It is a HUGE warning sign when a fund manager fails to deliver audited financial statements, regardless of the ostensible reasons for delay. What may be most shocking is that this firm engaged in unlawful conduct for at least 11 years until the SEC uncovered wrongdoing during a routine OCIE exam in 2018.
The SEC will offer no quarter to RIAs who ignore their basic compliance responsibilities. At a bare minimum, firms must appoint a dedicated and qualified CCO, adopt tailored policies and procedures, annually test the program, and generally attempt to comply with the Advisers Act. The initiation of proceedings, rather than a settled order, suggests that the SEC intends to pursue aggressive penalties.
Only retain service providers that have specialized knowledge and experience in asset management. You wouldn’t hire a family physician to perform surgery, so why would you hire a general practice accounting firm to conduct specialized regulatory audits? The same rationale applies to your lawyers, administrators, and compliance consultants.
OUR TAKE: Performing audits of registered advisers, broker-dealer, or public companies involves a thorough understanding of the applicable securities laws and accounting standards. Accounting firms should not undertake engagements without retaining a compli-pro that can help navigate the regulatory waters. Advisers and broker-dealers should not retain a firm that lacks a track record of practicing in this area.
The SEC censured and fined a private fund manager for failing to timely deliver audited financial statements to limited partners. Since the firm registered in 2012, it did not meet the 120-day deadline required by the custody rule (206(4)-2) with respect to 178 audits of 440 funds, a 40% failure rate. In some cases, no financial statements were ever delivered. The SEC faults the firm for failing to implement required policies and procedures to ensure delivery of the financial statements in accordance with the custody rule even though the firm, for most of the funds, had engaged a PCAOB audit firm to conduct the audits. The SEC also cites violations of the compliance rule (206(4)-7) for failing to conduct annual reviews of the adequacy and effectiveness of the compliance program.
OUR TAKE: Hire a compliance officer – either in-house or through a compliance services firm. These types of regulatory missteps can be easily avoided if you retain a professional that knows the rules and has the responsibility and authority to implement them. If you don’t, you subject your firm to a debilitating and humiliating public enforcement action.
OUR TAKE: We have found the staff to be fairly reasonable if a firm misses the deadline by a few days because of an unusual event such as a hard-to-value security or a change in auditors. When you consistently ignore a regulatory requirement and fail to make changes, the Enforcement Division will treat you as a regulatory recidivist and proceed accordingly.
OUR TAKE: The SEC is leveraging the Bank Secrecy Act, adopted to combat money laundering, to require broker/custodians to police advisers on their platforms for violations of the Advisers Act. It’s a novel legal theory to further the regulator’s enforcement goal of requiring large securities markets participants to serve in a gatekeeping role for the industry.
The SEC censured and fined an investment adviser and its principal for violating the custody rule because a dual employee also had trust powers. The adviser and a trust company engaged in a joint offering whereby each recommended the other’s services and shared office space. The trust company paid the adviser monthly “rent” based on the trust company’s revenue from the adviser’s clients. The adviser also appointed a dual employee that could receive and deposit checks as well as write checks on trust accounts to beneficiaries. The SEC asserts that the adviser violated the custody rule (206(4)-2) because the adviser, through the dual employee, had constructive custody of client assets, but the adviser failed to satisfy the rule’s requirements including notifying clients, segregating client assets, and engaging a surprise examination conducted by an independent public accountant.
OUR TAKE: Last year, the SEC cited violations of the custody rule as common exam deficiencies. While we think the rule is arcane and complicated (and needs re-drafting), advisers should seek expert help to understand when they are deemed to have custody and how to address the rule’s requirements. As shown in this case, the SEC can bring an enforcement action even without alleging any underlying client complaint or loss.
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.