March 17, 2025
What happened?
On March 7, 2025, the Securities and Exchange Commission (“SEC”) announced settled charges against a registered investment adviser, its former managing partner, and its former chief operating officer for misappropriation of private fund and portfolio company assets. According to the orders, the chief operating officer used portfolio company debit cards in more than 100 transactions to pay for vacations, clothing, and other personal expenses, and caused herself to be paid compensation in excess of her authorized salary. The total misappropriation was approximately $223,000 from portfolio companies. The managing partner caused the private fund to pay a business debt on a non-pro-rata basis, which should have been paid by a third-party entity controlled by the officers. This payment from the private fund resulted in both officers receiving an unearned benefit of $346,904.
The SEC found that the individuals breached their fiduciary duty and the anti-fraud provisions of the Advisers Act, and that the adviser failed to comply with the Advisers Act’s compliance and custody rules. It failed to respond to red flags that indicated misappropriation of assets and failed to obtain and timely distribute annual audited financial statements to investors in the private fund.
What does this mean for me?
An adequate compliance program would see to obtaining and timely distributing annual audited financial statements for a private fund. In the settlement above, the audited financial statements and attention to high-risk areas, such as expenses and allocations to a private fund, would have raised red flags within an effective compliance program. The SEC is going to be on the lookout for law-breaking behavior, particularly where it harms clients and investors. An effective and adequate compliance program should be too.
While the Private Fund Advisor Rules package was vacated by the Fifth Circuit, this settlement, like others, indicates that certain behavior of private fund managers those rules sought to address will still be scrutinized by the SEC. Expenses and allocations should only be charged to a private fund according to the governing documents of the fund. If using audited financial statements to meet the custody rule, they must be completed on time and distributed to investors.
The individuals both received monetary penalties, one received a bar from working in the industry, and the other received a 12-month supervisory suspension limiting him from investment advisory activities. The adviser itself received the highest monetary penalty for its systemic compliance failures, and irreparable reputational damage. Pay attention to compliance and resource your compliance program to make sure no one in your firm can inflict this kind of damage.
