What must occur if an investment adviser has custody of client funds?

When an investment adviser has custody of client funds, it is essential to adhere to strict regulatory requirements to ensure the protection of those funds. The requirement to file an audited balance sheet reflects the need for transparency and accountability in managing client assets. This involves having an independent auditor review the balance sheet and financial statements, which adds a layer of oversight and assurance that the adviser's handling of client funds is compliant with regulations and that funds are safeguarded.

By requiring an audited balance sheet, regulators can ensure that the investment adviser is accurately representing their financial condition and that they are managing client assets responsibly. This requirement aims to protect investors from potential fraud or mismanagement, making it a critical regulation for investment advisers with custody of client funds.