Fund Administrator Blamed for Client’s Fraud
The SEC has fined a large fund administrator and ordered disgorgement of its fees for failing to stop it client from defrauding the funds. Assuming administration duties from a prior fund administrator with whom it communicated, the respondent failed to escalate concerns about a receivable due from the manager, cash flow issues, and other accounting irregularities. According to the SEC, the manager misappropriated funds and instructed the administrator to book the cash transfer as a receivable due pursuant to a promissory note. The administrator also followed instructions to add fund expenses to the receivable, thereby inflating the NAV. The SEC charges that the administrator caused the manager’s Advisers Act violations through an act or omission that the administrator knew or should have known would contribute to the violations, pursuant to Section 203(k) of the Advisers Act.
Although we question the use of Section 203(k) to hold a non-registrant liable for the conduct of an adviser, the SEC has consistently asserted that it will hold service providers (e.g. administrators, auditors, lawyers, distributors) accountable if they stay silent about known legal violations. We recommend heightened due diligence to make sure that you don’t get stuck with a miscreant client. It’s always a red flag when the sales team brings a client who has just fired a qualified competitor for murky reasons.