I don’t want to keep harping on the investment adviser custody rule. Look, I mean, SEC CustodyFest was fun, but we’re not going back in that depth. Someday maybe, but not today.
But I’m going to harp a little bit. Because last week the SEC sued two CPAs and another accountant for failures associated with the surprise exam requirement of the custody rule. Surely you remember that each investment adviser that has custody of its clients’ assets must submit to an annual surprise examination by an independent public accountant to verify that the assets are still there. This requirement is obviously important for advisers, but it’s also important for the CPAs. In short, if a CPA engages to conduct such an exam, it ought to know how to do the exam, and it has to follow through on it. In this case, the SEC found problems on both counts.
The adviser here was Freedom One Investment Advisers had custody of client assets and engaged an accounting firm known as UHY LLP to conduct the surprise exams. According to the SEC’s Accounting Series Release No. 103, here’s what the CPA is supposed to do:
Make a physical examination of securities and obtain confirmation as appropriate;
Obtain confirmation of funds on deposit in banks; and
Reconcile the physical count and confirmations to the books and records.
ASR No. 103 further says that these books and records should be verified by examining the security records and transactions since the last exam and by obtaining written confirmations of the funds and securities in the clients’ accounts.
Here, the firm allegedly did not obtain confirmation of securities or funds held by Freedom One’s custodians and did not send any confirmation requests to Freedom One’s clients. They therefore also allegedly did not reconcile the confirmations to the books and records. They also allegedly failed to ensure that reports were issued for the surprise exams or to withdraw from the engagements.
The SEC found instances of aiding and abetting Freedom One’s alleged violations of the custody rule. As a result, all three associated principals and employees were barred from practicing before the Commission under Rule 102(e).
If you’re a CPA, and you’re engaged to conduct these surprise exams: (1) know what you’re doing, and (2) do it, or (3) don’t.