On November 19, 2015, the SEC sanctioned a registered investment adviser, its two owners, and a former chief compliance officer for violating the Advisers Act “custody rule” after previously settling similar charges and agreeing to “cease and desist” from future violations. Without admitting or denying the charges, the executives consented to the SEC’s findings that they caused and willfully aided and abetted the violations.
The former CCO agreed to pay a $60,000 penalty; two principals of the adviser agreed to a $1 million penalty and a one-year ban from raising money from new or existing investors.
The custody rule is designed to protect investor assets. Among other things, the rule requires an adviser that has “custody” of client assets to ensure that the custodian sends quarterly account statements to clients and that an independent public accountant verifies the assets in client accounts each year. Advisers of pooled investment vehicles (“funds”) that send investors audited financial statements within 120 days of a fund’s fiscal year-end, however, are not required to obtain independent verification of portfolio assets or to satisfy the quarterly account statements delivery requirement.
The SEC found that, for three fiscal years beginning in 2010, the adviser and its executives failed to timely distribute audited financial statements to investors in pooled investment vehicles managed by the adviser. This alleged failure violated Rule 206(4)-2, the so-called “custody rule” under the Advisers Act. Moreover, the SEC found, the advisers and the executives violated the cease and desist order relating to the previous violations.
The SEC found that, notwithstanding the prior settlement order, the adviser and its principals took no remedial action to ensure compliance with the custody rule. Moreover, the SEC found that the former CCO substantially assisted the adviser’s violations of the custody rule.
The SEC said that although the adviser’s compliance manual tasked the CCO with ensuring compliance with the custody rule, the CCO did not implement necessary policies or procedures to ensure such compliance. The SEC found that the former CCO “simply reminded people of the custody rule deadline without taking any more substantial action.” The SEC also criticized the former CCO for failing to notify the SEC staff of the adviser’s difficulties in meeting the custody rule deadlines.
The SEC suspended the CCO from serving as a chief compliance officer for one year.
Our take. This settlement comes after a series of speeches by SEC officials that it was not targeting CCOs or second-guessing them. The order provides an example of the threshold of undesirable behavior that a CCO must cross to spur an enforcement proceeding. To be sure, in light of the SEC’s public statements related to their concerns about recidivism, a repeat offense will likely catch the enforcement division’s eye.