February 16, 2023

SEC Proposes Radical Transformation of Custody Rule Into New Safeguarding Rule

On February 15, 2023, the Securities and Exchange Commission (the “SEC”) proposed a significant transformation of Rule 206(4)-2 (the “Custody Rule”) under the Investment Advisers Act of 1940 (the “Advisers Act”) into a new Rule 223-1 under the Advisers Act (the “Safeguarding Rule”) applicable to SEC-registered investment advisers.1 The proposed Safeguarding Rule would, among other things:

  • Broaden the rule to cover all client assets (and not just funds and securities), including, among other things, digital assets and real estate interests;
  • Expand the definition of “custody” to include discretionary investment authority for assets regardless of whether or not they are processed or settled on a delivery versus payment (“DVP”) basis (and will subject separately managed accounts with non-DVP assets (e.g., loans and privately offered securities) to surprise examinations);
  • Overhaul the requirements relating to qualified custodians, including that the adviser enter into a written agreement with the custodian with an extensive list of required provisions, particularly that the custodian has “possession or control” of client assets; and
  • Narrow the availability of the exception from the qualified custodian requirement for uncertificated privately-offered securities and physical assets and impose new restrictions where the exception still applies.

If adopted, the Safeguarding Rule would represent another radical change in the regulation of custodial practices under the Advisers Act and, like the existing Custody Rule, would likely present a number of significant and burdensome compliance challenges for investment advisers. Notably, more than one SEC commissioner raised concerns whether it is actually possible to satisfy the proposed Safeguarding Rule with respect to digital assets.

Comments on the proposed Safeguarding Rule will be due 60 days after its publication in the Federal Register.


These amendments to the Custody Rule are the most significant amendments since the overhaul to the Custody Rule in 2009 following the Madoff scandal. The 2009 version of the Custody Rule caused a number of difficult implementation issues for investment advisers. Since 2009, the SEC staff has issued guidance on a range of topics, including with respect to special purpose vehicles, certificated privately-offered securities, escrow accounts relating to a sale or merger, “inadvertent custody” based on contractual authority in custodial agreements, and standing letters of authorization. The SEC staff also issued a number of FAQs regarding the Custody Rule. Even so, significant compliance challenges with respect to the Custody Rule remain.

In 2019, the SEC staff solicited comments about the application of the Custody Rule (and potential revisions to the Custody Rule) with respect to (i) assets that are not processed or settled on a DVP basis and (ii) digital assets. However, no additional guidance on either topic has been issued prior to this proposal.

The current version of the Custody Rule has been the basis for numerous enforcement actions, including a set of enforcement actions last year that many have characterized as a “broken windows” approach.2 The SEC has focused particularly on audits of private funds and the related Form ADV disclosure.

Proposed Amendments

These new proposed amendments would represent another overhaul of the Custody Rule. Below is a short summary of some of the proposed changes:

  • New Broader Statutory Authorization. The proposed amendments redesignate the Custody Rule as a new Rule 223-1 under the Advisers Act (and re-characterizes it as a Safeguarding Rule) in order to rely on “the more expansive and explicit language” provided in Section 223 of the Advisers Act, which was added in the Dodd-Frank Wall Street Reform and Consumer Protection Act.
  • Expansion to All Types of Client Assets. The proposed amendments would expand the client assets captured within the Safeguarding Rule beyond funds and securities in client accounts to include any client “assets,” including “fund, securities or other positions” of which the adviser has “custody.” This would cover, among other assets, digital assets, real estate interests, and commodities, as well as “other positions” that may not be recorded on a balance sheet as an asset for accounting positions (e.g., short positions and written options). The SEC noted that based on fiduciary duty principles, which “extends to the entire relationship between the adviser and client regardless of the types of assets in a client account,” the proposed rule covers the entirety of a client account’s positions, holdings, or investments.
  • Expansion to Discretionary Investment Authority. The proposed amendments would expand the definition of “custody” to cover an adviser’s discretionary investment authority for both DVP and non-DVP assets. However, there would be an exception from the surprise examination requirement for DVP assets, but there would not be an exception for non-DVP assets. Therefore, for example, the new Safeguarding Rule would apply to any separately managed account containing non-DVP assets (e.g., loans, privately-offered securities), subjecting them to, among other requirements, the surprise examination requirement.
  • Amended Qualified Custodian Definition and New Foreign Institution Requirements. The proposed amendments generally retain the definition of “qualified custodian” that includes a federal or state-chartered bank or savings association, certain trust companies, a registered broker-dealer, a registered futures commission merchant, and certain foreign financial institutions, but with a “more robust set of requirements” for foreign financial institutions, including with respect to being subject to oversight by appropriate financial regulatory authorities, the segregation of assets, the ability to enforce judgements, and being legally subject to anti-money laundering regulations requirements similar to those of the Bank Secrecy Act.
  • Required Agreements with Qualified Custodian and New Requirements for Qualified Custodians. The proposed amendments would require an investment adviser to enter into a written agreement with the qualified custodian that includes long list of new required provisions, including provisions (i) requiring the custodian to have “possession or control” of the assets, (ii) requiring the custodian to provide quarterly account statements, (iii) requiring the custodian to obtain a written internal control report from an independent public accountant, (iv) specifying the agreed-upon level of authority (and permission for adviser or client to reduce such authority), and (v) requiring the custodian to provide certain “reasonable assurances” that are designed to ensure that client assets are “properly segregated” in a segregated custodial account and held in accounts protected from bankruptcy or other insolvency.
  • Changes and Restrictions to Exception for Privately Offered Securities. The proposed amendments would expand the exception with respect to uncertificated privately offered securities to include “physical assets” (including artwork, real estate, precious metals and physical commodities), but then imposes a number of restrictions on the investment adviser’s ability to rely on this exception, including that (i) the adviser must reasonably determine that ownership cannot be recorded and maintained with a qualified custodian and (ii) an independent public accountant must verify any purchase, sale or other transfer of beneficial ownership of such assets. The Release indicates that the SEC believes digital assets issued on public, permissionless blockchains would not satisfy the definition of privately-offered securities and advisers with custody of such assets would be required to maintain them with a qualified custodian.
  • Notification Requirements for Annual Audits. In connection with the annual audit exception, the proposed amendments would add a new requirement that the accountant notify the SEC Division of Examination of an audit report that contains a modified opinion or the resignation, dismissal, or other termination of the engagement of the accountant.

The proposal would also (i) amend Rule 204-2 under the Advisers Act to require additional and more detailed records of trade and transaction activity and position information and (ii) amend Form ADV to reflect the new Safeguarding Rule.

[1] Safeguarding Advisory Client Assets, SEC Release No. IA-6240 (Feb. 15, 2023) (the “Release”), available at
[2] See Our Client Alert: SEC Sends Message to Private Fund Sponsors on Audit Obligations Under Custody Rule Through Enforcement Actions, available at