The US SEC said on Tuesday that it has charged five investment adviser firms for failing to meet requirements related to the safekeeping of client assets.
Three of the firms were also charged with failing to update SEC disclosures regarding audits of their private fund clients’ financial statements in a timely manner. All five advisory firms agreed to settle the SEC’s charges and to pay more than $500,000 in combined penalties.
The firms charged are Lloyd George Management (HK) Ltd, Bluestone Capital Management LLC, the Eideard Group, Disruptive Technology Advisers LLC, and Apex Financial Advisors Inc. They each did not admit or deny the SEC’s findings.
Disruptive Technology agreed to pay a civil penalty of $225,000, the Eideard Group agreed to pay $80,000. Bluestone Capital agreed to pay $75,000, Apex agreed to pay $130,000, and Lloyd George agreed to pay a penalty of $50,000.
Audited financials
According to the SEC’s orders, the businesses failed to do one or more of the following: have audits performed; deliver audited financials to investors in a timely manner; and/or ensure a qualified custodian maintained client assets.
“We will continue to ensure that private fund advisers meet their obligations to secure client assets.”
Andrew Dean, Co-Chief, SEC Enforcement Division Asset Management Division
In addition, according to the SEC’s orders, two of the firms failed to promptly file amended Forms ADV to reflect they had received audited financial statements, and one of the firms did not properly describe the status of its financial statement audits for multiple years when filing its Form ADV.
Form ADV is a registration document that must be submitted to the SEC that includes identifying information and information about assets under management and investment fee structures, among other information.
“The Custody Rule and the associated Form ADV reporting obligations are core to investor protection,” said Andrew Dean, Co-Chief of the SEC Enforcement Division’s Asset Management Unit. “We will continue to ensure that private fund advisers meet their obligations to secure client assets.”
Investment Advisers Act
In September 2022, the SEC charged nine advisory firms as part of a similar, targeted sweep concerning violations of the Investment Advisers Act’s Custody Rule and Form ADV requirements by investment advisers for the private funds they advised.
In that 2022 roundup order, the SEC strongly encouraged investment advisers to ensure their compliance with the Custody Rule and the related Form ADV reporting and amending obligations. The SEC said in its press release announcing its order that “private fund advisers registered with the SEC are reminded that per the instructions to Form ADV, Part 1A, Schedule D, Section 7.B.23.(h), ‘If you check ‘Report Not Yet Received,’ you must promptly file an amendment to your Form ADV to update your response when the report is available.’”
The SEC is considering renaming the Custody Rule the Safeguarding Rule, and it has proposed broadening its requirements to account for advancements in the investment space.
The SEC warned advisers in that decision that it was critical for investor protection that private fund advisers update their filings with the SEC as required, as it helps the agency identify firms with possible ongoing issues regarding the Custody Rule.
The Custody Rule
The custody rule, or safekeeping of client assets, is contained in Rule 206(4)-2 under the Investment Advisers Act of 1940.
The SEC is considering renaming the Custody Rule, the Safeguarding Rule, and it has proposed broadening its requirements to account for what the regulator has described as huge growth and other advancements in the investment space. (Some compliance professionals have expressed concern for how they see the new requirements broadening their particular responsibilities in the custodial arena.)
On August 23, the regulator reopened the comment period for its revised definition and proposed rulemaking.
Private funds
The SEC just two weeks ago drafted new rules to overhaul the $18trn private fund marketplace in ways that will have an impact on this fast-growing sector.
(The Commodity Futures Trading Commission joined the SEC on the proposed amendments insofar as it pertains to those funds that are also registered with that agency as a commodity pool operator.)
The new rules revolve mainly around a disclosure form called “Form PF,” adding more transparency to these funds’ quarterly performance and fees charged to investors, while also barring some investors from getting preferential treatment over redemptions and portfolio exposure.
The rules also require private funds to perform annual audits.
The new rules usher in significant changes to the regulatory landscape of the private funds industry, and in light of them and this custody rule enforcement action it is critical that managers to private funds review their current policies, procedures and internal controls for adequacy purposes.
Such advisers must determine whether changes need to be implemented, including regulatory technology upgrades or additions, plus count on having the protection of investors be a primary focus, such as the disclosures they are providing, audits performed, and the measures they are taking to safeguard client assets with a qualified custodian.