Those looking to start a fund—or raise money in a fund—should be aware of the complex IRS rules and regulations, as well as the Security and Exchange Commission’s (SEC’s) Custody Rule. The registered investment advisor (RIA) of the fund should comply with the rule and working with a custodian can help. As Opportunity Zones (OZs) grow in awareness and popularity, it’s critical to make sure that your fund—and any fund that you may invest in—is set up for success. The Custody Rule is not new, but here is how it is relevant to the new OZ program and its participants.


Most of the readers of this publication are aware of what an Opportunity Zone Fund is: an investment vehicle that elects to be treated as a corporation or partnership for federal tax purposes, and invests in OZ properties or businesses. Because investors cannot invest directly in an OZ, a fund is the only way they can invest in these types of assets. Additionally, an Opportunity Zone Fund must invest at least 90% of its holdings in OZ properties or businesses. The guidelines and details for what qualifies as an OZ are widely published, and full details are available via the IRS and Treasury Department. To date, hundreds of funds whose primary investments are in OZs have been created.

An Opportunity Zone Fund is a pooled or single asset investment vehicle that can offer investors diversification with different risk and return profiles within the fund, and offer potential for tax-deferred growth and earnings. This emerging market is not a traditional equity or fixed-income play, but rather an alternative investment. Any real estate developer or fund manager creating a fund should be aware of the importance of the SEC’s Custody Rule, also known as SEC Rule 206(4)-2 under the Investment Advisers Act of 1940.


The Custody Rule under the Investment Advisers Act of 1940 requires RIAs that have custody of client funds or securities to maintain those assets with a qualified custodian. The custody rule’s key requirements include:

• Use of a “qualified custodian” to hold client assets

• Notices to clients detailing how their assets are being held

• Account statements for clients detailing their holding

• Annual surprise exams

• Additional requirements when a related qualified custodian is used

• The audit approach for advisers of pooled investment vehicles

The Custody Rule is one of the most important rules established to protect clients from the misuse of their funds and securities.


The intent of the Custody Rule is to enhance protections for investor assets. You may recall the infamous Bernie Madoff, who was arrested in 2008 for defrauding investors of approximately $17.5 billion. That was one of the most high-profile cases of a “Ponzi Scheme” in our time, but it certainly wasn’t the only one. In fact, almost 300 schemes involving more than $8 billion were uncovered between 2012 and 2015.[1][2] But the much-publicized Madoff scandal caused a crisis in confidence for investors, which persists today.

In 2010 the SEC amended the Custody Rule to strengthen controls for the custody of client assets, and encourage the use of independent custodians in order to increase investor confidence in RIAs and investment vehicles. The SEC stated in 2010 that “increased investor confidence could lead to more efficient allocation of investor assets, which could result in an increase in the assets under management of investment advisers, and depending on how those assets are invested, a potential increase in the availability of capital.”[2]


Under the Custody Rule, an RIA must maintain client funds and securities with a qualified custodian. The advisor must have a reasonable belief, after due inquiry, that the qualified custodian sends account statements directly to clients. In the adopting release to the 2010 amendments, the SEC expressed its belief that this requirement would increase advisory clients’ confidence. Because clients would receive two statements, one from the advisor and one from the independent custodian, advisors would be deterred from engaging in fraudulent activities, and clients would be able to detect any unauthorized activity in their accounts.[3]

Advisors that meet certain requirements are exempt from the investor statement delivery requirement if they have a pooled investment vehicle, which is subject to an annual U.S. GAAP financial statement audit. Advisors must distribute the audited financial statements to the fund’s investors. While this exception may be an efficient option for advisors who qualify, annual audited financial statements do not have the immediacy or transparency of monthly or quarterly statements sent to investors by the custodian. The fund-level statements sent to investors by the custodian provide investors a window into the transactions engaged in by the fund manager.

Enlisting the help of a custodian is generally a less expensive, less intrusive, and less time consuming than other options, and a custodian can help alleviate an administrative burden. Real estate developers and fund managers should consult with their legal and tax advisors to fully understand the Custody Rule, and determine what solution is right for their fund.


Even if you are not an RIA required to comply with the Custody Rule, engaging an independent custodian for your fund’s assets can help increase investor confidence by offering more transparency and accountability. Increasing investor confidence and can help your fund grow. In fact, the SEC amended the Custody Rule in part to encourage the use of independent custodians. And, qualified custodians provide an invaluable service at a relatively nominal cost.

Fund managers and RIAs that implement best practices in the earliest stages of the fund – and choose reputable service providers that are experienced in the world of real estate and private funds – can build trust with the fund’s investors. A custodian with relevant expertise and a respected reputation may provide a valuable layer of transparency and operational efficiency to the fund, creating an environment conducive to attracting investors, and ultimately helping the fund grow.


[1] Ten Years After Madoff, Updated Ponzi Database Shows Schemes Are Thriving.?Ponzitracker. com. April 2019.

[2] Securities and Exchange Commission, Adopting Release No. IA-2968 at p.75, December 30, 2009.

[3] Id, at p. 80.