SEC proposes custody relief for RIAs with discretionary trading authority

The Securities and Exchange Commission released a 760-page proposal on Thursday to revise the custody rule that requires registered advisors to hold client stocks, bonds and other assets at a brokerage or bank for safekeeping, and the relief it offers is conditional: the written-agreement and outside-exam requirements of the commission's abandoned 2023 draft would be dropped for RIAs that meet three conditions. Commissioner Paul Atkins said in a statement that it has been decades since the custody rules last underwent revision, and that the proposal seeks to ensure they are fit for purpose and better address current industry practices and the feedback the commission has received.

The provision that reaches deepest into daily practice is discretionary trading, the authority clients grant so that trades can be placed without approval for each individual one. That authority is the ordinary arrangement rather than a specialty: it accounts for $117.57 trillion of the $128.96 trillion in assets advisors manage, roughly nine-tenths of the total, on Financial Planning's figures. A custody rule that catches discretionary authority therefore touches most of the advised market, which is why a document full of compliance machinery is being read by people who run practices rather than only by their lawyers.

The anxieties around this were stirred in 2023, when the commission put forward a proposal, since abandoned, that would have subjected advisors to new requirements when they placed trades in client assets custodied at outside broker-dealers. RIAs would have had to enter written agreements with custodians specifying that records on investor assets be attainable on request and that client assets be protected against creditors if the custodian went bankrupt. Advisors with discretionary authority could also have been subject to surprise exams by outside accountants. The objection from the industry, as the coverage describes it, was volume: the requirement would have meant redrafting thousands of contracts.

That objection explains the shape of the relief now on offer. Redrafting custody agreements is a fixed cost that no client pays for. It scales with the number of custodian relationships rather than with assets or revenue, so a firm with two custodians and no general counsel carries much the same per-agreement work as a national RIA with a legal department, and those hours come out of the same week as client meetings and business development. Costs of that kind land hardest on the practices with the least cushion, the ones for whom a custodian's account minimum is already a live question, which is why a proposal that reads as technical news is worth an owner's morning. The 2023 requirements never took effect, and what firms anticipated spending on them is the measure of what the commission is now offering to remove.

The proposal also carries a self-custody option for client assets, which Financial Planning's summary pairs with the discretionary-trading relief and states without detail. What that option is meant for, whether it is aimed at advisors holding assets in newer forms or at firms looking for an alternative to the custodians they use today, the coverage does not set out, and it is likely to be among the provisions that draw comment before anything is finalized.

The three conditions are where the proposal does its actual work. The relief runs only to RIAs that meet all of them, which makes the test a documentation exercise as much as a question of conduct, because a firm will want to show that its discretionary arrangements satisfy each condition rather than assert it after the fact. Whether those conditions prove broad or narrow is the difference between most of that $117.57 trillion in discretionary assets staying outside custody treatment and a large share of it falling in.

The same coverage links readers to Fidelity's stated plan to end custody relationships with RIAs under $100 million. The two developments meet at the same practice from opposite directions, and the pairing is the useful part: the commission would lower what a firm owes in compliance work, while the account minimum that decides whether a smaller firm can stay on a platform is set somewhere else entirely. The proposal as described changes what advisors owe the regulator. It does not change what a custodian is willing to hold.

One constituency the proposal does serve is the custody business itself. Aaron Kaplan, founder and CEO of Prometheum Inc., called the changes a net positive for the regulated financial services industry, the investors it serves and qualified custodians such as Prometheum Capital, which he says make it possible to hold crypto assets with the same protections investors already expect from their brokerage accounts. A custody firm welcoming a custody rule surprises nobody. What the endorsement argues for is scope, meaning which assets a qualified custodian should be permitted to hold, and that argument reads as being about the next set of accounts rather than this proposal.

For now, an advisory practice has nothing to file. The commission has published a proposal, not a final rule, and the requirements that alarmed firms in 2023 were abandoned before anyone had to satisfy them. The three conditions attached to the discretionary-trading relief are the terms on which a firm either stays outside custody treatment or falls into it, and they are the part of the 760 pages worth reading first. Everything else can wait for a final rule that may not resemble the proposal. The last version of this one never arrived at all.