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Adviser Failed to Stop Principals from Looting Client Accounts

The SEC censured an investment adviser and ordered it to pay $1.7 Million in fines, disgorgement, and interest for failing to implement a compliance program that would detect and prevent the looting of client accounts.  Two firm principals ultimate went to prison for using their positions as fiduciaries over trust accounts to steal funds.  The SEC faults the firm for (i) failing to adopt legitimate policies and procedures, (ii) neglecting to obtain the required surprise examinations, and (iii) preparing misleading Form ADVs.  In addition to charging violations of the Advisers Act fiduciary, custody and compliance rules, the SEC also cites violations of Section 10(b) and Rule 10b-5, which prohibit fraudulent conduct in the offer or sale of securities, presumably for misleading statements made in Form ADV.

OUR TAKE: Just because the principal wrongdoers went to jail doesn’t mean the firm is off the hook.  The SEC holds the adviser accountable for allowing the conduct to continue.  It is also significant that the SEC uses 10b-5 as a charge, which opens the door to more significant civil and criminal penalties.

https://www.sec.gov/litigation/admin/2017/34-82399.pdf

Adviser Looted Trust Accounts and Over-Charged Clients

 The SEC barred an investment adviser from the industry and ordered him to pay over $1.7 Million in disgorgement in part for looting trust accounts for which he served as a trustee.  According to the SEC, the adviser sold trust assets and purported to replace those assets with lesser-valued securities in which he had a personal interest.  The SEC also accuses the adviser of over-charging management fees and making misrepresentations about conflicts of interest.

OUR TAKE: This type of misconduct is exactly why the SEC should move forward and require all advisers to obtain third party compliance reviews in an effort to weed out wrongdoers.  The custody rule (206(4)-2) deems an adviser to have custody where the adviser serves as the trustee of a trust, and requires an annual surprise examination to verify assets and prevent looting of the trust.  Unfortunately, an adviser that is willing to steal from clients probably doesn’t prioritize compliance.

https://www.sec.gov/litigation/litreleases/2017/lr23851.htm

Standing Letters of Authorization Cause Advisers to Have Custody

The staff of the SEC’s Division of Investment Management, in a recent No-Action Letter, has opined that an adviser has regulatory custody of client assets where a client grants even limited authority to transfer assets to a designated third party.  As a result, an adviser who has received standing letters of authorization (SLOAs) from one or more clients must report those assets in its response to Item 9 of Form ADV.  The staff will allow such an adviser to dispense with the custody rule’s surprise examination requirement so long as it meets several conditions including ensuring that the third party custodian appropriately verifies the SLOA, provides transfer of funds notices to the client, and sends the client annual reconfirming notices.  In companion releases, the staff also provided guidance about transferring assets between custodians and inadvertent custody arising from custodial contracts.

OUR TAKE: The IM staff continues to take a hard line with respect to its broad view of the custody rule regardless of the underlying policy arguments.  The relief from the surprise audit may be cold comfort, as we expect few custodians will be willing to spend the resources and subject themselves to additional liability to accommodate SLOAs (without additional fees).

https://www.sec.gov/divisions/investment/noaction/2017/investment-adviser-association-022117-206-4.htm