Christopher Kelly, the chief compliance office of Sands Brothers Asset Management LLC – a registered investment adviser – agreed to pay a fine of US $60,000 and be suspended from acting as a CCO for one year to resolve charges brought by the Securities and Exchange Commission related to the firm’s alleged recidivist failure to comply with the SEC’s so-called “custody rule.” This rule requires advisers who have custody of client funds to implement certain procedural safeguards. Under certain circumstances – applicable to SBAM – advisers must distribute audited financial statements to all limited partners within 120 days of the end of each fiscal year (click here to access the relevant rule – Rule 206(4)-2 under the Investment Advisers Act). According to the SEC, in 2010, in connection with a prior SEC enforcement action, SBAM, as well as its two co-chairmen, Steve Sands and Martin Sands, consented to the entry of an order by the agency to cease and desist from violating the custody rule. However, despite this Cease and Desist Order, in each year from 2010 through 2012, SBAM distributed the required financial statements to its limited partners later than required by the relevant rule. Although SBAM’s compliance manual required Mr. Kelly to ensure SBAM’s compliance “with the restrictions and requirements” of the custody rule, the SEC claimed “[h]e knew that the audited financial statements were not being distributed on time.” Moreover, said the SEC, Mr. Kelly “implemented no policies and procedures to ensure compliance with the custody rule… At most, he simply reminded people of the [rule] deadline without taking any more substantial action.” Separately, SBAM, and both Mr. Sands agreed to pay a fine of US $1 million and not to raise new funds from investors for one year to resolve charges by the SEC related to SBAM’s alleged violation of the custody rule.
Compliance Weeds and My View: As previously pointed out in prior versions of Bridging the Week, Securities and Exchange Commission rules require investment advisers to adopt and implement written policies and procedures “reasonably designed” to ensure the adviser’s compliance with applicable law. The chief compliance officer solely is responsible to “administer” policies that are adopted by the adviser (click here to access Rule 206(4)-7 under the Investment Advisers Act). (Click here for details regarding the SEC’s requirements in the article, “Investment Adviser Chief Compliance Officer Blamed in SEC Lawsuit for President’s Theft of Client Funds; SEC Commissioner Criticizes Enforcement Actions Against CCOs Generally” in the June 21, 2015 edition of Bridging the Week.) At Sands Brothers Asset Management, however, the compliance manual tasked the CCO with ensuring the firm’s compliance with the custody rule – thus placing a higher obligation on the CCO than required by rule, and transferring the legal responsibility of the adviser to Mr. Kelly. CCOs should be mindful of any language in their firms’ compliance manual that places any obligation on them to ensure compliance with any applicable law. CCOs can help firms comply with applicable law, but they cannot guarantee compliance as they typically have no supervisory authority. Here the SEC acknowledged that Christopher Kelly, SBAM’s CCO, reminded personnel of relevant deadlines, but by not doing more, he was held accountable for SBAM’s failures. At a minimum, said the SEC, Mr. Kelly should have notified “…staff of the Commission of any difficulties the Adviser was encountering in meeting the custody rule deadlines.” Once again, this seems an outcome that unfairly punishes a compliance officer for actions of an adviser and its senior officer he or she can influence but not control!