SEC Prosecutes RIA President/CCO for Custody Rule Violations
The SEC has commenced enforcement proceedings against an investment adviser and its principal/Chief Compliance Officer for misstating client account balances by virtue of failing to comply with the custody rule (206(4)-2). The SEC charges that the adviser maintained custody of client assets because it held an omnibus position on behalf of its clients at the transfer agent of a fund company. The SEC asserts that the president/CCO knew that the firm had to comply with the comply rule but failed to ensure (i) the necessary surprise exam by a third party audit firm and (ii) delivery of account statements from a third party custodian. As a result, the SEC states that the firm was able to consistently overstate client assets. The SEC charges violations of the antifraud rules and the custody rule.
OUR TAKE: If in fact the president/CCO did know about the custody rule and simply chose to save money by not engaging a third party audit, it was simply foolish short-term thinking to assume he could fix the problem once the SEC caught on. Now he faces serious consequences including fines and potential industry bars. One odd side note is that not even the SEC can figure out the motive or the cause of the overstated assets, noting that not even the defendant could explain why balances were overstated.