Surety Bond

Fennwick Larne Advisers is registered as an investment adviser in State G and has never held client funds or securities. Beginning July 1 it will accept client cheques made payable to the firm and will hold client share certificates. State G has no rule prohibiting advisers from taking custody. Under NASAA's model custody rule, before taking custody the firm must:

1. A.Do nothing, because an adviser that is already registered may take custody without any further filing.Incorrect. Custody triggers a notification obligation and heightened financial and safekeeping requirements.
2. B.Obtain the Administrator's written pre-approval before accepting any client funds or securities.Incorrect. No advance approval is required; notification is.
3. C.Notify the Administrator on Form ADV that it has or will have custody of client funds or securities.Correct. Where custody is not prohibited, notification on Form ADV is the required threshold step.
4. D.Post a surety bond in place of notifying the Administrator.Incorrect. A bond may be required in some circumstances, but it is not a substitute for the Form ADV notification.

Why: Where custody is not prohibited, an adviser that has or will have custody of client funds or securities must notify the Administrator of that fact on Form ADV. Custody also carries a higher minimum net worth and the safekeeping requirements of the model rule, but the threshold step in this fact pattern is the Form ADV notification.

State N requires a surety bond of every investment adviser that maintains custody of client funds. Trenmere Asset Counsel has been unable to obtain a bond on acceptable terms and proposes instead to deposit cash and marketable securities of the required amount with the state. Under the Uniform Securities Act, this proposal is:

1. A.impermissible, because only a surety bond issued by a licensed insurer satisfies the requirementThe Act contemplates a deposit of cash or securities as an alternative.
2. B.impermissible, because an adviser unable to obtain a bond is by definition not qualified for registrationInability to obtain a bond is not a statutory disqualification, and the Act supplies an alternative.
3. C.permissible, because the Act allows a deposit of cash or securities to be accepted in lieu of a required bondCorrect. Cash or securities may be deposited in place of the bond.
4. D.permissible only if the adviser also relinquishes custody of client funds while the deposit is outstandingThe deposit substitutes for the bond; it does not require the adviser to give up custody.

Why: The Act's bonding provision permits a deposit of cash or securities to be accepted IN LIEU OF any bond the Administrator requires. The purpose of the requirement is to have assets available to satisfy claims of injured clients; a deposit of cash or securities serves that purpose as well as a surety bond does. So an adviser that cannot obtain a bond is not thereby shut out of the business, provided the Administrator accepts the deposit in the amount required.

State N has adopted a rule requiring a surety bond of every registered investment adviser that has custody of client funds. Fennell Loch Advisers has custody, does not want to buy a bond, and offers instead to deposit cash and marketable securities with the Administrator in the required amount. Under the Uniform Securities Act, the Administrator:

1. A.may accept the deposit only if the adviser also carries fidelity insuranceThe Act attaches no insurance condition to the deposit alternative.
2. B.must accept an appropriate deposit of cash or securities in lieu of the bondCorrect. The Act states that a deposit of cash or securities shall be accepted in place of any bond the Administrator requires.
3. C.may not require a bond at all from an adviser that has custody, because bonding is reserved for broker-dealersCustody and discretionary authority are exactly the circumstances in which the Act contemplates a bond for advisers.
4. D.must reject the deposit, because a surety bond is the only permitted form of securityThis contradicts the express deposit alternative in the Act.

Why: The Act lets the Administrator require surety bonds of registrants who have custody of or discretionary authority over client funds or securities, and lets the Administrator set the conditions of the bond. It also provides that an appropriate deposit of cash or securities must be accepted in lieu of any required bond. The registrant therefore has a genuine choice of how to satisfy the requirement.

State Q's Administrator requires investment advisers with custody to post a surety bond. Thistlewood Advisory, subject to that rule, asks what latitude it has. Under the Uniform Securities Act, which statement is correct?

1. A.The Administrator may require the bond in addition to the net-worth requirement, and may refuse a cash deposit.Both halves are wrong: the Act bars stacking the bond on an adviser already meeting net worth and requires acceptance of a cash deposit.
2. B.A surety bond may never be required of an investment adviser under the Act.The Administrator may require bonding of advisers with custody or discretionary authority.
3. C.The Administrator must accept a deposit of cash or securities in lieu of the bond, and may not require a bond of an adviser whose net worth exceeds the prescribed amount.Correct. The Act both compels acceptance of a cash or securities deposit and forbids requiring a bond from an adviser already above the net-worth threshold.
4. D.The bond must be written to cover only the Administrator, not private claimants.The bond must provide that a person with a cause of action under the Act may sue on it.

Why: The Uniform Securities Act requires the Administrator to accept a deposit of cash or securities in lieu of a required surety bond, and it prohibits requiring a bond of an adviser whose net worth already exceeds the amount the Administrator has set. Bonds must also permit suit by any person with a cause of action under the Act for the applicable statute-of-limitations period.