Page 36 - Investment Advisor October 2022

any rulemaking that comes out to focus safekeeping of client assets and/or to Jim Lundy, a partner and member of
on descriptive disclosures.” timely update their SEC disclosures to the Securities Enforcement & Litigation
The SEC said in its exam priorities, reflect the status of audits of finan- Practice at Foley & Lardner LLP, told me
released in late March, that it would cial statements for the private funds in an email that the enforcement actions
focus its exams this year on RIAs’ use they advised. The advisors, all of which “relate primarily to the audit require-
of 12b-1 fees in wrap fee accounts where agreed to settle the SEC’s charges and ments of the custody rule, and some
the RIA may be responsible for pay- pay combined penalties of over $1 mil- of the allegations against certain firms
ing transaction fees, along with revenue lion, are: BiscayneAmericas Advisers indicate fairly straightforward failures
sharing arrangements. LLC, Garrison Investment Group LP, to be in compliance with this aspect of
The agency said that RIA exams will Janus Henderson Investors US LLC, the custody rule. Further, enforcement
focus on whether advisors “are acting Lend Academy Investments LLC, Polaris will enforce the laws and rules ‘on the
consistently with their fiduciary duty Equity Management Inc., QVR LLC, books’ while their policy making col-
to clients, looking at both duties of care Ridgeview Asset Management Partners leagues in other divisions are engaged in
and loyalty, including best execution LLC, Steward Capital Management Inc., rule making.”
obligations, financial conflicts of inter- and Titan Fund Management LLC. The Sept. 9 actions, Lundy added,
est and related impartiality of advice, The SEC’s orders found that some of “align with the public statements of SEC
and any attendant client disclosures.” the firms failed to have audits performed leaders regarding increasing scrutiny of
Ron Rhoades, associate professor of or to deliver audited financials to inves- compliance with the custody rule and
finance at Western Kentucky University tors in certain private funds in a timely the private fund industry more broadly.”
and director of its personal financial manner, thereby violating the Investment C. Dabney O’Riordan, chief of the
planning program, told me in another Advisers Act’s Custody Rule; and certain SEC Enforcement Division’s Asset
email that he’d be disappointed if the advisors failed to promptly file amended Management Unit, added in the state-
SEC seeks to address 12b-1 fees “only Form ADV to reflect they had received ment that “registered private fund
through rules that merely enhance fund audited financial statements after having advisers’ failures to fulfill their report-
fee disclosures in some manner, without initially reported that they had not yet ing obligations make it harder for the
severely restricting the utilization of received the audit reports. SEC to identify firms with possible on-
fund share classes with 12b-1 fees.” In addition, one advisor — QVR — going issues regarding the Custody Rule.
These 12b-1 fees, Rhoades said, “don’t did not properly describe the status of It is critical for investor protection that
benefit fund shareholders, and rather its financial statement audits when fil- private fund advisers update their filings
act to their detriment. Shareholders ing its Form ADV, nor did it update its with the SEC as required.”
rarely understand 12b-1 fees. Outside of response in its Form ADV annual updat- Firms “are strongly encouraged
the defined contribution space (where ing amendment for multiple years, as to ensure their compliance with the
R-1, R-2, etc. shares exist), 12b-1 fees are required, the SEC said. Custody Rule and the related Form ADV
not negotiable by clients.” Janus — which as of May had $269 reporting and amending obligations,”
Another problem, he says, “is that billion in assets under management, the SEC said. In particular, private fund
12b-1 fees, particularly of the 1% variety including roughly $43 billion managed advisors registered with the SEC “are
(often seen in Class C shares), are — in in pooled investment vehicles — failed to reminded that per the instructions to
essence — ‘investment advisory fees in timely distribute annual audited finan- Form ADV, Part 1A, Schedule D, Section
drag.’ There is no reason for the SEC to cial statements prepared in accordance 7.B.23.(h), ‘If you check ‘Report Not
permit ‘asset-based fees’ to be charged with generally accepted accounting Yet Received,’ you must promptly file
by brokers, when investment advisory principles, or GAAP, to certain investors an amendment to your Form ADV to
fees would be more appropriate.” in a private fund that it advised, accord- update your response when the report is
ing to the SEC. available,’” the SEC states.
SEC CUSTODY, FORM ADV ACTIONS The SEC’s Division of Investment Without admitting or denying the
On Sept. 9, the SEC levied actions Management is considering recom- findings, the firms agreed to be cen-
against registered investment advisors mending that the SEC propose amend- sured, to cease and desist from violating
for custody rule and Form ADV viola- ments this year to existing rules and/or their respective charged provisions, and
tions. Two of the firms violated just the propose new rules under the Investment to pay civil penalties collectively total-
custody rule and one Form ADV, while Advisers Act of 1940 to improve and ing more than $1 million.
six of the firms violated both. modernize the regulations around the
According to the SEC, the firms custody of funds or investments of cli- Washington Bureau Chief Melanie Waddell can
failed to comply with requirements for ents by RIAs. be reached at [email protected].

34 INVESTMENT ADVISOR OCTOBER 2022 | ThinkAdvisor.com