Client Consent

Brightwater Advisory holds a standing letter of instruction signed by client Omar Sadiq authorizing the firm to wire funds from his custodial account to his building contractor on request. Regarding custody, Brightwater:

1. A.Does not have custody, because Sadiq signed the authorization and consents to each transferConsent establishes that the transfers are authorized; it says nothing about the adviser's degree of access. Custody turns on the adviser's power over client assets, and a client can freely consent to giving an adviser custody.
2. B.Has custody, because it has authority to withdraw client funds and direct them to a third partyCustody includes any arrangement giving the adviser authority to obtain possession of or withdraw client funds. A standing authorization to move money to a third party is exactly that authority, which is why such letters are the classic source of inadvertent custody.
3. C.Does not have custody, because the funds go to a third party rather than into the adviser's own accountThe destination of the money is irrelevant. What matters is the adviser's power to move client assets out of the account, and authority to send funds anywhere the adviser directs is broader access, not narrower.
4. D.Has custody only if Brightwater also serves as the qualified custodian for the accountThis confuses being a custodian with having custody. An adviser that never holds the account and never touches the recordkeeping can still have custody through authority over assets held at an unaffiliated custodian.

Why: Custody is defined by authority over client assets, not by possession or by where the money ultimately lands. A standing authorization permitting the adviser to move client funds to a third party confers the ability to withdraw client assets and therefore constitutes custody, commonly called inadvertent custody because firms acquire it without intending to. Client consent to the arrangement does not negate it.

An investment adviser wants to sell a bond out of the firm own inventory to an advisory client. To do so lawfully, the adviser must:

1. A.Simply charge a fair price, since disclosure is not required for bondsIncorrect - disclosure and consent are required for principal transactions regardless of security type.
2. B.Disclose the capacity and obtain the client consent before completion of each such principal transactionCorrect - principal transactions require disclosure and consent before completion, trade by trade.
3. C.Obtain blanket consent once at account opening covering all future principal tradesIncorrect - blanket prospective consent does not satisfy the rule.
4. D.Avoid all disclosure to prevent influencing the client decisionIncorrect - the adviser must disclose, not conceal, the principal capacity.

Why: Acting as principal with an advisory client requires disclosure of the capacity and client consent before completion of the transaction, on a transaction-by-transaction basis. Blanket prospective consent does not satisfy the requirement.