A SEC registered investment adviser to several registered mutual funds was the subject of a recent SEC enforcement action for violations of custody requirements under the Investment Company Act of 1940 (See also, In the Matter of Water Island Capital LLC, Release No. 31455). Investment companies that publicly offer their shares are registered as investment companies under the Investment Company Act of 1940.
In this enforcement action, the investment adviser to the registered funds, maintained fund assets (about $247 million) at the funds’ broker-dealer counterparties instead of maintaining those assets as required with the funds’ qualified bank. The Investment Company Act generally requires that registered fund assets be maintained with a qualified custodian such as a bank, including the cash proceeds from the sale of those assets. Indeed, the adviser’s compliance policies and procedures in place at the time required that fund assets and sale proceeds be maintained in the custody of a qualified bank. However, according to the SEC, for at least the period during January to September 2012, the adviser allowed fund broker-dealer counterparties instead of the bank to hold fund assets of approximately $247 million in cash collateral.
This failure by the adviser caused violations of the custody and supervision rules under the Investment Company Act.
In order to settle the SEC’s enforcement matter, the adviser agreed to the issuance by the SEC of a cease and desist order and to payment of a civil penalty in the amount of $50,000.