The Securities and Exchange Commission (SEC) has recently settled allegations of violations of its Custody Rule with five registered investment advisors who work with private funds. This settlement emphasizes the significance of compliance with the rule as the agency plans to expand its scope.
Compliance Failures Result in Fines
The SEC announced fines totaling over $500,000 due to alleged compliance failures by the firms. These failures included not conducting required audits and failing to update Form ADV regulatory filings to accurately reflect audits of private-fund holdings.
Andrew Dean, co-chief of the SEC Enforcement Division’s asset-management unit, emphasizes the importance of the Custody Rule and the associated reporting obligations, stating, “We will continue to ensure that private-fund advisors meet their obligations to secure client assets.”
The five firms involved in the enforcement actions are as follows:
- Disruptive Technology Advisers
- Apex Financial Advisors
- The Eideard Group
- Bluestone Capital Management
- Lloyd George Management
Censure and Cease-and-Desist Orders
As part of their settlements, each firm agreed to a censure and a cease-and-desist order. The SEC imposed fines of $225,000 on Disruptive, $130,000 on Apex, $80,000 on Eideard, $75,000 on Bluestone, and $50,000 on Lloyd George.
None of the firms provided comments regarding the allegations. Each settled the charges without admitting or denying any wrongdoing.
Bundling Enforcement Actions for Impact
The SEC often combines enforcement actions to send a strong message to the industry about its vigilance against misconduct in specific areas. This strategy was recently employed when the SEC, along with another regulator, jointly announced fines of $1.8 billion for record-keeping violations by several large Wall Street firms. These violations were related to employees conducting business through unapproved channels like WhatsApp.
Gurbir Grewal, the SEC’s director of enforcement, explains that bundling settlement announcements has a more significant deterrent effect and grabs more attention than releasing them individually.
Custody Rule Violations: An Ongoing Concern
The recent penalties associated with Custody Rule violations have proven to be a significant blow for the firms involved. Although these fines may not reach the heights seen in record-keeping cases, they serve as a stark reminder of the importance of compliance. The Custody Rule has become a focal point for regulatory examinations, with an emphasis on custody and the accompanying reporting obligations.
Last September, the SEC settled with nine registered investment advisors (RIAs) over violations of the Custody Rule and Form ADV reporting requirements. These settlements highlight the seriousness of non-compliance in this area.
In addition to these actions, the SEC is currently engaged in a rule-making initiative to broaden the scope of assets that trigger Custody Rule obligations for advisors. As this initiative progresses, it is crucial for advisors to stay informed and understand how these changes may impact their operations.
When an advisor is found to have custody of client assets, they are responsible for safeguarding those assets at a qualified custodian and adhering to a set of auditing and reporting standards. Failure to meet these requirements can have severe consequences.
In the most recent enforcement cases, the SEC discovered that the firms in question were relying on exemptions outlined in the Custody Rule. However, they failed to meet certain criteria necessary to qualify for these exemptions. This oversight led to penalties being imposed.
Disruptive, Bluestone, and Eideard were charged by the SEC for not obtaining the necessary audits of their funds and failing to distribute audited financial statements as required. Similarly, Apex was penalized for its failure to deliver audited statements in a timely manner. Additionally, Disruptive, Bluestone, and Apex were found to have neglected prompt updates to their Form ADV forms in relation to their auditing activities.
In another case, Lloyd George, a Hong Kong-based firm, enlisted an auditor that did not meet the SEC’s standards. According to the commission, a firm must use an auditor that complies with either the Public Company Accounting Oversight Board or the generally accepted auditing standards in the United States. Additionally, Lloyd George failed to proactively distribute its financial statements as required, instead making them available only upon request.
These recent enforcement actions underscore the importance of properly adhering to the Custody Rule and keeping abreast of any changes in regulatory requirements. Firms must ensure that they meet all obligations, including obtaining necessary audits, distributing financial statements promptly, and updating their Form ADV forms in a timely manner. By doing so, they can avoid the significant penalties and reputational damage associated with Custody Rule violations.