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January 15, 2013

NASAA Proposes Changes to Model Custody and Recordkeeping Rules

By John M. Jascob, J.D.

NASAA has released for internal and public comment proposed amendments to NASAA's model custody and recordkeeping rules in order to clarify requirements relating to the inadvertent custody of client funds by investment advisers. The proposed changes, which would amend NASAA's Model Rules under both the Uniform Securities Act of 1956 and the Uniform Securities Act of 2002, resolve an inconsistency between the custody and recordkeeping rules as to when an investment adviser will not be deemed to have custody of client securities or funds received inadvertently. The proposal would also more closely align the language of the recordkeeping rule to that of the custody rule.

As written, NASAA's model custody rules under both the 1956 and 2002 Acts deem custody to include possession of client funds or securities unless the investment adviser receives them inadvertently and returns them to the sender promptly, but in any case within three business days. Rule 102(e)(1)-1(B) and Rule USA 2002 411(f)-(1) further note that receipt of checks drawn by clients and made payable to third parties will not meet the definition of custody if forwarded to the third party within three business days of receipt, provided the adviser maintains the records required under the recordkeeping rule. Both of NASAA's model recordkeeping rules, however, provide that certain recordkeeping requirements related to inadvertent possession of client funds include situations in which the adviser held or obtained a client's securities or funds and forwarded third-party checks within 24 hours.

The proposed rule amendments resolve the discrepancy between the custody and recordkeeping rules by amending the recordkeeping rules to change the timeframe for forwarding checks to third parties from 24 hours to three days. The proposal also more closely aligns the language of the recordkeeping rule to that of the custody rule. These language changes clarify that timeframes for determining whether inadvertent possession constitutes custody is measured from the time of receipt of the securities or funds; change a reference to "third party" checks to more closely conform to model custody rule language by stating checks must be drawn by clients and made payable to third parties; and make minor, non-substantive grammatical changes.

The comment period will remain open until February 12, 2012. NASAA requests that comments be sent via email to Greg Abram, Chair of the Investment Adviser Section Regulatory Policy and Review Project Group, and Joseph Brady and A.Valerie Mirko of the NASAA Legal Department. Comments may also be submitted in hard copy to the NASAA Legal Department in Washington, D.C. NASAA also welcomes any general comments on the model custody and recordkeeping rules.


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