Firm Fined for Violating Custody Rule and Miscalculating Performance Fees

WHAT HAPPENED?

Recently, the U.S. Securities and Exchange Commission charged a private fund adviser with violating sections of the Advisers Act governing performance fee calculations, the Custody Rule, and written policies and procedures and annual review requirements; the firm is solely owned by its Chief Compliance Officer and manages $79 million in client assets.

Between 2014 and 2016, investors in a private fund the firm managed were overcharged in violation of the fund’s private placement memorandum (PPM). The PPM stated that the fund would be charged a twenty percent annual performance fee when its net asset value exceeded a high watermark. However, the adviser charged performance fees without the fund meeting these conditions for multiple years, costing investors nearly $51,000 in undue fees.

During the same time period, the adviser also failed to adhere to the Custody Rule, which prohibits the commingling of fund assets with other holdings and requires the engagement of an independent public accountant to periodically examine the fund. The adviser violated the rule by keeping the fund assets in the firm’s own brokerage account, instead of an account held by a certain brokerage firm, in the name of the fund, and as specified in the PPM. The adviser also failed to engage an independent public accountant to complete an annual audit and surprise examination of the fund’s assets for three consecutive years. As a result, investors in the fund never received the audited financials they were entitled to.

SEC staff also found the firm did not have adequate policies and procedures in place concerning its custody obligations and performance fee calculations, nor did it conduct an annual review of its compliance policies and procedures, as required by the Advisers Act.

The SEC ultimately found the firm violated several sections of the Advisers Act. The firm and its owner were censured and ordered to pay over $60,000 in fines and reimbursements to harmed investors.

The firm could have avoided these compliance violations and damage to investors by implementing more thorough compliance oversight. Because the firm’s owner and president also acted as the CCO and conducted all trading activity for the fund, it is likely essential compliance tasks were missed or forgotten.

WHAT DOES THIS MEAN FOR ME?

While it is not always possible for firms to have a dedicated CCO, it is still important for the firm to have independent compliance support and expertise. Compliance staff members who are responsible for other areas of your firm’s operations may have trouble also keeping up with all compliance tasks and implementing changes to SEC rules and regulations.

If your firm would benefit from additional compliance support, Fairview can help close the gap. Our dedicated and knowledgeable team of compliance professionals has helped Chief Compliance Officers maintain meaningful compliance programs since 2005. Contact us today for more information about our services.

About the Author:

Fairview®
Founded in 2005 with the goal of developing streamlined solutions for investment advisers, Fairview® is now servicing investment advisers, foundations, and funds with nearly $300 billion in collective assets.