If you're a Registered Investment Advisor (RIA) and you take custody of client assets, the SEC requires you to undergo an annual surprise custody examination. These audits can sound intimidating, but knowing what to expect can ease the process and help you stay in compliance. 

Do you need a custody audit? 

Not sure if you fall under the custody rule? It’s more than just physically holding client funds. Custody can include having login credentials to client accounts, acting as a trustee, or performing bill-pay functions under certain arrangements. Because the rules are nuanced, your compliance officer should consult legal counsel to determine whether your firm falls under the custody rule. They’ll help you interpret your specific situation and determine if your firm has custody under SEC guidelines. 

Choosing the Right Auditor 

Custody audits are a specialized type of engagement. You will want a CPA firm that understands the intricacies of the custody rules and has specific experience with custody examinations. A knowledgeable auditor will conduct a compliant exam and help you understand any gaps or risks that could raise red flags during the process. 

How to Prepare for a Custody Audit 

Be sure to keep your documentation in order. Auditors will need access to: 

• A listing of accounts under custody during the annual period, including existing, new, and closed accounts. 
  • This should be maintained as a working list throughout the year. 
• Client account agreements for accounts subject to the audit. 
• Transaction records, including: 
  • Client account statements
  • Custodian statements
  • Detailed transaction activity during this audit period

What happens during the audit? 

The fieldwork phase is where your auditor performs detailed testing to assess whether your firm is complying with the custody rules. This phase begins after the auditor has selected the “surprise” audit date during the annual period. 

As part of fieldwork, the auditor typically performs the following procedures on a sample of client accounts, which are selected without prior notice to management: 

• Confirmation of cash and securities held by the qualified custodian, verifying that these assets are held in a separate account either under the client’s name or in the name of the Company.
• Reconciliation of cash and securities to the Company’s books and records for each selected client account. 
• Client confirmation of account holdings, requesting verification of cash and securities held as of the surprise date, along with confirmation of all activity within the examination period (from the prior surprise audit date to the current one). 
• Inspection of trade confirmations from the qualified custodian for purchases, sales, and other activity during the examination period. 
• Confirmation with the client of closed accounts or returned funds to ensure appropriate handling of client assets. 
• Detailed testing of new client accounts opened during the examination period, including review of supporting documentation. 

Throughout fieldwork, auditors may request additional documentation as needed. For example, alternative procedures may be required when custodian or client confirmations are not returned. 

Reporting 

Once fieldwork wraps up, your auditor will require you to initiate the Form ADV-E, which they will file along with their examination report. The Form ADV-E must be filed within 120 days of the surprise date. 

Lutz can Help Navigate Custody Compliance 

After confirming your custody status through legal counsel, it’s important to partner with an experienced custody auditor. Our audit team brings experience in custody examinations and works with RIAs across the country to meet SEC requirements. Contact us to discuss how we can support your compliance efforts.