Adviser Fined for Technical Violations of Custody Rule
An adviser and its principal were censured and fined for violations of the Advisers Act’s custody rule, even though no client was harmed.
The principal arranged for clients to invest in promissory notes issued by a company controlled by one of his clients. He then placed copies of the notes in clients’ online dropbox accounts rather than their brokerage accounts which were reviewed by the firm’s CCO and CIO. The SEC charges the firm and the principal with skirting the custody rule (206(4)-2), which requires a qualified custodian and specific reporting. The SEC asserts that the firm was subject to the custody rule because, although it was not registered at the time of the conduct, it should have been based on its assets under management. The SEC notes that the mortgage company repaid the notes and no client suffered losses.
Because of the potential for (Madoff-like) wrongdoing, the SEC requires strict compliance with the custody rule, even in the absence of client harm. This is the type of “broken windows” enforcement – technical enforcement without client harm – that supposedly ended when Mary Jo White left the SEC. Perhaps, the Gensler-led SEC is going back to the future.
Read SEC Order here.