Fund Sponsor Fined for Failing to Comply with Custody Rule

The SEC censured and fined a registered investment adviser to private funds for failing to comply with the custody rule as then in effect. The adviser opted to rely on the delivery of audited financial statements rather than deliver quarterly account statements. However, in one year, the financial statements included an auditor’s disclaimer of opinion, making them insufficient to satisfy the requirements of the rule. In another year, the adviser simply failed to deliver the financial statements to investors. The SEC also cited the adviser for a false ADV, which indicated that the adviser did not have custody of assets when it did by virtue of serving as the managing member/general partner of a private fund. The SEC also alleged several recordkeeping violations including failing to maintain and produce bank and brokerage statements, advisory contracts, trade blotters, and confirms.

OUR TAKE: Although the “old” custody rule applied to this case, the same basic requirements apply: firms must deliver audited financial statements (without an auditor disclaimer) to investors. Also, this case is an example how recordkeeping deficiencies, which may not alone result in an enforcement action, can compound a more substantive action.