The Securities and Exchange Commission (SEC) rounded out a busy month of issuing enforcement actions by charging three investment advisory (IA) firms with violations of Section 206(4) and Rule 206(4)-2 of the Investment Advisers Act of 1940 (the “Custody Rule”). The Custody Rule requires IA firms who “have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets” to fulfill a specific set of standards and implement safeguarding protections in order to properly maintain such funds and securities. According to the cease and desist orders issued by the SEC, Further Lane Asset Management (“Further Lane”), GW & Wade (“GW&W”), and Knelman Asset Management Group (“Knelman”) failed to have annual “surprise exams” conducted as required by the Custody Rule. Further Lane and its CEO Jose Miguel Araiz were additionally charged with other federal securities law violations, including fraud relating to a “fund-of-funds” that they controlled. Further Lane and Araiz were ordered to pay disgorgement and prejudgment interest of $347,122, along with a $150,000 penalty and suspension from the industry for one (1) year.
For GW&W, the SEC press release stated that “the firm did not have proper safeguards as a custodian of client funds, and failed to identify itself as a custodian to independent auditors and in public disclosures,” which opened up clients to potential harm and contributed to a third-party fraud against one GW&W client. GW&W was charged with additional violations of other federal securities laws and was fined $250,000. GW&W also reimbursed the client exposed to the third-party fraud and agreed to a censure and cease-and-desist order.
Knelman and its CEO and Chief Compliance Officer (CCO) Irving P. Knelman were found in violation of the Custody Rule for not having “surprise exams” conducted by an independent accounting firm on the assets in their affiliated private fund, Rancho Partners I, which is required since the fund had not obtained annual audits of the fund’s financial statements. Other violations by Knelman and the CCO included “improper discretionary cash distributions to Rancho members” and “failure to conduct annual compliance reviews.” The firm was ordered to pay a $60,000 penalty, and the CCO was fined $75,000 and was barred from serving as a CCO for three (3) years.
All three firms additionally agreed to a number of compliance-related undertakings, including working with an independent compliance consultant.
Importantly, Andrew Ceresney, co-director of the SEC’s Division of Enforcement made the following statement in the press release: “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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