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SEC Strengthens Rules Governing Investment Advisers

At Wednesday's open meeting, the Commission adopted rules intended to better protect investors from fraud and theft by investment advisers.  As we summarized in our May 20, 2009 post, SEC Proposes Rules on Investor Funds Controlled by Investment Advisers, the rules proposed in May require:

that investment advisers have an annual “surprise exam” by an independent accounting firm. To help prevent advisers from rigging their own “surprise” by a friendly or unqualified accountant, in the case of advisers or affiliates of the adviser holding clients’ assets directly, the “surprise exam” would have to be conducted by a PCAOB-registered and inspected accountant.

Another aspect of these proposals would apply to investment advisers whose client assets are not held or controlled by a firm independent of the adviser, requiring them to obtain a written report prepared by a PCAOB-registered and inspected accountant that, “among other things, describes the controls in place, tests the operating effectiveness of those controls, and provides the results of those tests” (i.e., their SAS-70 reports).

In addition to these “surprise exam” provisions, the proposed amendments also would require that custodians holding the assets of advisory clients deliver the custodial statements directly to the individual advisory clients rather than sending them through the investment adviser. Advisory clients would be encouraged to compare the statements they receive from the adviser with those they obtain from the custodian, making it more difficult for an adviser to prepare false account statements, and making it possible for clients to find discrepancies.

According to the Commission the surprise exam and custody controls review provisions of these rules will "apply additional safeguards where the safeguards are needed most — that is, where the risk of fraud is heightened by the degree of control the adviser has over the client’s assets.”

The rules were adopted substantially as proposed and will become effective 60 days after their publication in the Federal Register.  The full text of the final rule release will be available in a week or so on the SEC's website,