SEC Charges Manager Of Private Equity Fund With Violation Of The Custody Rule

The SEC has settled an administrative action with the managing member of a fund of private equity funds.  In an examination the SEC staff learned that the  manager was violating the custody rule (Rule 206(4)-2 under the Investment Advisers Act) because  the manager did not have a reasonable basis for believing that a qualified custodian was sending quarterly statements to private equity investors members and the manager had not arranged for annual surprise exams of the fund’s assets. Alternatively, the manager had not arranged for the funds financial statements to be audited annually and distributed to the funds investors.

In addition, Rule 206(4)-7 under the Advisers Act – requires investment advisers registered with the SEC to:

  • adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and rules adopted under the Act;
  • review at least annually the adequacy of the policies and procedures and the effectiveness of their implementation; and
  • designate a Chief Compliance Officer, who is a supervised person, responsible for administering the policies and procedures.

The SEC alleged the manager’s policies and procedures were not reasonably designed to prevent violations of the custody rule. The firm’s compliance manual did not acknowledge that the manager had custody over the fund’s assets. Thus, it had no written policies and procedures to ensure that it met the requirements of the custody rule regarding the fund’s assets. The manager also failed to conduct annual reviews of its compliance policies and procedures and the effectiveness of their  implementation and failed to institute a documented process to identify potential compliance risks and conflicts of interest.

The SEC also alleged the manager’s Form ADV contained untrue statements of material fact. Although the manager had custody of the fund’s assets, the manager stated in its Forms ADV that it did not maintain custody of client assets or securities.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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