SEC Charges Five RIAs with Violations of Custody Rule

On September 5, 2023, the SEC announced it had charged five SEC registered investment advisers (“RIAs”) with violating the Investment Advisers Act of 1940, as amended, including Rule 206(4)-2 thereunder (known as the “Custody Rule) and related failures to file accurate Form ADVs. The SEC charges were the result of a “targeted sweep” initiated by the SEC relating to violations of the Custody Rule, the second sweep for Custody Rule violations in the last twelve months.

The Custody Rule requires an RIA that is deemed to have custody of client funds and securities to implement certain procedures to prevent the loss, misuse or misappropriation of such funds and securities. RIAs to pooled investment vehicles, such as limited partnerships or limited liability companies, have the option to comply with certain provisions of the Custody Rule by causing the funds they advise to undergo an annual audit and then distributing the audited financial statements to all investors within 120 days of the funds’ fiscal year end (or within 180 days, in the case of a fund of funds) (the “audit provision”).

While the alleged violations of the Custody Rule range in scope, the SEC charged each RIA with failure to comply with the Custody Rule’s audit provision and/or failure to maintain client funds and securities with a qualified custodian. Specifically, the RIAs either did not arrange for the financials of their funds to undergo an annual audit or did not distribute the audited financial statements to investors within the prescribed time periods. In addition, the SEC alleged that (i) two of the RIAs failed to promptly update their Form ADVs to indicate receipt of their funds’ audited financials and (ii) one RIA incorrectly indicated on its Form ADV that its funds’ financial statements were audited.

Without admitting or denying the findings, the RIAs agreed to pay fines ranging in amounts from $50,000 to $225,000. The SEC’s sweep provides another example of the SEC’s increased scrutiny of the private funds industry. Notably, the private fund adviser rules adopted by the SEC in late August will require RIAs to obtain an audit of their private funds’ financials that meets the requirements of the audit provision. RIAs therefore should ensure their private funds’ audits are conducted accordingly to avoid regulatory action.

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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Tannenbaum Helpern Syracuse & Hirschtritt LLP

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