In July, we wrote the Custody Rule (or, perhaps, the Safeguarding Rule) is back and promised to see you in October. On October 1, 2026, the U.S. Securities and Exchange Commission (“SEC”) proposed new rules and amendments to the custody rules under the Investment Advisers Act of 1940 (“Advisers Act”) and the Investment Company Act of 1940 (“40 Act”) (“Proposed Rule”). The Proposing Release (Release Nos. IA-7023; IC-36353) generally keeps the existing custody framework but redesignates Advisers Act Rule 206(4)-2 as Rule 223-1 under Section 223 of the Advisers Act.
This alert addresses what Chairman Atkins calls “long-needed modernizations” of rules that “have not been amended for decades.” Our companion alert, “The Custody Rule Is Back (Part II): Crypto Finally Gets Its Own Lane,” covers the proposal’s crypto framework.
According to the SEC, the Advisers Act modernization of the Proposed Rule consists of the following features:
- Provides an exception based on discretionary trading authority;
- Eliminates Public Company Accounting Oversight Board requirements;
- Amends certain requirements of the audit provision;
- Provides an exception based on standing letter of authorizations;
- Provides an exception based on inadvertent custody; and
- Updates the recordkeeping and disclosure requirements.
The 40 Act modernization of the Proposed Rule consists of the following features:
- Permits registered funds to maintain assets in the custody of any registered broker-dealer whose custody is subject to Exchange Act Rule 15c3-3;
- Eliminates the physical segregation requirement for assets held by broker-dealer custodians;
- Eliminates the periodic independent accountant examination requirement;
- Eliminates the requirement that the fund's board ratify custodial contracts; and
- Updates the recordkeeping and disclosure requirements.
While this alert will not focus on all modernization aspects, we highlight some key components below.
Discretionary Trading: The Concern We Raised Was Addressed
Our July alert singled out the most problematic feature of the 2023 proposal: treating discretionary authority alone as enough to bring assets within the custody framework. Instead, the Proposed Rule would except from the custody rule assets over which an adviser has custody solely based on its discretionary trading authority, if:
- the adviser executes (and only has authority to execute) trades from and into designated client accounts in the client’s name, or the transfer is recorded in the client’s name by the issuer;
- the adviser has no authority to transfer client assets to itself, a related person, or an account it or a related person controls, or to any other account that is not the client’s unless the client directs the transfer in connection with the trading; and
- the adviser complies with the rule for any other authority that separately gives it custody.
The exception does not turn on whether trades settle delivery-versus-payment. Further, the exception covers only trading (not bill payment or other one-way transfers) and broadly drafted grants of authority that amount to a general power of attorney may defeat it.
Standing Letters of Authorization: Codified
In July, we noted that an adviser acting under a standing letter of authorization (“SLOA”) may be deemed to have custody even when the client established the arrangement. Not much has changed. The Proposed Rule instead codifies an exception from the surprise examination requirement – similar to the position SEC staff took in a 2017 no-action letter.
Importantly, the adviser still maintains custody. The exception is from the surprise examination, not from the Proposed Rule.
Fee Deduction: Unchanged
We also questioned whether automatic fee deduction should still create custody. The proposal does not change that treatment. An adviser whose sole basis for custody is fee deduction of the adviser’s fees remains excepted only from the surprise examination requirement.
Again, advisers are still subject to the Proposed Rule, just not the surprise examination requirement.
Other Modernizations
- Inadvertent Custody. The Proposed Rule would except custody arising solely from a custodial agreement if the adviser did not recommend, request, or require the client’s choice of custodian, and either has no copy of the agreement and no knowledge or reason to know it confers custody, or, upon learning, promptly notifies the client and custodian in writing, repudiates the authority, and requests its removal.
- PCAOB Requirement Eliminated. Accountants performing pooled vehicle audits, surprise examinations, and internal control reports under the rule would no longer need to be registered with, and subject to regular inspection by, the PCAOB. They must still be independent public accountants.
- Pooled Vehicle Audits. The Proposed Rule would extend the audited financial statement delivery deadlines for funds of funds and funds of funds of funds and modify the first-year audit timing requirements for pooled investment vehicles formed near the end of their fiscal year. Newly formed vehicles formed within 90 days of fiscal year-end could distribute first-year (potentially unaudited) statements within 90 days and deliver audited statements covering both years after the second year. Statements would generally have to follow U.S. GAAP, with a reconciliation alternative for foreign pooled vehicles, and could be delivered to an investor’s independent representative.
- Client Notice. The notice sent when opening a qualified custodian account would have to include the client’s account number.
- Form ADV. Item 9 would be revised for readability, with conforming changes for the redesignated rule. For example, conforming changes will include the addition of new questions requiring disclosure as to each custody exception relied upon.
- Accountant Guidance. The SEC also discusses expected revisions to its 2009 guidance on independent public accountant engagements.
Comments are due by December 7, 2026, or 60 days after Federal Register publication, whichever is later (SEC press release), under File No. S7-2026-35.
We remain available to help firms assess the proposal and prepare for the final rule.