Steps for Interpreting Schwab's Custody provisions

By Cory Roberson, Principal at FIN Compliance and FIN Lancer

We’ve received numerous inquiries for interpretation into Charles Schwab’s custodial procedures (for firms who use its portfolio center/advisor services) in light of the SEC’s no-action letter on the issue in February 2017.   As such, please refer to notes below on the issue. 

SEC and State-Registrants should continue to rely on their existing jurisdictions’ interpretation of the custody rule.  Schwab is adhering to (adding changes) based on their own interpretation as a qualified custodian, and accordingly, doesn’t act as the regulator/examiner that defines the requirements for your firm.

With that said, all firms who use Schwab services should evaluate its current instructions for first and third-party money movements. 

First-Party Movements (transfers between client accounts with same name)

What doesn’t trigger enhanced custody* (surprise exam not required)

·         Moneylink to transfer/journal funds

·         Sending checks directly to clients

·         Wire Authority (if client signs Schwab authorization form with new instructions)

What does trigger enhanced custody* (surprise exam required)

·         Maintaining Wire Authority (without client signing Schwab authorization form with new instructions)

Third Party Movements (transfers between client accounts with different names)

What doesn’t trigger enhanced custody* (surprise exam not required)

Seven conditions (as defined by Schwab) met

1.    Client provides signed instruction to custodian with third-party disbursement info

2.    Client authorizes IA in writing to direct transfers to third-party (e.g., on custodian form)

3.    Custodian verifies client instruction (e.g., signature verification and transfer of funds notice)*

4.    Client may terminate or change the instruction with custodian

5.    IA cannot change instruction with custodian

6.    IA maintains records showing that third-party is not related to IA**

7.    Custodian sends initial and annual notice & reminder to client

What does trigger enhanced custody* (surprise exam required)

·         Seven conditions (as defined by Schwab) above NOT met.

*Note:  I used the term enhanced custody above to describe Schwab’s interpretation that may or may not prompt surprise examination requirements for your firm.

Summary (based on Schwab’s interpretation)

What to do to avoid enhanced custody (surprise examination/custody rule provisions)

First Party Movement:

1.    Remove current first-party wire authority from all accounts;

2.    Set up new standing instructions with destination account detail and client signatures, or send one-time wires;

3.    Retain check and journal authority;

Third Party Movements:   Follow seven conditions above

FAQ: http://advisorservices.schwab.com/public/file/P9946015/SEC_WPFA_FAQ__miniupdate_final.pdf

**Related parties (those who serve as trustees) -  enhanced custody provisions may not be imputed on an advisor who serves as a trustee for a family member.

Footnote 139 of the Adopting Release explains, however, that the role of the supervised person as trustee will not be imputed to the advisory firm if the supervised person has been appointed as trustee as a result of a family or personal relationship with the grantor or beneficiary and not as a result of employment with the adviser. A similar analysis would apply where the supervised person serves as the executor to an estate as a result of a family or personal relationship with the deceased. A personal relationship developed as a result of providing advisory services to a client over many years is not the type of "personal relationship" contemplated by footnote 139. (Modified March 5, 2010.)   https://www.sec.gov/divisions/investment/custody_faq_030510.htm

We understand that supervised persons may, on occasion, engage the advisory firm to advise an estate, conservatorship or personal trust for which the supervised person serves as executor, conservator or trustee. We would not view the adviser to have custody of the funds or securities of the estate, conservatorship, or trust solely because the supervised person has been appointed in these capacities as a result of family or personal relationship with the decedent, beneficiary or grantor (and not a result of employment with the adviser). https://www.sec.gov/rules/final/ia-2176.htm

Contact Us to learn more about how your firm can adhere to Custody rule compliance regulations for the SEC or State. Call us at: 650-305-2688 or email: cory@RIAreview.com. 

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Compliance and Business Management

FIN Compliance (FINCompliance.io) is a consortium of compliance services including: RIA Consults-Roberson Consults Group, a compliance consulting firm, RIA Review, a compliance-management software tool (SaaS), B-D Review, a RIA/Broker-Dealer compliance management software tool, and FINLancer is a business management portal featuring:  E-signature tools; Invoicing integration, Vendor Directory, continuity directory*, business client document portal, and more (available by Q3 2019).  Access all services on one site: FINCompliance.io.

Impact

FIN Missions (FINmissions.com) provides business support group sessions for other entrepreneurs.  In addition, Cory has volunteered for more than fifteen youth programs in locations such as like S. Korea, China, S. Africa, Thailand, and India.