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A recent enforcement action demonstrates that the SEC will not ignore compliance violations, especially those that continue over long periods of time. On March 7, 2019, the SEC brought an enforcement action against a registered investment adviser in New York City and its sole owner for allegedly violating some of the most basic rules under the Advisers Act, including violations of:

  • Rule 206(4)-7, better known as the Compliance Rule; and
  • Rule 204-2, the Books and Records Rule.

In addition, the firm failed to comply with the requirements of Rule 206(4)-2, the Custody Rule, despite that the firm was deemed to have custody for multiple reasons.

Compliance Rule deficiencies

The Compliance Rule requires SEC-registered investment advisers to adopt and implement written policies and procedures that are reasonably designed to prevent violations of the Investment Advisers Act and rules thereunder. In addition, advisers must review their policies and procedures annually to ensure they are adequate and effective.

From October 2004 until November 2015, the firm did not adopt and implement any written compliance policies and procedures and did not conduct the annual reviews required by the Compliance Rule. The cause of these violations was the adviser’s owner, who was the firm’s sole control person. The adviser created written compliance policies and procedures for the first time only after being notified of an SEC examination in 2015.

The Compliance Rule also requires that an investment adviser designate a Chief Compliance Officer (“CCO”), who is responsible for administering the firm’s adopted policies and procedures.  The SEC has stated that a firm’s CCO must be (i) knowledgeable regarding the Advisers Act; (ii) competent in regarding to administering the firm’s compliance program; and (iii) empowered to enforce compliance with the firm’s adopted policies and procedures*.  Investment advisers are required to name the firm’s designated CCO in their annual filing of Form ADV.

Between 2004 and 2015, the firm identified two different individuals as holding the title of CCO; however, during the course of their designation, neither was responsible for administering the firm’s policies and procedures.  In fact, the owner of the firm was responsible for compliance, yet he took no steps to keep the firm compliant. As owner of the firm, although he was empowered, he took no steps to become knowledgeable regarding the Advisers Act, or to administer a compliance program, failing to meet the SEC’s requirements of a CCO.  Education of the requirements of the Advisers Act could have been achieved in a number of ways such as:

  • Attending training events on investment advisory compliance issues;
  • Visiting the SEC’s website to review the Commission’s compliance guidance; or
  • Contacting SEC staff members for guidance on compliance issues.

Instead, the owner blatantly disregarded important statutes and rules governing the conduct of advisers registered with the SEC. As noted below, violations of the Compliance Rule will typically cause a firm to also violate the Books and Records Rule, and can lead to Form ADV deficiencies.

Books and Records Rule deficiencies

The Books and Records Rule requires SEC-registered investment advisers to make and keep certain true, accurate, and current books and records related to their advisory business, including a journal showing the firm’s cash receipts and disbursements. The rule also requires an adviser to keep a general ledger reflecting the adviser’s assets, liabilities, reserves, capital, income and expense accounts. In addition, every SEC-registered investment adviser is required to make and keep true, accurate, and current copies of the adviser’s policies and procedures for the past five years, including any records documenting the firm’s annual review of them.

The enforcement action against the firm alleged that the adviser did not make and retain:

  • A true, accurate, and current journal showing cash receipts and disbursements;
  • A true, accurate, and current general ledger reflecting assets, liabilities, reserves, capital, income, and expense accounts;
  • A true, accurate, and current copy of written compliance policies and procedures; and
  • A true, accurate, and current record to prove the firm conducted an annual review of the firm’s written compliance policies and procedures pursuant to the Compliance Rule.

The SEC alleged that the firm’s owner knew, or reasonably should have known, that the firm failed to make and keep certain true, accurate, and current books and records related to its advisory business.

Custody Rule deficiencies

The Custody Rule requires investment advisers who have custody of client funds or securities to implement appropriate procedures to safeguard the assets over which they are deemed to have custody. This includes a requirement to arrange for an independent public accountant to conduct surprise examinations of assets over which the firm has custody, unless the firm qualifies for an exemption. Furthermore, advisers to private funds must ensure that the fund is subject to annual audit by an independent public accountant registered with, and subject to inspection by, the Public Company Accounting Oversight Board (“PCAOB”) and that audited financial statements of the fund are distributed to investors on an annual basis.

The investment adviser was deemed to have custody of client funds and securities for two reasons: (a) the firm’s owner served as trustee over a client trust account managed by the firm; and (b) the firm’s owner, as well as a second employee, served as managing members of a private fund managed by the firm.

The SEC found that the adviser violated the Custody Rule by:

  • Failing to engage an independent accountant to perform an annual surprise examination of the trust account assets over which the firm’s owner served as trustee;
  • Failing to obtain annual audits of the private fund; and
  • Failing to distribute audited financial statements to the fund’s investors.

The SEC alleged that the advisory firm’s owner knew, or reasonably should have known, that the adviser held custody over the assets in trust account and in the private fund.

Form ADV deficiencies

In multiple Forms ADV filed with the SEC, the firm made the following misstatements:

  • Falsely stated that the adviser did not have custody of client assets;
  • Repeatedly misidentified an individual as being the firm’s CCO, even though that person was never responsible for administering written compliance policies and procedures for the RIA; and
  • Identified a second individual as the firm’s CCO in one Form ADV, even though this person was unaware of these responsibilities.

One individual was named as CCO for purposes of “window dressing.” Obviously, naming a figurehead as the firm’s CCO will not make a favorable impression with examiners.

Cease-and-desist action

Because of the extremely serious compliance violations, the SEC instituted administrative and cease-and-desist proceedings.  As a result, the firm and its owner face potential civil penalties, a cease-and-desist order, and monetary fines.

It is difficult to see what defense could conceivably be offered by the investment adviser to justify these deficiencies.

The enforcement action can be found HERE.


This and other recent enforcement actions by the SEC send a clear message that, even in the absences of ill intent, the Commission will still sanction advisers who ignore their compliance obligations. As this enforcement action illustrates, the owner and the firm demonstrated obvious disregard for their compliance duties.

A strong compliance program should be designed to help advisers live up to their fiduciary obligations and protect investors. Certainly, it is imperative that advisers implement and enforce an effective compliance program. When examiners uncover widespread and persistent compliance deficiencies, they will always question whether an adviser is making a good faith effort to be compliant.




This article is not a solicitation of any investment product or service to any person or entity. The content contained in this article is for informational use only and is not intended to be and is not a substitute for professional financial, tax or legal advice.


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