SEC Charges Private Fund Administrator with Gatekeeping Failures

by Perkins Coie
Contact

The Securities and Exchange Commission (SEC) announced two administrative settlements in June with a fund administrator that provided accounting and fund administration services to several private funds based on its alleged failure to heed red flags and correct faulty accounting by two private fund managers.  The fund administrator, Apex Fund Services (US), Inc. (Apex) agreed to pay more than $350,000 to settle the SEC’s charges.

Apex served as the fund administrator for two private fund managers, ClearPath Wealth Management (ClearPath) and EquityStar Capital Management (EquityStar) at varying times between 2011 and 2014.  Pursuant to its contracts with the various private funds, Apex was required to perform a variety of services, including, but not limited to:  keeping the accounts and records of the funds; arranging the issue, redemption and repurchase of fund interests; calculating fees and other allocations payable to the funds in accordance with offering documents; preparing financial statements for the fund in accordance with generally accepted accounting principles; liaising with the funds’ auditors with respect to annual financial statements; determining and issuing statements detailing the value of each investor’s fund interest; and providing monthly account statements to investors.  The SEC alleged that in carrying out these functions Apex missed or ignored clear indications of fraud perpetrated by both private fund managers, making Apex a “cause” [1] of that fraud under Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. [2]

Investigation Background - ClearPath

With respect to ClearPath, the SEC specifically alleged that, despite being notified in July 2012 of undisclosed brokerage accounts dating back to August 2011, one with a negative balance of $4.1 million generated by margin borrowing against another fund account, Apex continued to issue net asset value (NAV) packages, balance sheets, profit and loss statements, and capital account balances to both ClearPath and its auditors reflecting the fund’s invested balance ($4.8 million) only. 

According to the SEC, Apex did not make any adjustments to the previously issued NAV packages or capital account statements after learning of the margin accounts.  This resulted in the auditors issuing an unqualified opinion overvaluing the investment balance by more than $4 million.  The SEC also claimed that Apex failed to account for loan balances and cash commingling transactions made in violation of fund offering documents in ClearPath’s NAV packages and capital account statements, and recorded unsupported investment amounts “due from investment manager” as repaid when ClearPath simply transferred those funds from another fund it managed.  In May 2015, concerning related subject matter, the SEC filed fraud charges against ClearPath and its owner, Patrick Churchville (Churchville), under Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder, among others, alleging that Churchville misappropriated investor funds and then lied to investors to lull them into believing their investments were safe. 

Investigation Background - EquityStar

With respect to EquityStar, the SEC alleged that Apex accounted for EquityStar owner Steven Zoernack’s withdrawals of more than $1 million directly from the funds as receivables (fund assets) without any evidence that EquityStar and Zoernack were willing or able to repay the amounts.  The commission also alleged that Apex provided monthly investor statement NAVs to investors on behalf of Zoernack and EquityStar that, by virtue of the undisclosed withdrawals, materially overstated the value of the investors’ holdings in the funds.  According to the SEC, Apex continued to account for Zoernack’s withdrawals as receivables for a period of almost two years even though, according to the SEC, Apex knew or should have known that Zoernack would not repay the money, during which time Zoernack continued to make withdrawals. 

The SEC claimed that Apex should have known that Zoernack would not repay the amounts he withdrew based on two communications received from EquityStar’s previous fund administrator warning Apex about investor complaints of “mounting losses,” as well as Zoernack’s past felony fraud convictions, of which Apex would have been aware had it conducted due diligence on Zoernack at the time their engagement began.  As with the SEC’s charges with respect to ClearPath and Churchville, the SEC charged Zoernack and EquityStar with making false and misleading statements to investors and making unauthorized fund withdrawals under Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder, among others. 

Although the SEC did not allege that Apex directly participated in any of ClearPath’s or EquityStar’s wrongful conduct, the SEC concluded that, as a result of Apex’s failure to act upon knowledge it possessed regarding both the ClearPath and EquityStar schemes, Apex was a cause of the investment managers’ violations of Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. 

SEC’s Message

In charging Apex, the SEC is highlighting its expectation that fund administrators take affirmative action to ensure that fund records provide accurate information about the value and existence of fund assets.  Indeed, SEC Division of Enforcement Director Andrew Ceresney explained that liability was specifically ascribed to Apex because “Apex failed to live up to its gatekeeper responsibility and essentially enabled the schemes to persist at each of these advisory firms until the SEC stepped in.” 

The SEC’s action against the fund administrator here should serve as a warning to all gatekeepers, including service providers, compliance professionals and auditors, that the SEC will use negligence-based securities laws to hold service providers responsible, especially where indications of fraud are ignored.

 

 

Endnotes

[1]Section 203(k) of the Investment Advisers Act of 1940 (Advisers Act), the provision under which the cease-and-desist actions were brought, allows the SEC to impose a cease-and-desist order upon any person that is, was, or would be a cause of another’s violation, due to an act or omission the person knew or should have known would contribute to such violation. 

[2] Section 206(2) of the Advisers Act prohibits any investment adviser from engaging in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client. Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder make it unlawful for any investment adviser to a pooled vehicle to make any untrue statement of a material fact or omit to state a material fact necessary to make the statements made not misleading, or otherwise engage in any act, practice or course of business that is fraudulent, deceptive or manipulative.

[View source.]

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.

© Perkins Coie | Attorney Advertising

Written by:

Perkins Coie
Contact
more
less

Perkins Coie on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.