Oct. 30, 2023
The Securities and Exchange Commission (“Commission”) is reopening the comment period for its proposal, Safeguarding Advisory Client Assets, Release No. IA–6240 (Feb. 15, 2023) (“Proposal”), which proposed a new rule under the Investment Advisers Act of 1940 (“Advisers Act” or “Act”) that would redesignate and amend the current custody rule. In light of the adoption of the private fund adviser audit rule, which generally requires a registered investment adviser to obtain an annual financial statement audit of each private fund it advises in accordance with the audit provision of the current custody rule, reopening the comment period will allow interested persons additional time to assess the proposed amendments to the current custody rule's audit provision in light of the private fund adviser audit rule. Against The Commission's proposed safeguarding rule and expansion of the audit provision under Title 17 section 275.206(4)–2, there are several arguments that can be made: Unnecessary burden on small business advisors: While the proposed rule aims to strengthen investor protections, it places an undue burden on smaller businesses managing private funds. The cost of hiring an external auditor to perform surprise examinations every year could significantly increase their expenses, potentially making it difficult for them to operate profitably. This could discourage small players from entering the industry, reducing competition and limiting options for investors. Overlapping requirements: Both the proposed safeguarding rule and existing current custody rule impose surprise examination requirements. Expanding the reach of the latter to include more entities may lead to confusion and inconsistencies in compliance practices among advisors. As both rules cover different aspects of asset management, duplicative reporting obligations might result, thereby increasing administrative costs without providing additional value to stakeholders. Imposing restrictions on non-U.S. Clients: Requiring financial statements for non-U.S. Clients to adhere strictly to U.S. Generally Accepted Accounting Principles (GAAP) could prove challenging due to significant cultural, legal and regulatory barriers. For example, accounting principles differ considerably between European Union member states, meaning that it may take time for foreign practitioners to adjust to American standards. Furthermore, forcing international clients to modify their books to fit US norms could put them off investing in US markets altogether. Redundancy: With the introduction of the private fund adviser audit rule, many advisors already carry out financial statement audits annually for their funds. Therefore, implementing another layer of auditing oversight via the expanded audit provision seems redundant since it essentially doubles up on compliance work required. It may thus add unnecessary complexity, resulting in higher operational costs for advisors and potentially causing delay in delivering results to investors. In conclusion, while investor protection should always be prioritized, the proposed safeguarding rule and expansion of the audit provision seem overly broad and burdensome, particularly for small businesses and non-U.S. Entities. Careful consideration needs to be taken to avoid overlapping requirements, excessive costs, and inflexible application of GAAP principles across diverse global economies. A balanced approach that considers practicality, consistency, and efficacy will best serve all parties involved.