On November 19, 2015, the SEC announced a settlement with investment advisory firm Sands Brothers Asset Management, LLC for violating the Custody Rule, SEC Rule 206(4)-2, which requires that registered investment advisers who have custody of their clients’ assets put in place policies and procedures intended to safeguard those assets against loss, misuse or misappropriation. The SEC also imposed sanctions on Sands Brothers’ Chief Compliance Officer who was subjected to a one-year suspension and a fine for aiding and abetting these violations.
The Sands Brothers settlement comes on the heels of considerable commentary by SEC Commissioners and staff on the circumstances justifying the discipline of a chief compliance officer of a registered investment adviser. Earlier this year, then SEC Commissioner Daniel M. Gallagher explained his dissent from two decisions imposing sanctions on a CCO. In his comments, Commissioner Gallagher voiced concern that such outcomes improperly place the obligation to implement compliance policies and procedures on the CCO, where, in Commissioner Gallagher’s view, such responsibilities are intended to be borne by the Firm. Those comments triggered a response from both Commissioner Luis A. Aguilarand SEC Chair Mary Jo White.
Most recently, in a speech earlier this month, SEC Director of Enforcement, Andrew Ceresney, outlined three types of conduct that would lead the staff to recommend an enforcement action against a CCO. The first category involves CCOs who are affirmatively involved in misconduct that is unrelated to their compliance functions. Such cases often involve CCOs who “wear other hats” and serve as CEO, CFO or some other position in addition to being the CCO, and have engaged in intentionally fraudulent or harmful conduct while operating in that other role. The second category involves CCOs who intentionally mislead or obstruct the SEC staff, especially during the course of an investigation or examination. We recently blogged about one such case.
The third category involves CCOs who exhibit a “wholesale failure” to carry out their compliance responsibilities. Such cases often involve situations where a CCO is accused of “egregious conduct,” such as the failure to create policies and procedures to prevent an employee from misappropriating client funds, the failure to report a material compliance matter like a conflict of interest or aiding and abetting such behavior.
The SEC order in the Sands Brothers matter reflects that several factors referenced by Director Ceresney appear to have been present. For example, the firm’s CCO also held the position of COO and failed to implement any changes, substantive or otherwise, to the firm’s policies and procedures, even though Sands Brothers had been censured for the same conduct in 2010, and he was aware that the firm still was actively violating the Custody Rule.