Investment advisers provide a wide range of investment advisory services and help individuals and institutions make financial decisions. From individuals and families seeking to plan for retirement or save for college to large institutions managing billions of dollars, clients seek the services of investment advisers to help them evaluate their investment needs, plan for their future, and develop and implement investment strategies. Advisers can include money managers, investment consultants, and financial planners. They commonly manage the investment portfolios of individuals, businesses, and pooled investment vehicles, such as mutual funds, pension funds, and hedge and other private funds. Many investment advisers also engage in other businesses, such as insurance broker or broker-dealer services. Many investment advisers charge clients fees for investment advisory services based on the percentage of assets under management, but others may charge hourly or fixed rates and, in certain circumstances, performance fees. 15 U.S.C. § 80b-2(a)(11). Advisers Act’s registration requirement.broad fiduciary duty on advisers to act in the best interest of their clients. The Advisers Act imposes a Most small- and mid-sized advisers are regulated by the states and prohibited from registering with SEC.an exemption from registration must register with SEC. To register, applicants file a Form ADV with SEC. Once registered, an adviser must update the form at least annually. SEC-registered advisers are subject to five types of requirements: (1) fiduciary duties to clients; (2) substantive prohibitions and requirements, including that advisers with custody of client assets take steps designed to safeguard those client assets; (3) contractual requirements; (4) record-keeping requirements; and (5) oversight by SEC. Large advisers who do not meet SEC oversees registered investment advisers primarily through its Office of Compliance Inspections and Examinations, Division of Investment Management, and Division of Enforcement. Specifically, the Office of Compliance Inspections and Examinations examines investment advisers to evaluate their compliance with federal securities laws, determines whether these firms are fulfilling their fiduciary duty to clients and operating in accordance with disclosures made to investors and contractual obligations, and assesses the effectiveness of their compliance-control systems. The Division of Investment Management administers the securities laws affecting investment advisers and engages in rule making for consideration by SEC and other policy initiatives that are intended, among other things, to strengthen SEC’s oversight of investment advisers. The Division of Enforcement investigates and prosecutes certain violations of securities laws and regulations. Nearly 10,000 advisers were registered with SEC as of April 1, 2013.Collectively, these advisers managed nearly $54 trillion in assets for about 24 million clients. The majority of these SEC-registered advisers each managed less than $1 billion in assets, and a majority had 100 or fewer clients. Specifically, as shown in figure 1, about 71 percent of the registered advisers (around 7,133 advisers) managed less than $1 billion in assets. Furthermore, the largest 94 registered advisers (about 1 percent of all SEC-registered advisers) managed about 50 percent of the total regulatory assets under management. In addition, as shown in figure 2, about 6,000 registered advisers (nearly 60 percent of all registered advisers) reported having 100 or fewer clients, while approximately 1,200 advisers (around 12 percent of all registered advisers) reported having more than 500 clients. An adviser indirectly, client funds or securities or has any authority to obtain possession of them, in connection with advisory services provided by the adviser to the client. Custody includes: possession of client funds or securities; any capacity that gives the adviser legal ownership or access to client assets, for example, as a general partner of a limited partnership, managing member of a limited liability company, or a comparable position for another pooled investment vehicle (e.g., hedge fund); or any arrangement, including a general power of attorney, under which the adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian upon its instruction to the custodian. SEC’s custody rule regulates the custody practices of investment advisers and contains a number of investor protections. The rule requires advisers that have custody to maintain client assets with a “qualified custodian,” which includes banks and savings associations, registered broker-dealers, registered futures commission merchants, and certain foreign financial institutions. This requirement, along with other parts of the rule, helps prevent client assets from being lost or stolen. Furthermore, qualified custodians are subject to regulation and oversight by federal financial regulators and self-regulatory organizations. Some registered advisers also engage in other businesses, such as broker- dealers that provide custodial services to themselves or related advisers. The rule requires advisers that have custody of client assets to have a reasonable basis, after due inquiry, for believing that the custodian sends periodic statements directly to the clients. An adviser can satisfy the due-inquiry requirement in a number of ways, such as by receiving a copy of the account statements sent to the clients or written confirmation from the custodian that account statements were sent to the adviser’s clients. This requirement serves to help assure the integrity of account statements and permit clients to identify any erroneous or unauthorized transactions or withdrawals by an adviser. If an adviser also elects to send its own clients account statements, it must include a note urging its clients to compare the custodian’s and adviser’s account statements. The SEC custody rule requires advisers with custody of client assets to hire an independent public accountant to conduct an annual surprise examination, unless the advisers qualify for an exception. A surprise examination is intended to help deter and detect fraudulent activity by having an independent accountant verify that client assets—of which an adviser has custody—are held by a qualified custodian in an appropriate account and in the correct amount. The accountant determines the time of the examination without prior notice to the adviser, and the accountant is to vary the timing of the examination from year to year. SEC initially required all advisers to undergo surprise examinations when it adopted the custody rule in 1962. Over the following decades of administering the custody rule, SEC staff provided no-action relief from the surprise examination requirement where other substitute client safeguards were implemented. In 2003, SEC amended the custody rule by generally requiring an adviser to maintain client assets with qualified custodians and relieving the adviser from the examination requirement if its qualified custodian sent account statements directly to the adviser’s clients. In its proposed rule at that time, SEC noted that the examination was performed only annually, and many months could pass before the accountant had an opportunity to detect a fraud. In its 2009 proposed amendments, SEC revisited the 2003 rule making in light of its significant enforcement actions alleging misappropriation of client assets. In expanding the surprise examination requirement, SEC noted that an independent public accountant may identify misuse that clients have not, which would result in the earlier detection of fraudulent activities and reduce resulting client losses. While SEC expanded the reach of the surprise examination requirement in its final 2009 rule amendments, it provided several exceptions to the requirement. As shown in figure 3, advisers meeting the following conditions may not be required to undergo a surprise examination: an adviser that is deemed to have custody of client assets solely because of its authority to deduct fees from client accounts; an adviser that is deemed to have custody because a related person has custody, and the adviser is “operationally independent” of the related person serving as the custodian; or an adviser to a pooled investment vehicle (e.g., hedge fund) that is subject to an annual financial statement audit by an independent public accountant registered with and subject to regular inspection by the Public Company Accounting Oversight Board (PCAOB) and distributes the audited financial statements prepared in accordance with generally accepted accounting principles to its clients is deemed to have satisfied the surprise examination requirement. Advisers that maintain client assets as the qualified custodian or use a related person qualified custodian rather than maintaining client assets with an independent qualified custodian may present higher risk to clients. In recognition of such risk, SEC also imposed in its 2009 rule amendments a new internal control reporting requirement on advisers that maintain client assets or use related person qualified custodians (see fig. 3 above). The internal control report must include an opinion of an independent public accountant as to whether suitable controls are in place and operating effectively to meet control objectives relating to custodial services. This includes the safeguarding of assets held by the adviser or related person. An adviser that directly maintains client assets as a qualified custodian or maintains client assets with a related person qualified custodian must obtain or receive from its related person an internal control report annually from an accountant that is registered with and subject to regular inspection by PCAOB. Advisers qualifying for a surprise examination exception because of their use of a related person but operationally independent custodian still must obtain an internal control report from their related person. In conjunction with the amendments to the custody rule, SEC also amended its record-keeping rule. The revised rule requires advisers to maintain a copy of any internal control report obtained or received pursuant to the SEC custody rule. The rule also requires advisers, if applicable, to maintain a memorandum describing the basis upon which they determined that the presumption that any related person is not operationally independent under the custody rule has been overcome. According to SEC, requiring an adviser to retain a copy of these items provides SEC examiners with important information about the safeguards in place and assists SEC examiners in assessing custody-related risks. Around 4,400 advisers, about 45 percent of all SEC-registered advisers, reported having custody (for reasons other than their authority to deduct In addition, fees) of over $14 trillion in client assets as of April 1, 2013.around 500 advisers, about 11 percent of the 4,400 advisers with custody, reported serving as the qualified custodian or having a related person qualified custodian of client assets. As discussed, the SEC custody rule imposes certain minimum requirements generally on all advisers with custody, but not all of the rule’s requirements apply to all advisers.