Custody Rule and Annual Audit Failures Lead to $75,000 SEC Penalty
SEC Releases
Introduction
The SEC announced settled administrative proceedings against a $1.4 Billion ($22.3 Million in Pooled Investment Vehicles) RIA that served as the investment adviser to multiple Private Funds for violations of the Investment Advisers Act Custody Rule.
According to the SEC’s Order, a related person of the Adviser served as the Managing Member of the Funds, resulting in the Adviser having custody of client assets under the Custody Rule. The SEC found that the Adviser failed to comply with the Custody Rule by neither obtaining the required annual audits nor satisfying the alternative custody safeguards for multiple fiscal years.
As a result, the SEC found that the Firm willfully violated Section 206(4) of the Investment Advisers Act and Rule 206(4)-2 and imposed remedial sanctions, including a cease-and-desist order, censure, and a $75,000 civil monetary penalty.
Key Takeaways
- Failure to satisfy Custody Rule requirements.
- The SEC found that the Adviser had custody of client assets because a related person served as the Managing Member of the Private Funds it advised. As a result, the Firm was subject to the requirements of Rule 206(4)-2 under the Investment Advisers Act.
- Required Annual Audits were not performed.
- For fiscal years ranging from 2015 through 2024 (depending on the Fund), the Adviser failed to have the Private Funds audited by an Independent Public Accountant as required under the Custody Rule’s audited financial statement alternative.
- Audited Financial Statements were not distributed.
- Because the required Audits were not conducted, the Firm also failed to timely distribute GAAP-compliant audited financial statements to investors in the pooled investment vehicles.
- Alternative Safeguards were not implemented.
- The SEC found that the Adviser neither satisfied the audited financial statement alternative nor complied with the other custody safeguards required under Rule 206(4)-2(a)(2)-(5), including the applicable notification, account statement, and verification requirements.
- Multiple Private Funds were impacted.
- The Order found that the Custody Rule deficiencies affected four Private Funds advised by the Firm.
Vigilant’s Conclusion
The SEC’s Order serves as another reminder of the importance of maintaining on-going compliance with the Advisers Act Custody Rule, particularly for Advisers to Private Funds that rely on the audited financial statement alternative.
Advisers should periodically evaluate whether they have custody of client assets through direct or indirect relationships, confirm that required annual audits are being performed by qualified independent public accountants, and ensure audited financial statements are distributed to investors within the required timeframes.
Firms should also periodically review their compliance policies, procedures, and internal controls to verify that custody obligations are being satisfied on an on-going basis and appropriately documented.
To learn more about our Compliance Solutions and how we can help, schedule a call with Vigilant.