Custody

An investment adviser that takes custody of client assets generally must:

1. A.Cease all advisory activityCustody is permitted, not prohibited; it simply carries heightened obligations. Advisers holding client cash or securities must segregate them, send account statements, and notify the Administrator, but they continue advising.
2. B.Follow safekeeping rules like segregation and client noticeCorrect - custody imposes safeguarding obligations.
3. C.Do nothing specialCustody is the single fact that triggers the most demanding safeguards in the state rules, because it puts client property within the adviser's reach. Treating it as routine ignores the segregation, statement, notice, and surprise-examination requirements that attach.
4. D.Register as a broker-dealerBroker-dealer registration turns on effecting securities transactions for the account of others, not on holding client assets. An investment adviser with custody remains an adviser and meets its obligations through the custody rules, often by using a qualified custodian.

Why: Custody triggers safekeeping requirements such as segregation of assets, account statements, and notice to the Administrator.

Under NASAA net-worth rules, higher minimum capital is generally required for advisers that have:

1. A.Fewer than 5 clientsClient count drives the de minimis registration analysis, not the net-worth requirement. Minimum financial requirements scale with what the adviser can do to client assets, so a firm with five clients and custody faces the higher bar while one with hundreds of non-discretionary clients does not.
2. B.No clientsAn adviser with no clients holds no client assets and exercises no authority over them, so there is nothing for a capital cushion to protect against. The requirement rises with exposure to client property, and here there is none.
3. C.Custody of client assetsCorrect - custody demands more capital.
4. D.A small officeOffice size, headcount, and physical footprint have no bearing on minimum net worth. The rule keys on the adviser's authority over client assets, so a two-person firm holding client funds faces a higher requirement than a large firm that neither has custody nor exercises discretion.

Why: Advisers with custody face higher minimum net-worth requirements than those with only discretionary authority.

An adviser must disclose a financial condition that is:

1. A.Never disclosedAn adviser's financial trouble is exactly what clients need to hear about when the adviser holds their assets, trades their accounts, or has already collected fees for services not yet delivered. Treating financial condition as permanently off-limits would defeat the purpose of the disclosure rule.
2. B.Reasonably likely to impair its ability to meet client commitmentsCorrect - material financial impairment must be disclosed.
3. C.Its projected profitsForward-looking earnings estimates are the adviser's own business forecast and are not required disclosure. The rule targets a present condition likely to impair the adviser's ability to meet its commitments to clients, which is a solvency question rather than a profitability projection.
4. D.Better than its competitorsFavorable comparisons are marketing, not mandated disclosure, and unsubstantiated ones create their own advertising problems. The disclosure obligation is triggered by adverse financial condition, so a firm doing well has nothing to report under this rule.

Why: An adviser with discretion, custody, or substantial prepaid fees must disclose any financial condition reasonably likely to impair its ability to meet commitments to clients.

Under NASAA custody rules, an adviser with custody generally must undergo:

1. A.Registration as a bankBanks are among the entities that may serve as qualified custodians, which is the thread of truth here. But the adviser is not asked to become a bank; it must submit to an independent verification of the client assets it holds.
2. B.A daily auditDaily auditing would be ruinously expensive and would defeat the design of the safeguard. The examination works because it is annual and unannounced, so the adviser cannot prepare for it; frequency is not what gives it force.
3. C.No examination everHolding client assets is the circumstance that most calls for outside verification, not one that excuses it. Certain narrow exceptions exist, such as an adviser deemed to have custody solely because it deducts fees under specified conditions, but the general rule is the opposite of never.
4. D.An annual surprise examination by an independent accountantCorrect - the surprise-exam safeguard.

Why: An adviser with custody generally must have an annual surprise examination by an independent accountant, subject to exceptions.