Current through Register Vol. 50, No. 9, March 1, 2024
RELATES TO:
KRS
292.331(4),
292.336(6),
7 U.S.C.
6f
NECESSITY, FUNCTION, AND CONFORMITY:
KRS
292.500(3) authorizes the
commissioner to promulgate administrative regulations necessary to carry out
the provisions of KRS Chapter 292.
KRS
292.331(4) authorizes the
commissioner to require a minimum liquid net capital for investment advisers.
KRS
292.336(6) authorizes the
commissioner to prescribe rules for the conduct of business by investment
advisers. This administrative regulation establishes the requirements for
minimum liquid capitalization and bonding for an investment adviser.
Section 1. Definitions.
(1) "Custody" means holding, directly or
indirectly, client funds or securities, or having any authority to appropriate
them or obtain possession, in accordance with the requirements established in
Section 2 of this administrative regulation.
(2) "Independent party" means a person that:
(a) Is engaged by the adviser to act as a
gatekeeper for the payment of fees, expenses and capital withdrawals from the
pooled investment;
(b) Does not
control, is not controlled by, and is not under common control with the
adviser; and
(c) Does not have, and
has not had within the past two (2) years, a material business relationship
with the adviser.
(3)
"Independent representative" means a person who:
(a)
1. For
an advisory client, acts as an agent; or
2. For a pooled investment vehicle:
a. Acts as an agent for the limited partners
of a limited partnership, for members of a limited liability company, or for
other beneficial owners of another type of pooled investment vehicle; and
b. By law or contract is obligated
to act in the best interests of the advisory client or the limited partners,
members, or other beneficial owners;
(b) Does not control, is not controlled by,
and is not under common control with the adviser; and
(c) Does not have, and has not had within the
past two (2) years, a material business relationship with the
adviser.
(4) "Net worth"
means an excess of assets over liabilities as determined by generally-accepted
accounting principles, but shall not include as assets:
(a) Deferred charges, goodwill, franchise
rights, organizational expenses, patents, copyrights, marketing rights,
unamortized debt discount and expense, or any other intangible asset;
(b) Home, home furnishings, automobiles, and
any other items not readily marketable, if the adviser is an
individual;
(c) Advances or loans
to stockholders and officers or related parties of stockholders or officers, if
the adviser is a corporation;
(d)
Advances or loans to partners or related parties of partners, if the adviser is
a partnership; and
(e) Advances or
loans to members or related parties of members, if the adviser is a limited
liability company.
(5)
"Qualified custodian" means any of the following institutions or entities not
controlling and not controlled by, nor under common control with, the adviser:
(a) A bank or savings association that has
deposits insured by the Federal Deposit Insurance Corporation;
(b) A registered broker-dealer holding the
client assets in customer accounts;
(c) A registered futures commission merchant
under Section 4f(a) of the Commodity Exchange Act,
7 U.S.C.
6f(a), holding the client
funds in customer accounts, but only with respect to the client funds and
futures contracts in those accounts or other securities incidental to
transactions in the purchase or sale of a commodity for future delivery or
options thereon; and
(d) A foreign
financial institution that customarily holds financial assets for its
customers, if the foreign financial institution keeps the advisory client's
assets in customer accounts segregated from the institution's proprietary
assets.
Section
2. Custody Standards.
(1) Custody
shall include:
(a) Possession of client funds
or securities unless the funds or securities are:
1. Received inadvertently; and
2. Returned to the sender within three (3)
business days of the receipt of the funds or securities;
(b) Receipt of a check drawn by a client and
made payable to an unrelated third party unless:
1. The check is forwarded to the third party
within twenty-four (24) hours of receipt; and
2. The adviser maintains appropriate records
to document the preceding;
(c) Any arrangement, including a general
power of attorney, under which the adviser is authorized or permitted to
withdraw client funds or securities maintained with a custodian that are not
excluded under subsection (2) of this section;
(d) Any capacity that gives the adviser
access or legal ownership to client funds or securities, including if the
adviser is a general partner of a limited partnership, managing member of a
limited liability company, or holds a comparable position for another type of
pooled investment vehicle, or is trustee of a trust; or
(e) Any advance fee arrangement in which an
adviser receives payment in excess of $500 for work not to be completed within
six (6) months of receipt of the payment from the client.
(2) Custody shall not include an arrangement
for direct deduction of fees from a client account held with a qualified
custodian if the adviser provides the following safeguards:
(a) The adviser has written authorization
from the client to deduct advisory fees from the account;
(b) Each time a fee is directly deducted from
a client account, the adviser concurrently:
1.
Sends the qualified custodian notice of the amount of the fee to be deducted;
and
2. Sends the client an invoice
itemizing the fee, including the formula used to calculate the fee, the amount
of assets under management that the fee is based on, and the time period
covered by the fee; and
(c) At least quarterly, the qualified
custodian sends to the client an account statement identifying the amount of
funds and each security in the account at the end of the period and setting
forth all transactions in the account during that period.
Section 3. Capital Requirements.
An investment adviser registered or required to register pursuant to the
Securities Act of Kentucky, KRS Chapter 292, shall meet the net worth
requirements established in this section:
(1)
An adviser who has custody of client funds or securities, except an adviser
having custody due entirely to advising pooled investment vehicles and
complying with Section 4(5) or 5(3) of this administrative regulation, shall
maintain a minimum net worth as follows:
(a)
For advisers with assets under management of $25,000,000 or less, the minimum
net worth required shall be $35,000.
(b) For advisers with assets under management
in excess of $25,000,000, the minimum net worth required shall be
fifteen-hundredths of one percent (.0015) of assets under management.
(c) An adviser may substitute all but $10,000
of the net worth required under paragraphs (a) and (b) of this subsection with
a surety bond for the substituted amount issued by a bonding company that is
qualified to do business in Kentucky.
(2) An adviser who requires prepayment of
advisory fees six (6) months or more in advance and in excess of $500 per
client shall also maintain capital as required in subsection (1) of this
section.
(3) An adviser who has
discretionary authority over client funds or securities, but does not have
custody of client funds or securities shall maintain a net worth as follows:
(a) For advisers with assets under management
of $25,000,000 or less, the minimum net worth required shall be
$10,000.
(b) For advisers with
assets under management in excess of $25,000,000, the minimum net worth
required shall be one-tenth of one percent (.001) of assets under
management.
(c) An adviser may
substitute, for any part of the net worth required under paragraphs (a) and (b)
of this subsection, a surety bond for the substituted amount issued by a
bonding company that is qualified to do business in Kentucky.
(4) An adviser shall maintain a
positive net worth at all times.
(5) The commissioner may require that a
current appraisal be submitted to establish the value of any material
asset.
(6) An adviser shall compute
its net worth at least once every month at the end of the month and shall
maintain a record of each computation along with supporting documentation for a
period of two (2) years. Each computation shall be accompanied by documentation
of the assets under management for the adviser at that point in time.
(7) If the computation of net worth results
in an amount that is less than required by subsections (1) through (4) of this
section, the adviser shall by the close of business on the next business day
following the determination of a deficiency, notify the commissioner by
facsimile or electronic mail. After transmittal of this notice, the adviser
shall promptly file with the commissioner a report of its financial condition,
including a balance sheet, a year-to-date income statement and copies of
supporting documentation.
(8) An
adviser shall not be deemed to be exercising discretion if the adviser places
trade orders with a broker-dealer pursuant to a third party trading agreement
if:
(a) The investment advisory contract
specifically states that the client does not grant discretionary authority to
the adviser and the adviser in fact does not exercise discretion with respect
to the account; and
(b) A third
party trading agreement is executed between the client and a broker-dealer
which specifically limits the adviser's authority in the client's broker-dealer
account to the placement of trade orders and deduction of adviser
fees.
(9) An adviser
that has its principal place of business in a state other than Kentucky shall
maintain the minimum capital as required by the state in which the adviser
maintains its principal place of business, if the adviser is licensed in that
state and is in compliance with that state's minimum capital
requirement.
Section 4.
Custody of Client Funds or Securities. An investment adviser registered or
required to register pursuant to the Securities Act of Kentucky, KRS Chapter
292, shall comply with the requirements established in this section, if the
adviser has custody of client funds or securities.
(1) The funds and securities shall be
maintained by a qualified custodian:
(a) In a
separate account for each client under that client's name; or
(b) In accounts that contain only the
client's funds and securities, under the adviser's name as agent or trustee for
the client.
(2) The
adviser shall notify the client in writing of the qualified custodian's name,
address, and the manner in which the funds or securities are maintained
promptly when the account is opened and following any changes to this
information.
(3)
(a) Account statements shall be sent to the
client, either:
1. By the qualified custodian
and the adviser shall have a reasonable basis for believing that the custodian
sent an account statement, at least quarterly, to each of the adviser's clients
for which it maintains funds or securities, identifying the amount of funds and
each security in the account at the end of the period and setting forth all
transactions in the account during that period; or
2. By the adviser, if the following
conditions are met:
a. The adviser shall send
an account statement, at least quarterly, to each client for whom the adviser
has custody of funds or securities, identifying the amount of funds and each
security of which it has custody at the end of the period and setting forth all
transactions during the period;
b.
An independent certified public accountant shall verify all client funds and
securities by actual examination on an annual basis. The adviser shall file a
copy of the accountant report and financial statements with the commissioner
within thirty (30) days of the completion of the examination, along with a
letter from the accountant stating that it has examined the funds and
securities and describing the nature and extent of the examination; and c. The
adviser, upon notice from the certified public accountant of finding any
material discrepancies during the course of the examination, shall notify the
commissioner within one (1) business day of the finding, by means of a
facsimile transmission or electronic mail, followed by certified first class
mail.
(b) If
the adviser is a general partner of a limited partnership, managing member of a
limited liability company, or holds a comparable position for another type of
pooled investment vehicle, the account statement required by paragraph (a) of
this subsection shall be sent to each limited partner, member, other beneficial
owner, or their independent representative.
(4) A client may designate an independent
representative to receive on his behalf notices and account statements as
required under subsections (2) and (3) of this section.
(5) An adviser who has custody and who does
not meet the exception established in Section 5(3) of this administrative
regulation shall, in addition to the safeguards established in subsections (1)
through (4) of this section, comply with the following:
(a) Hire an independent party to review all
fees, expenses, and capital withdrawals from the pooled accounts; and
(b) Send all invoices or receipts to the
independent third party detailing the amount of the fees, expenses, or capital
withdrawals and the method of calculation so that the independent party can:
1. Determine that the payment is in
accordance with the pooled investment vehicle standards; and
2. Present to the qualified custodian
approval for payment of the invoice with a copy provided to the
adviser.
Section 5. Exceptions to Custody
Requirements. The custody requirements in Section 4 of this administrative
regulation shall not apply to the exceptions listed in this section:
(1) Shares of mutual funds. With respect to
shares of an open-end company as defined in Section 5(a)(1) of the Investment
Company Act of 1940, 15 U.S.C. 80a-5(a)(1),
the adviser may use the company's transfer agent in lieu of a qualified
custodian for purposes of complying with Section 4 of this administrative
regulation.
(2) Certain privately
offered securities.
(a) An adviser shall not
be required to comply with the custody requirements with respect to securities
that are:
1. Acquired from the issuer in a
transaction or chain of transactions not involving a public offering;
2. Uncertificated, and ownership thereof is
recorded on the books of the issuer or its transfer agent in the name of the
client; and
3. Transferable only
with prior consent of the issuer or holders of the outstanding securities of
the issuer.
(b) The
exception provided in paragraph (a) of this subsection shall not be available
with respect to securities held for the account of a limited partnership,
limited liability company, or other pooled investment vehicle, unless the
entity is audited on an annual basis. The adviser shall distribute the audited
financial statements as required by subsection (3) of this section.
(3) Limited partnerships subject
to annual audit. An adviser shall not be required to comply with Section 4(5)
of this administrative regulation with respect to the account of a limited
partnership, limited liability company, or other type of pooled investment
vehicle that is subject to an annual audit and distributes its audited
financial statements prepared in accordance with generally accepted accounting
principles to all limited partners, members, or other beneficial owners, within
120 days of the end of its fiscal year.
(4) Registered investment companies. The
adviser shall not be required to comply with Section 4 of this administrative
regulation with respect to the account of an investment company registered
under the Investment Company Act of 1940, 15 U.S.C. 80a-1
to 80a-64.
(5) Beneficial trusts. An adviser having
custody due entirely to serving as trustee for a trust, the beneficial owner of
the trust being a parent, grandparent, spouse, sibling, child, or grandchild of
that person, including blood or step relationships in these categories, shall
not be deemed as having custody of the trust funds for purposes of being
required to comply with the safekeeping requirements of Section 4 of this
administrative regulation or the net worth requirements of Section 3(1) of this
administrative regulation. This exclusion shall not apply to any other trust
not expressly excepted for which this person is serving as trustee. Any trust
not expressly exempted and its trustees shall be in compliance with this
administrative regulation. This exclusion shall inure to the benefit of the
employer of the registered person while an employment relationship
exists.
STATUTORY AUTHORITY:
KRS
292.331(4),
292.336(6),
292.500(3)