May 24, 2023

Our Comments on the SEC’s Proposed Safeguarding Rule

On February 16, 2023, we circulated a client alert, “SEC Proposes Radical Transformation of Custody Rule Into New Safeguarding Rule,” concerning the proposed 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) that would be applicable to SEC-registered investment advisers.

On May 8, 2023, we submitted a comment letter addressing a wide range of concerns with the proposal. Our primary concerns relate to the potential upheaval in the custodial market. We believe the Safeguarding Rule would have significant negative effects on advisory clients, who will bear a significant share of the increased costs associated with compliance with the proposed Safeguarding Rule, and on smaller SEC-registered investment advisers, who will face increased competitive disadvantages both to larger investment advisers and to unregistered non-US investment advisers. We are particularly concerned about a rule whose compliance is based so heavily on the bargaining power of the investment adviser and its clients. Finally, we believe that the proposed Safeguarding Rule does not adequately consider the consequences of sweeping in a wide range of assets that are not funds or securities, including crypto assets but also including real estate assets, loans, and other assets.

Among other comments and recommendations, our comment letter addressed the following issues:

Scope of Assets Required to Be Maintained at a Qualified Custodian

  • An expansion of the scope of assets to be maintained at a qualified custodian should be matched with an expansion of the types of qualified custodians.
  • The Safeguarding Rule will lead to inefficient advisory structures, particularly with respect to assets that are difficult or costly to maintain with a qualified custodian.

Exception for Assets Not Required to Be Maintained at a Qualified Custodian

  • The exception creates a trap for assets where a qualified custodian can maintain ownership or control but cannot (or will not) comply with the other requirements of the Safeguarding Rule.
  • There should not be a requirement that the books of the issuer be nonpublic in the privately offered securities exception.
  • There is no evidence of uncertificated, privately offered securities of a client being at risk from the insolvency of the adviser, and there should not be any requirement to maintain such securities with a qualified custodian.
  • There are assets other than “privately offered securities” and “physical assets” that cannot be maintained with a qualified custodian.
  • As an alternative, the SEC should expand the privately offered securities exception to include other assets that share similar protections against misappropriation as privately offered securities.
  • The SEC should provide an exception for an asset that cannot be maintained with a qualified custodian in accordance with the Safeguarding Rule because it would violate or conflict with other laws or regulations.
  • The SEC should allow an investment adviser to consider whether maintaining a privately offered security or physical asset with a qualified custodian is in the best interests of the client in accordance with the fiduciary duty of the investment adviser to the client, taking into consideration, among other things, the cost and quality of such custodial services.
  • Investment advisers should not be required to maintain their assets in the name of a bank (or other similar custodian) as nominee of their clients.
  • The transaction verification requirement will not significantly affect the misappropriation of client assets and will be more costly than the SEC expects.
  • If independent verification remains required, then more third parties other than independent public accountants should be permitted to perform these services.

Scope of Definition of Custody

  • The SEC should continue to exclude discretionary authority from the definition of “custody” under the Safeguarding Rule, at least for delivery-versus-payment (DVP) assets.
  • The SEC should also exclude limited discretionary authority with respect to non-DVP assets from the definition of “custody” where there are other safeguards in place.
  • The SEC should limit the term “discretionary authority” to mean only where such authority does not include the consultation or other participation of the client (or a representative or agent of the client).

New Requirements for Qualified Custodians

  • The proposed Safeguarding Rule does not appreciate the absence of bargaining power for most advisers, especially small and mid-sized advisers.
  • The Safeguarding Rule does not appreciate circumstances where a client and custodian have a preexisting relationship, including a preexisting contractual arrangement.
  • The Safeguarding Rule would increase costs associated with accounts for clients and also the time associated with opening new accounts for clients.

Reasonable Assurance and Written Agreement Requirements

  • The SEC should not seek to set due care and indemnification standards that are inconsistent with the market and not required by the custodian’s primary regulator.
  • The internal control report should not be required from unaffiliated custodians, or at least should provide more exceptions for when such an internal control report is not required.
  • The SEC should clarify that the provision of records requirement may be restricted by applicable privacy or similar laws.
  • The economic analysis with respect to the written agreement and reasonable assurances requirements for qualified custodians is severely flawed in many respects.

Requirements for Foreign Financial Institutions

  • The requirements on foreign financial institutions will unnecessarily disqualify a large number of foreign financial institutions from acting as qualified custodians, causing direct and indirect investor harm.
  • A foreign financial institution should not have to subject itself to US jurisdiction to act as a qualified custodian.
  • Requiring a foreign financial institution to be subject to anti-money-laundering laws equivalent to US law is overinclusive of what is necessary to support the safeguarding of client assets.
  • The specific requirements for foreign financial institutions should not include the due care, segregation, and internal controls requirements that duplicate the reasonable assurances and custodial agreement requirements.
  • Analogies to Rule 17f-5 under the Investment Company Act are flawed because of the material differences between US registered fund products and the much more varying investment products advised by SEC-registered investment advisers.

Requirements for Banks and Savings Associations

  • The SEC should clarify that state-chartered trust companies and banks may act as qualified custodians under the Safeguarding Rule.

Futures Commission Merchants

  • Futures commission merchants should be permitted to hold assets other than client funds, security futures, and other securities incidental to transactions in commodities.

Adviser Segregation Requirements

  • The SEC should incorporate an exemption for loan syndication accounts similar to those covered by the Madison Capital no-action letter.

Annual Audit Exemption

  • The Safeguarding Rule should cover all different types of legal entities that undergo an annual audit.
  • The Safeguarding Rule should incorporate the existing SEC staff guidance for the audit of non-US legal entities.
  • The Safeguarding Rule should clarify that no US GAAP reconciliation is required where there are no US persons to whom the statements would be delivered.
  • The Safeguarding Rule should permit regulated entities to rely on the annual audit if such annual audit is done in compliance with the requirements of the client’s primary regulator.
  • The Safeguarding Rule should permit investors or clients to waive the requirement for a stub audit and have a first-year audit that exceeds 12 months.
  • The SEC should provide additional flexibility to avoid annual audits for end-of-life closed-end funds.
  • The SEC should provide an exception for employee vehicles from the annual audit and surprise examination requirements.

Delivery Requirements for Pooled Investment Vehicle Clients

  • Pooled investment vehicles should not be required to send a notice to investors with respect to the opening of an account at a qualified custodian if it satisfies the annual audit exemption.
  • The SEC should provide exceptions for special purpose vehicles, blockers, and other aggregators that are formed below the pooled investment vehicle.
  • The SEC should provide an exception for fund of funds investing in underlying funds managed by related persons.


  • The SEC should not require an investment adviser to maintain a memorandum that indicates the basis of the investment adviser’s custody.
  • The SEC should not require an investment adviser to maintain the account identification information in the format that the amended Recordkeeping Rule would require.
  • The SEC should not require an investment adviser to maintain a record of each asset (and related information).
  • The SEC should clarify that confirmations of trades are not necessary where they are not otherwise produced.

Form ADV

  • The definition of discretionary authority on Form ADV should be consistent with the definition of discretionary authority in the Safeguarding Rule.
  • The SEC should consider whether there are sufficient benefits to the SEC’s examination program to justify the administrative burden on investment advisers completing the new table in Item 9.A.(2).
  • Qualified custodians reported on Section 7.B.(1) of Schedule D should not be required to be reported on Section 9.C.(1) of Schedule D.
  • The SEC should revise or remove the question with respect to client assets that are not maintained by a qualified custodian in accordance with the Safeguarding Rule.
  • The SEC should remove the requirements to update Form ADV for audit opinions and internal control reports that contain an unqualified opinion.

Treatment of Crypto Assets

  • The SEC should be encouraging the use of SEC-registered investment advisers to help investors protect themselves against the risks of investing in crypto assets.
  • The Safeguarding Rule puts SEC-registered investment advisers at a competitive disadvantage with non-US and other unregistered investment advisers, which also hurts investors.
  • The Safeguarding Rule will cause SEC-registered investment advisers to provide advice on crypto assets to clients in inefficient structures.
  • The SEC has previously adjusted the federal securities laws for technological and other innovations.
  • The SEC is putting investment advisers (who are acting in good faith in seeking to provide investment advice on crypto assets to their clients) in an almost-impossible position and causing more fiduciary duty traps.

Real Estate

  • Real property has a long-standing set of laws reducing the risk of misappropriation that make the Safeguarding Rule unnecessary with respect to the evidence of real property ownership.


  • Many loans are at low risk of misappropriation, making the Safeguarding Rule unnecessary with respect to the related loan documents.

Extraterritorial Application

  • The SEC should acknowledge that the Safeguarding Rule will be treated at least like the Custody Rule with respect to non-US investment advisers providing advice to non-US clients.
  • The SEC should expand the limitations on the extraterritorial application of the Safeguarding Rule to ensure that US advisers are not subject to a severe competitive disadvantage compared with non-US advisers with respect to non-US clients.

Grandfathering and Transition Period

  • Grandfathering is necessary to avoid interfering with a wide range of existing contractual relationships in violation of existing judicial precedents.
  • One year is not sufficient for custodians to revise their business model and for advisers and custodians to negotiate and execute thousands of new agreements.

Comment Period and Re-Proposal

  • The comment period for the Safeguarding Rule was too short for such a radical proposal.
  • The SEC should re-propose the Safeguarding Rule after considering the comments.