Private Fund Custody for Newly SEC-Registered RIAs: Audit or Surprise Exam?

If your firm is a registered investment adviser (RIA) with the U.S. Securities and Exchange Commission (SEC) and acts as managing member of its own private funds, you have custody of those funds’ assets under Rule 206(4)-2 of the Investment Advisers Act (the Rule). The Rule gives you two ways to comply. One is an annual audit of each fund. The other is a qualified custodian that sends statements to every investor, plus a yearly surprise exam by an outside accountant.

When does an RIA have custody of a private fund?

The Rule says an adviser has custody if it holds client funds or securities, directly or indirectly, or has the authority to get possession of them. Paragraph (d)(2) names general partners and limited liability company (LLC) managing members specifically as having custody of fund assets, as does any similar role that gives the adviser legal ownership of or access to fund assets.

A sponsor that sets up an LLC for each deal and serves as managing member of all of them is deemed to have custody of every one of those LLCs. What the fund owns doesn’t matter. We have seen this with deals in senior housing, office buildings, private credit, and interests in private real estate investment trusts (REITs).

Many firms first run into the Rule’s burdens when they register with the SEC as an investment adviser. If you used to operate under another adviser’s registration, compliance was that firm’s responsibility. Once you register on your own, the Rule applies to your firm directly.

What are the two ways a private fund can comply?

The Rule requires annual verification of fund assets, and it lets the adviser choose how. Whichever path you choose, paragraph (a)(1) requires a qualified custodian to hold the fund’s cash and securities. Banks and broker-dealers are among the institutions treated as qualified custodians under paragraph (d)(6), so an operating account at a bank in the fund’s name covers the cash. The two paths differ in the reporting and verification that come on top of that.

The audit path

Paragraph (b)(4) covers funds audited at least once a year by an independent accountant that is registered with and inspected by the Public Company Accounting Oversight Board (PCAOB). The fund also has to send financial statements prepared under Generally Accepted Accounting Principles (GAAP) to all investors within 120 days of fiscal year end. A fund that does this is exempt from the client notice and custodian statement requirements and is treated as having met the surprise exam requirement. The SEC’s October 2026 proposed amendments would remove the PCAOB requirement, but they are not final yet.

Audited funds can also use the privately offered securities exception in paragraph (b)(2). It lets the adviser keep an interest like the fund’s LLC stake in a property company outside a custodian if three conditions are met. The fund acquired the interest directly from the issuer in a private transaction. There is no certificate, and ownership is recorded only on the issuer’s books. And the interest can’t be transferred without the issuer’s consent. An unaudited fund can’t use this exception.

The custodian path

Here the qualified custodian holds all of it, the private interests and the cash. You need a reasonable basis, after due inquiry, to believe the custodian sends statements at least quarterly to each investor. Once a year an independent accountant shows up unannounced and verifies the assets under paragraph (a)(4).

Which one costs less?

The cost mostly depends on how many funds you run. Every fund on the audit path needs its own PCAOB-firm audit every year, so an adviser with 10 single-asset funds of $4 million to $8 million each pays for 10 audits. No fund on the custodian path needs its own audit. The surprise exam is done under a single written agreement between the adviser and its accountant and covers all client funds and securities of which the adviser has custody. The accountant still verifies each fund’s assets, so the fee grows with the number of funds, but you are paying for one exam. Sponsors with several small deal-by-deal vehicles usually choose a custodian for that reason.

How soon does the first surprise exam have to happen?

Within six months of the adviser becoming subject to the requirement. After that, the accountant picks a date each calendar year without telling you in advance and files Form ADV-E with the SEC within 120 days of that date.

Before the first exam, the custodial account has to be open, the positions have to be on the custodian’s books, and the investor records have to be current. At American Estate & Trust (AET), a fund account can open in a single day once we have the entity’s know-your-customer (KYC) documents and governing agreements. Custodians built around individual retirement accounts often take weeks. Either way, if you start in month five, you won’t have much time to fix anything the accountant finds.

What does a qualified custodian hold for a real estate fund?

It holds the fund’s interest in the deal, which is usually a membership interest in the entity that owns the property. The custodian doesn’t take title to the real estate.

Here’s a structure we see often. Each fund is an LLC that puts investor capital into a property company run by an outside developer. The property company owns the land, carries the debt, and handles operations. The fund owns a class of membership interests in the property company under a signed operating agreement. The custodian holds the documents that show the fund’s ownership, records the position on its books in the fund’s name, and reports it on statements.

A state-chartered trust company can serve as a qualified custodian. The Advisers Act definition of “bank” in Section 202(a)(2) includes trust companies that exercise fiduciary powers and are supervised and examined by state banking regulators. AET is chartered in Nevada and acts as qualified custodian for private funds on that basis.

Any custodian will want to read the operating agreement before it agrees to hold the position. Transfer restrictions, consent rights, and how the interest is documented all affect how the custodian records it. If you’re comparing custodians, here’s how AET works with RIA deal sponsors.

Does the fund’s cash have to move to the custodian too?

On the custodian path, funds typically move their cash to the custodian. The Rule covers client “funds and securities,” and the fund’s cash counts as client funds.

Many sponsors keep each fund’s operating cash at a local bank. Banks are qualified custodians, so holding the cash there is fine. Statements are where it breaks down. Paragraph (a)(5) requires statements to go to every investor in the fund, and a commercial bank sends the fund’s statement to the fund. Your bank isn’t going to mail a copy to each of your 60 limited partners (LPs).

When the cash sits in the fund’s custodial account, capital contributions come in there and distributions go out from there, so every one of those transactions shows up on the statement the custodian sends to investors.

For a typical real estate fund, that account sees a burst of activity during the raise, regular distributions once the property produces income, and a final distribution at sale.

Who has to receive the account statements?

The custodian sends them directly to each limited partner or member of the fund under paragraph (a)(5). A statement that goes only to the fund or the general partner (GP) doesn’t count, and neither does the GP forwarding the custodian’s statement to investors. The SEC staff’s custody rule frequently asked questions describes these as statements the custodian sends “directly to investors” in the pool.

The one alternative is an independent representative. That’s a third party that acts for the investors, has a legal or contractual duty to act in their best interest, isn’t controlled by or under common control with the adviser, and hasn’t had a material business relationship with the adviser in the past two years. The full definition is in paragraph (d)(4). The fund itself and the GP don’t qualify.

A sponsor that has always had one quarterly report go to the GP will need to change that on the custodian path. On the audit path the single report is fine, because audited funds are exempt from statement delivery.

The SEC staff says the statement should show the funds and securities held by the fund and the transactions the fund entered into. Some custodians also send each investor a statement showing their ownership percentage and the cash paid to them. Investors find those useful, and they go out in addition to the fund-level statement.

To keep statements accurate, the sponsor has to tell the custodian when investors come in or leave, or when allocations change. If the register falls behind, statements go to the wrong people, and the surprise exam is usually where that comes to light.

What if our current custodian isn’t keeping up?

You can move. The new custodian will need a current schedule of every position, the underlying documents, and confirmation of which positions have already been released.

Sponsors who come to us from another custodian often describe the same history. The old custodian went through a bank merger or turned over its account staff. The position list stopped getting updated. Documents the sponsor asked to have returned after a property sale never came back, and the gaps surfaced at audit time. Before the transfer begins, reconcile the old custodian’s list against your own records so the new custodian starts from an accurate schedule.

Does the custodian handle KYC on fund investors?

That’s your call. Some advisers keep investor onboarding in-house and give the custodian only what it needs to send statements. Others have the custodian run anti-money laundering (AML) and KYC checks on every investor and set up investor-level records.

AET’s business portal supports both. Sponsors run capital calls and distributions and upload fund documents there, and we can add investor onboarding with AML and KYC for funds that want it. We don’t provide fund accounting or fund administration, so if you need net asset value (NAV) calculations or partnership accounting you’ll still want a fund administrator.

Is the custody rule changing?

It might. On October 1, 2026, the SEC proposed amendments that would renumber Rule 206(4)-2 as Rule 223-1 and update parts of it. Comments are due December 7, 2026. Until the SEC adopts a final rule, Rule 206(4)-2 as described above still applies.

For private funds, the change that matters most is on the audit path. The proposal would drop the requirement that the fund’s auditor be registered with and inspected by the PCAOB, which could widen the pool of firms that can do the audit. It would also write into the rule that audited financials must follow U.S. GAAP. A fund formed in the last 90 days of its fiscal year could send unaudited statements for that short first year and fold it into the next year’s audit, which matters for sponsors that form a new LLC for each deal.

The custodian path stays the same. Statements would still go to every investor, and the annual surprise exam would still apply. We cover the rest in what the 2026 custody rule proposal means for private fund advisers.

This proposal follows an earlier one. The SEC proposed a broader safeguarding rule in February 2023 and withdrew it on June 12, 2025.

Frequently asked questions

Do private funds need a qualified custodian? Yes, at least for cash, and the bank holding the fund’s operating account usually meets that. A fund audited each year by a PCAOB-registered accountant that sends audited financials to investors within 120 days can keep qualifying private interests outside a custodian and skips the statement and surprise exam requirements. An unaudited fund has to keep all of its cash and securities with a qualified custodian and get a surprise exam every year.

Is a surprise exam cheaper than a fund audit? For advisers with many small funds, it often is, because one exam covers every fund in the adviser’s custody. A single large fund that already needs audited financials for investors or lenders may find the audit path cheaper. Ask your accountant to quote both. If the SEC adopts its October 2026 proposal, audits would no longer need a PCAOB-registered firm, which could change the math.

Is Rule 206(4)-2 being replaced? The SEC proposed in October 2026 to renumber it as Rule 223-1 and amend parts of it. Until a final rule is adopted, Rule 206(4)-2 applies as written.

Does a qualified custodian have to take title to the fund’s real estate? No. When the fund owns an interest in a property company, the custodian holds and records that interest, and the deed stays with the property company.

Can a trust company be a qualified custodian? Yes. The Advisers Act definition of “bank” includes state-chartered trust companies that exercise fiduciary powers and are supervised and examined by state regulators. AET is chartered and examined by the Nevada Financial Institutions Division.

When does a newly registered RIA need its first surprise exam? Within six months of becoming subject to the requirement. The accountant files Form ADV-E within 120 days of each exam.

Talk to us about your funds

If you registered recently and the six-month clock is running, send us the operating agreement for one of your funds and a list of your current and planned vehicles. We’ll show you how we would hold the positions and what investor statements would look like. Book a call with our team, or read our earlier piece on the SEC custody rule for RIA deal sponsors.

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This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax, or investment advice. Advisers should confirm how Rule 206(4)-2 applies to their funds with compliance counsel and their independent accountant.