SEC Issues Custody Rule Guidance For Advisers Holding Privately Offered Securities

8월 8, 2013


Rule 206(4)-2 of the Investment Advisers Act of 1940 (the “Custody Rule”) requires registered investment advisers to hold client funds and securities with a qualified custodian, subject to certain exceptions—such as the exception for certain “privately offered securities.”[1] Advisers to private funds may invest in privately offered securities, for example portfolio companies, for which they receive private stock certificates. These certificates do not qualify as “privately offered securities” under the Custody Rule, which defines the term more narrowly than its common use. As a result, they must be kept with a qualified custodian. On August 1, 2013, the Securities and Exchange Commission’s (the “SEC”) Division of Investment Management (the “Division”) advised that, provided certain conditions are met, it will not object if advisers to private funds do not maintain private stock certificates with a qualified custodian.[2]

In addressing the application of the Custody Rule to private stock certificates, the Division’s guidance builds on the exception for “privately offered securities.” Under the Custody Rule, “privately offered securities” are securities that are: (1) acquired from the issuer in a transaction or chain of transaction not involving a public offering; (2) uncertificated, and ownership thereof is recorded only on the books of the issuer or its transfer agent in the name of the client; and (3) transferable only with the prior consent of the issuer or holders of the outstanding securities of the issuer. The Division’s guidance highlights adviser comments that, although a security evidenced by a private stock certificate does not technically qualify as a “privately offered security,” such securities are similar in all material respects because, in each case, the client’s ownership interest in the security is not impacted by the existence (or lack thereof) of the certificate. It also emphasizes adviser comments that requiring advisers to maintain private stock certificates with a qualified custodian imposes substantial costs without added protections for investors.

Accordingly, the Division’s guidance concludes that private security certificates do not have to be maintained with a qualified custodian provided the following conditions are met:

  1. The adviser’s client is a pooled investment vehicle that is subject to a qualifying financial statement audit;
  2. The private stock certificate can only be used to facilitate a change in beneficial ownership of the security with the prior consent of the issuer or holders of the outstanding securities of the issuer;
  3. Ownership of the security is recorded on the books of the issuer or its transfer agent in the name of the client;
  4. The private stock certificate contains a legend restricting transfer; and
  5. The private stock certificate is appropriately safeguarded by the adviser and can be replaced upon loss or destruction.

The Division also noted that it considers the following to be privately offered securities: (1) securities evidenced by ISDA master agreements that cannot be assigned or transferred without the consent of the counterparty; and (2) securities represented by partnership agreements, subscription agreements, and LLC agreements, because the ownership documents are not certificates (provided such securities meet the other elements of the definition of “privately offered securities” under the Custody Rule, as described above).

Private fund advisers should keep in mind that the exception from the qualified custodian requirement for privately offered securities is only available if the advisers fully satisfy the requirements of the so-called “audit exemption” available to private fund advisers. This exemption requires that the private fund is subject to audit at least annually by an independent public accountant registered with, and subject to inspection by, the Public Company Accounting Oversight Board, and the fund must distribute its audited financial statements prepared in accordance with GAAP to all beneficial owners of the fund within 120 days of the end of its fiscal year.[3] In certain circumstances, funds organized under the laws of a country other than the United States, or that have a general partner or other manager with a principal place of business outside of the United States, may be able to rely on principles other than GAAP for the financial statements.

O’Melveny & Myers LLP is assisting investment adviser clients with analyzing and complying with the new guidance. For questions or additional information regarding your obligations under the Custody Rule, please contact Heather Traeger at (202) 383-5232 or Kris Easter at (202) 383 5364.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Heather Traeger, an O'Melveny partner licensed to practice law in the District of Columbia and Texas,and Kris Easter, an O'Melveny counsel licensed to practice law in the District of Columbia and Texas, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

Portions of this communication may contain attorney advertising. Prior results do not guarantee a similar outcome. Please direct all inquiries regarding New York's Rules of Professional Conduct to O’Melveny & Myers LLP, Times Square Tower, 7 Times Square, New York, NY, 10036, Phone:+1-212-326-2000. © 2013 O'Melveny & Myers LLP. All Rights Reserved.