as the investment
				  adviser to that trust, the investment adviser shall:
(A) Notify the commissioner in writing that
				  the investment adviser intends to use the safeguards required under this
				  section. The notification shall be given on Form ADV;
(B) Send to the grantor of the trust, the
				  attorney for the trust if it is a testamentary trust, the co-trustee (other
				  than the investment adviser, investment adviser representative, or employee,
				  director, or owner of the investment adviser); or a defined beneficiary of the
				  trust, at the same time that it sends any invoice to the qualified custodian,
				  an invoice showing the amount of the trustees' fee or investment management or
				  advisory fee, the value of the assets on which the fees were based, and the
				  specific manner in which the fees were calculated;
(C) Enter into a written agreement with a
				  qualified custodian which specifies:
(i) That
				  the qualified custodian shall not deliver trust securities to the investment
				  adviser, any investment adviser representative or employee, director, or owner
				  of the investment adviser; nor transmit any funds to the investment adviser,
				  any investment adviser representative or employee, director or owner of the
				  investment adviser, except that the qualified custodian may pay trustee fees to
				  the trustee and investment management or advisory fees to investment adviser;
				  provided that:
(A) The grantor of the trust or
				  attorneys for the trust, if it is a testamentary trust, the co trustee (other
				  than the investment adviser, investment adviser representative, or employee,
				  director, or owner of the investment adviser); or a defined beneficiary of the
				  trust has authorized the qualified custodian in writing to pay those
				  fees;
(B) The statements for those
				  fees show the amount of the fees for the trustee and, in the case of statements
				  for investment management or advisory fees, show the value of the trust assets
				  on which the fee is based and the manner in which the fee was calculated;
				  and
(C) The qualified custodian
				  agrees to send to the grantor of the trust, the attorneys for a testamentary
				  trust, the co-trustee (other than the investment adviser, investment adviser
				  representative, or employee, director or owner of the investment adviser); or a
				  defined beneficiary of the trust, at least quarterly, a statement of all
				  disbursements from the account of the trust, including the amount of investment
				  management fees paid to the investment adviser and the amount of trustees' fees
				  paid to the trustee;
(ii)
				  Except as otherwise set forth below in subparagraph (8)(C)(ii)(A), the
				  qualified custodian may transfer funds or securities, or both, of the trust
				  only upon the direction of the trustee (who may be the investment adviser,
				  investment adviser representative, or employee, director, or owner of the
				  investment adviser), who the investment adviser has duly accepted as an
				  authorized signatory. The grantor of the trust or attorneys for the trust, if
				  it is a testamentary trust, the co-trustee (other than the investment adviser,
				  investment adviser representative, or employee, director, or owner of the
				  investment adviser); or a defined beneficiary of the trust, shall designate the
				  authorized signatory for management of the trust. The direction to transfer
				  funds or securities, or both, can only be made to the following:
(A) A trust company, bank trust department or
				  brokerage firm independent of the investment adviser for the account of the
				  trust to which the assets relate;
(B) The named grantors or to the named
				  beneficiaries of the trust;
(C) A
				  third person who is independent of the investment adviser with respect to
				  payment of the fees or charges of the third person including, but not limited
				  to: attorney's, accountant's, or qualified custodian's fees for the trust; and
				  taxes, interest, maintenance or other expenses, if there is property other than
				  securities or cash owned by the trust;
(D) Third persons independent of the
				  investment adviser for any other purpose legitimately associated with the
				  management of the trust; or
(E) A
				  broker-dealer in the normal course of portfolio purchases and sales; provided
				  that the transfer is made on payment against delivery basis or payment against
				  trust receipt;
(D) Waiver of net worth, bonding and audited
				  financial statement requirements. An investment adviser having custody solely
				  because the investment adviser meets the definition of custody as defined under
				  this section and who complies with the safekeeping requirements in paragraphs
				  (1) through (5) and (8) shall not be required to meet the financial
				  requirements for an investment adviser with custody as provided in section
				  16-39-433, the bonding requirement set forth in section 16-39-434 and the
				  audited financial statement requirement set forth in section
				  16-39-437.