The Securities and Exchange Commission on Monday sanctioned three SEC-registered advisory firms for violating the “custody rule” that requires them to meet certain standards when maintaining custody of their clients’ funds or securities.
SEC investigations by the Enforcement Division’s Asset Management Unit following referrals by agency examiners found that New York-based Further Lane Asset Management, Massachusetts-based GW & Wade, and Minneapolis-based Knelman Asset Management Group failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct surprise exams.
The firms also committed other violations of the federal securities laws, the SEC said, and each firm has agreed to settle the SEC’s charges.
“The heart of the relationship between advisors and their customers is the safety of client assets,” said Andrew Ceresney, co-director of the SEC’s Division of Enforcement, in a statement. “Surprise exams or procedures associated with audited financial statements provide additional safeguards against assets being stolen or misused. These firms failed to comply with their custody rule obligations, and other firms who hold client assets should take notice that we will vigorously enforce such requirements.”
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The SEC notes that while the majority of investment advisors do not maintain custody of client assets, which are instead held by qualified third-party custodians like a bank or broker-dealer, advisors must comply with the custody rule “if they have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets.”
The commission amended the custody rule in 2010 to require all advisors with custody to undergo an annual “surprise exam” to verify the existence of client assets.
Advisors also must have a reasonable basis to believe that a qualified custodian is sending account statements to fund investors at least quarterly, the SEC said. “Advisors with custody of hedge fund or other private fund assets may alternatively comply with the custody rule through fund audits by a PCAOB-registered auditor, after which financial statements must be delivered to investors.”
The SEC issued orders instituting settled administrative proceedings against the three firms for deficiencies related to the custody rule – Rule 206(4)-2 under Section 206(4) of the Investment Advisers Act of 1940.
The SEC released a detailed description of each action.
Further Lane Asset Management
According to the SEC’s order against Further Lane Asset Management (FLAM) and its CEO, Jose Miguel Araiz, despite maintaining custody of assets of hedge funds managed by FLAM and affiliated adviser Osprey Group Inc. (OGI), Araiz and FLAM failed to arrange an annual surprise examination to verify the funds’ assets. The funds’ investors also did not receive quarterly account statements from a qualified custodian of the funds as required by the custody rule.