SEC Custody Rule

In response to Madoff’s scheme, the SEC adopted a new rule that took effect last Friday. Under this rule, if the SEC finds that an advisory firm has custody over client assets, that firm must pay for an annual audit.

Compliance with this rule will cost firms from $16,000 to $100,000 annually. Thus, investment advisors have found a way around it. By splitting the advisor and trustee into separate operations, an advisor can manage client assets without being considered the custody provider. This is known as a directed trust, and it costs a lot less to arrange this scheme than it does to comply with the SEC rule.

See Jerry Cooper, New SEC Custody Rule Boon for Directed Trust Providers, Trust Advisor Blog, March 19, 2010.