Understanding Fund Custody in Private vs. Publicly Offered Funds

Rule 206(4)-2 of the Investment Advisers Act of 1940 outlines the fund custody compliance requirements for registered advisors. In the simplest terms, the rule requires financial advisors who have custody of client assets to ensure that those assets are safely and securely held with a qualified custodian. The SEC distinguishes between private vs. publicly offered funds in determining when and how the fund custody rules apply to financial advisors.

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Publicly Offered Fund Custody Rules

Custody refers to when an advisor holds client funds or securities, either directly or indirectly, or has the authority to take possession of them. The SEC’s custody rule exists to ensure that client assets are protected from misuse, misappropriation or theft.

Publicly offered funds, including mutual funds and exchange-traded funds, are covered under Rule 206(4)-2. Fund custody rules require registered investment advisors to:

• Choose a qualified custodian, which may be a bank, broker-dealer or other entity, to hold client assets.
• Notify clients in writing of the selected custodian’s name, contact information and how the assets are held.
• Reasonably believe that the custodian will send account statements to clients on a quarterly basis.
• Undergo a surprise annual examination to verify client assets and securities holdings.

In 2023, the SEC proposed amendments to the custody rule that would expand its scope. The proposed amendments would:

• Broaden the list of assets subject to the rule. Assets would include real estate, options and short positions, cryptocurrency, precious metals, artwork, physical commodities and all other assets that advisors custody for their clients.
•  Enhance the definition of custody and impose additional requirements on qualified custodians.
• Create new recordkeeping rules for advisors and require them to disclose additional information about fund custody arrangements to the SEC.

The existing custody rule would also be redesignated as Rule 223-1, the “Safeguarding Rule.”

Privately Offered Funds and the Custody Rule

Rule 206(4)-2 provides an exemption from custody rules for certain privately offered securities, including private funds. Privately offered securities are not offered for sale to the general public. They’re also not required to register with the SEC.

Advisors are not required to adhere to fund custody requirements for certain privately offered securities that are:

• Acquired from the issuer in a transaction (or group of transactions) that does not involve any public offering.
• Uncertificated, with ownership recorded only in the issuer’s books or with its transfer agent in the client’s name.
• Transferable only with prior consent from the issuer or holders of the outstanding securities of the issuer.

However, that could change if the SEC moves forward with the proposed Safeguarding Rule. Notably, the proposed amendments would:

“Modify the current custody rule’s exception from the obligation to maintain client assets with a qualified custodian for certain privately offered securities, including expanding the exception to include certain physical assets.”

That means that if the proposed amendments are formally privately offered, funds would no longer be exempt from custody requirements.

As of February 2025, the Safeguarding Rule underwent multiple public comment periods. However, no formal implementation or compliance date was established. The proposed changes were met with pushback from registered investment advisors who argued that the costs of ensuring compliance would be significant.

Frequently Asked Questions

What is the Purpose of the Fund Custody Rule?

The SEC’s custody rule serves two purposes. First, it ensures that client assets are safeguarded by requiring advisors to hold them with a qualified custodian. Requiring advisors to keep client assets separate from their own is intended to reduce the likelihood of misuse or abuse.

Second, the custody rule alleviates advisors of the burden of maintaining client assets. For example, a qualified custodian can assume responsibility for sending account statements to each client they hold assets for. The eliminates what might otherwise be a time-consuming task from the advisor’s busy day-to-day schedule.

Does the Custody Rule Apply to Exempt Reporting Advisors?

Under the current rulemaking guidelines, exempt reporting advisors are not subject to fund custody compliance requirements. Only registered investment advisors are required to comply.

What Is the SEC Safeguarding Rule?

The SEC Safeguarding Rule is a series of proposed amendments to the existing custody rule. If the new rule were to take effect, privately offered funds would no longer be exempt from custody requirements. Advisors would also face additional recordkeeping and reporting requirements.

Perhaps more importantly, the proposed rule change would expand custody requirements to a broader range of assets. Assets would include cryptocurrencies, commodities, real estate and artwork. At the time of this writing, the future of the Safeguarding Rule remains uncertain. Many financial advisors and industry experts have spoken out against the increased financial and time costs that compliance would likely require.

Bottom Line

Adhering to fund custody rules is critical for maintaining compliance. It’s important for both new and established advisors to stay up to date on the latest regulatory changes. Monitoring compliance trends and risks can help you anticipate rule changes before they happen, so your firm isn’t scrambling to adapt at the last minute.

Tips for Growing Your Advisory Business

• In the digital age, successful advisors understand the importance of online visibility. Building a website, becoming active on social media and developing trust through an email newsletter are all effective ways to cultivate a loyal following and develop your brand identity. Partnering with an advisor marketing platform is another avenue you might explore if you’d like to connect with clients. SmartAsset AMP (Advisor Marketing Platform) is a holistic marketing service that financial advisors can use for client lead generation and automated marketing. Sign up for a free demo to explore how SmartAsset AMP can help you expand your practice’s marketing operation. Get started today.
• Choosing a custodian is a weighty decision and it’s one that typically requires some research and planning. When comparing RIA custodians, consider the range of services offered, the cost and the level of support you’ll receive if you have questions or need help. Talking to other advisors about what they do or don’t like about their custodians can help you choose the right custodian for your firm.

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