Q2 If you answered yes to question #1, do you exclude the separate account in your client count and AUM?

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Joella Farmer
5 years ago
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1 Q1 Has anyone taken the position that separately managed accounts investing only in real property are not considered advisory clients and therefore not within the Custody Rule (and not subject to the surprise audit and bank statement requirement)? Answered: 9 Skipped: % % 8 Total 9 1 / 7

2 Q2 If you answered yes to question #1, do you exclude the separate account in your client count and AUM? Answered: 1 Skipped: % % 0 Total 1 2 / 7

3 Q3 Do you have signatory authority at the property level bank account or the ability to move cash from the property level bank accounts to the account level bank account? Answered: 8 Skipped: % % 1 Total 8 3 / 7

4 Q4 If yes, does your surprise audit include both account level bank accounts and property level bank accounts? Answered: 6 Skipped: % % 0 Total 6 4 / 7

5 Q5 Do you send bank statements to investors from each separate property level bank account in addition to the account level bank account? Answered: 8 Skipped: % % 3 Total 8 5 / 7

6 Q6 If you are not sending statements (at either the account level or the property level), what are you relying on to get comfortable with this decision? We understand that clients generally do not want to receive these statements; however we are wondering what measures you have taken to exclude any account statements from client delivery. (for example, have you limited your ability to move cash in these accounts, gotten written consent from clients, legal opinions, etc.) Answered: 3 Skipped: 6 # Date 1 We are definitely in this boat so if you hear anything from others, we would like to share in this info as well! Bailey,pat@principal.com 2 Generally stay away from having account level access to cash for separate accounts. Also, we consider the property level bank accounts to be administratively necessary for the business operations of a property. We use 3rd party property managers who maintain the accounts and perform bank reconciliations. While we do have signing authority on wholly owned property accounts, we rarely ever transact upon them. In addition, we do not debit our advisory fees from any bank accounts under our control. Clients pay fees directly to advisor s billing department. But generally we rely on the annual independent audit as the basis for not sending the bank statements. We ve also heard from certain clients that they do not want to receive bank statements. 3 For separate accounts (whether in/out of scope) we simply send all statements, regardless of what clients wants. Separate accounts that hold only RE and no JVs are excluded from the surprise audit; accounts with JVs are in scope, regardless of whether we have determined that the JV is not a security. For pooled vehicles not complying with private fund audit rule, we send fund level statements (not operating account) to an independent rep, and offer to fund investors the opportunity to receive them directly from the custodian. We get comfortable on the fund side that the overall approach we are taking meets the spirit of rule: PCAOB independent fund audit, fund level bank account statement delivery and an audit of client accounts that we do not subject to the surprise audit that is similar in scope to the surprise audit. 10/27/2014 1:19 PM 10/24/ :37 AM 10/24/2014 9:56 AM 6 / 7

7 Q7 Do you have any comments or thoughts or best practices to share about how you interpret or apply the custody rule? Answered: 5 Skipped: 4 # Date 1 Separate accounts are scoped into Custody at our Company. If they are not exempted by the audit rule (ie issuing financials within 120 days after fiscal year end) they are subjected to surprise cash examinations. We also have our custodian send bank statements directly to our clients each month for all accounts where we have the ability to move funds. 2 Do the independent audit. Indepndence is measured differently for the SEC than it is for AICPA. Seek legal guidance. 3 This is a very difficult issue. I think that a truly best practice would be for the advisor to explain to the client to the effect that although we have represented to you we are an investment advisor, we are taking the position that your account is not getting the benefit of the IAA rules (or we are excluding your account from certain rules) but I don't think anyone does this. So the second best course of action is to make clear in your procedures the action you are taking in this area and to ensure compliance with those actions, and to at least identify items of the custodial rule that make sense and apply them consistently in your procedures. 4 We do have separate account clients consisting of pension fund clients. Our typical structure is that our pension fund client will invest in real estate property with an unaffiliated operating partner in an SPV LLC or LP structure. Generally, the unaffiliated operating partner is the Managing Member or General Partner of the LP. On occassion our affiliated entity may be the Co-Managing Member. We therefore have taken the position that we do not have custody of the SPV assets as we cannot unilaterally direct the movement or transfer of SPV cash. In the limited cases whereby we do not have a joint venture unaffiliated partner in a property investment (i.e. direct investment by a client), we do have the property level bank statements sent directly to the client. I don't believe however that the SEC ever invisioned this practice as it does not make sense for a client to receive pages and pages of property bank statements that show tenant receipts and property expenses. We have not received any pushback from a client that receives these bank statements. Generally it is a lower level person within the client that is receiving the statements. We also have a few instances where there is a need for us to hold separate account client assets in a bank account that we maintain outside of the SPV (i.e. client fundings for future tenant improvements). We also have statements sent to the client. On a semi-annual basis, we confirm with the clients that they are in fact receiving these statements. We also have KPMG do a surprise examination on the separate account instances where we have custody. Their surprise examination also covers the provision of the Custody Rule governing "private offered securities" since we maintain all investment agreements for our clients. So KPMG will confirm separate account invested capital balances with our clients and will select a sample of our client agreements. With respect to our commingled private funds, we send audited financial statements to investors within 120 days after year end which exempt us from other aspects of the custody rule relating to private funds. 5 If someone at the firm is a signer on an account for a client we consider it part of the custody exam process. There are a few states that don't allow us as signers, only the fee manager is the signer, these are not included in the custody work. 10/28/2014 1:46 PM 10/24/ :37 AM 10/24/2014 9:56 AM 10/24/2014 9:43 AM 10/24/2014 8:29 AM 7 / 7

Rule 206-4(2) Custody Webinar

Rule 206-4(2) Custody Webinar Understanding the New Requirements Affecting RIAs Steven Stone Morgan Lewis Washington, DC 03 30 10 www.morganlewis.com Understanding the New Requirements Affecting RIAs Custody Timeline Key Definitions