On October 1, the SEC proposed its long-promised rewrite of the custody rules under the Advisers Act and the Investment Company Act (Release No. IA-7023; File No. S7-2026-35). Nearly every headline has focused on the crypto piece: a framework that would, for the first time, let advisers self-custody crypto assets when no qualified custodian is available. Most private equity managers can skim that part. The section worth reading closely is the one most coverage treats as an afterthought, a package of “modernizations” to Rule 206(4)-2 that goes straight at the audit provision and a handful of other private fund pain points.
The proposal mostly writes existing staff relief into the rule itself, with a few new accommodations and a couple of details that could catch managers who assume the new rule works the way old FAQs did.
Not the 2023 Proposal Coming Back
The 2023 Safeguarding proposal would have expanded the rule to cover all client assets and layered on new custodial protections; the Commission withdrew it in June 2025. The new proposal keeps the rule’s scope at client funds and securities for advisory clients other than registered funds and BDCs. The most visible structural change is largely cosmetic: the rule would be redesignated Rule 223-1, reflecting the explicit safeguarding authority Congress added in Section 223 of the Advisers Act through Dodd-Frank.
For a PE manager, the core architecture, GP custody satisfied through the audit provision, stays exactly where it is.
The Audit Provision: Where the Real Relief Is
No more PCAOB inspection requirement. The proposal would drop the requirement that the accountant performing private fund audits (and surprise exams) be registered with, and subject to regular inspection by, the PCAOB. An independent public accountant is still required. The SEC’s rationale is candid: PCAOB inspections focus on public company audits and don’t actually reach custody rule engagements. In theory, this widens the auditor pool and lowers cost, particularly for SPVs, co-invest vehicles, and smaller funds. In practice, don’t expect your LPs to be indifferent. Institutional investors care about the name on the opinion, and a rule change won’t alter that.
Stub-period audits. For a vehicle formed within the last 90 days of its fiscal year, the adviser could skip the stub-period audit, provided financial statements (which may be unaudited) go to investors within 90 days of that year-end. The following year’s audit would then cover both periods. This is genuinely useful, but read the trigger carefully: it keys off formation, not first close or commencement of investment activity. And the 90-day delivery deadline for those first-year statements is tighter than the standard 120.
Codified extensions and GAAP. The 180-day deadline for funds of funds and 260 days for funds of funds of funds, currently staff relief, would be written into the rule. The release also confirms, now at the Commission level, that short delays caused by reasonably unforeseeable circumstances generally won’t be violations if the adviser reasonably believed delivery would be timely and delivers promptly once the issue clears. The US GAAP requirement would be codified, with non-US vehicles and those with a non-US-based GP permitted to use another standard (e.g., IFRS) if US investors receive a reconciliation of material differences.
Escrows, Trading Authority, and Form ADV
Three other items deserve attention from PE shops specifically.
First, the release includes Commission guidance on seller escrow accounts following a portfolio company sale: indemnity holdbacks and similar reserves. The guidance would allow limited commingling of client and non-client assets, subject to safeguards that include a time limit and inclusion of the escrow in the fund’s audit. Anyone who has tried to fit a multi-seller escrow into the custody rule knows this has been a gray area for years.
Second, a new conditional exception for discretionary trading authority would cover non-DVP transactions, including loans and private fund interests. Don’t over-read it. A private fund GP has plenty of other powers that confer custody, so this won’t take a GP out of the rule. It matters more for separately managed accounts and certain co-invest arrangements.
Third, the Form ADV amendments would require some advisers to answer “yes” to the custody question even though nothing about their arrangements has changed (including advisers whose custody arises solely from fee deduction or through an operationally independent related person) and would add questions identifying which exceptions an adviser relies on. Most PE advisers already answer “yes,” but the new exception-level detail will be visible to LPs and examiners. Make sure it lines up with what your DDQ says.
What to Do Now
Nothing changes yet. The proposal has no legal effect, and FY2026 audits remain due under the current rule, which means a PCAOB-inspected auditor and the usual 120-day deadline for calendar-year funds. Comments are due 60 days after Federal Register publication, so the window will likely run into December.
That window is the opportunity. If the formation-based stub-period trigger or the escrow conditions would create friction for how your funds are actually structured, now is the time to say so. In the meantime, inventory what the proposal would touch: funds formed late in the fiscal year, offshore vehicles currently preparing US GAAP statements, open escrows from recent exits, and your current Form ADV custody responses.
How Trillium Can Help
Trillium can map each of your vehicles against the proposed audit-provision changes, flagging where the proposal helps, where it creates new timing risk, and where you’re already relying on staff relief that is about to become rule. We can also review your Form ADV custody responses alongside your DDQ so the new exception-level reporting doesn’t surprise your investors, and help you sharpen comment-letter points if any provision cuts against how your funds operate.