As sure as day follows night, summerfollows spring and kids follow an ice-cream truck, new securities regulations follow financial scandals.

It would seem inevitable that in the wake of recent epic advisor frauds the securities watchdogs would seek ways to make those schemes more difficult to perpetrate in the future. The by-product of that regulatory response: Compliance is more complicated and expensive for those advisors who are actually interested in doing business within the confines of the law. (Those would-be perpetrators of fraud, well, they can just ignore the new regulations too.)

At the end of last year, the U.S. Securities and Exchange Commission (SEC) adopted amendments to the custody standard, Rule 206(4)-2 under the Investment Advisers Act of 1940. The previous custody obligations for most advisors required little more than placing the assets with an independent custodian, disclosing to clients where their money was being held and ensuring that the custodian was sending account statements to clients. Some advisors were also required to have independent verification of certain client assets. The new rule, which took effect on March 12, is a game changer for affected advisors.

To put the new rule in perspective, there are two critical elements to understand. First, the SEC has not changed its already broad definition of whom is deemed to be in custody; and second, the SEC has added new client disclosure and auditing requirements for those deemed to have custody, depending upon the reasons that the advisor is regarded to be in custody in the first place.

KEY CHANGES

Here are the key changes that advisors need to be aware of:

* Related persons. The SEC now says an advisor has custody not only if he or she has possession or the authority to take possession of client funds, but also if a "related person" has possession or authority to take possession. By "related person," the SEC means anyone controlling or controlled by the advisor or under common control with the advisor. That includes, among others, an advisor's own employees and representatives. You'll have to review their activities to determine whether they qualify as custody.

* Reporting. Most advisors-those deemed to be in custody solely because they have the authority to debit their fees from the client's account-will opt to continue to keep those assets with a qualified custodian (or a financial institution that is permitted to behave like one), which includes banks, broker-dealers and, with respect to mutual fund shares, the mutual fund transfer agent. Those advisors will also have to furnish notification to clients as to the whereabouts of their assets (typically already done in the form of a new account application) and ensure that the custodian delivers account statements directly to the client at least quarterly (which banks and broker-dealers are already obligated to do). It's no longer sufficient for advisors to send their own account statements to clients in place of the custodians'.

Advisors who do send their own supplemental statements to clients will be required to add boilerplate language to those statements, urging clients to compare the advisor's statement with the custodian's. Such language may state that, "Clients are urged to compare the custodian's account statements with the advisor's supplemental statements." In other words, if you continue to send your clients statements the rule requires advisors to add language saying, "Here is a snapshot of your assets and their respective performance, but, hey, don't take our word for it."

* Surprise examinations. Some advisors who have custody of client assets for reasons beyond the simple fact that they debit fees from client accounts are going to have to undergo an annual surprise examination of those assets by an independent public accounting firm that is registered with Public Company Accounting Oversight Board (PCAOB). While the SEC has admitted that the verification of custody has absolutely nothing to do with PCAOB qualification, it likely wanted to ensure a higher standard than "the CPA around the corner" would afford. In so doing, the SEC has narrowed the number of those that can perform this examination to about 1,300 accounting firms across the U.S.

Advisors who had custody when the new rule went into effect on March 12 will have to undergo an exam before the end of this year. Advisors who gained custody after the effective date will have to have their surprise exam performed within six months after they became subject to the rule.

Advisors who choose to maintain physical custody of client assets themselves (self-custody) or with an affiliate are in for a world of hurt. In addition to the surprise examination, the advisor or affiliate (as the case may be) must have a PCAOB-registered accounting firm prepare a SAS-70 type internal control report (that is, an in-depth audit of their controls and processes) to assess the adequacy of its internal procedures for ensuring the safekeeping of client assets. Advisors who maintain custody at operationally independent affiliates may not need the surprise examination but will have to obtain the internal control report from the affiliate.