SEC reprimands CCO over custody rule failings

An investment advisor must a pay fine and go through compliance training after its accounting firm failed to perform a ‘surprise exam’, among other custody rule violations.

Last month the SEC sanctioned investment advisor Freedom One and its president, chief executive officer and chief compliance officer, Mark Wayne, for violations of the custody rule.

Wayne was unable to respond to a request for comment by press time.

SEC-registered private equity firms who have “custody” (or access to) fund assets must safe-keep them at an investment bank, broker-dealer or some other “qualified custodian”.

As a further safeguard, the custody rule subjects GPs to an annual surprise examination by an independent public accountant to verify their funds’ assets.

However, since a 2010 rule change, if a fund distributes audited financial statements to LPs within 120 days of the end of each fiscal year (180 days for fund of funds), the GP can avoid the hassle of a surprise exam (which most do).

But, in this instance Freedom One engaged an accounting firm to perform a surprise exam, which failed to follow through and conduct the exam in 2008.

In 2009 and 2010, a different accounting firm conducted surprise exams but they were deemed insufficient by the SEC as they were limited to only a subset of Freedom One accounts.

Following the 2010 rule change permitting audited financial statements to be sent to clients, in lieu of the surprise exam, Wayne and Freedom One failed to send out the statements.

One lawyer speaking to PE Manager said GPs will incur the wrath of the SEC if they fail to show that copies of their audited financial statements were distributed to all investors and not that the statements were only made available “upon request”.

The SEC charged Wayne with aiding and abetting and causing these violations because as chief executive and compliance officer of Freedom One, he took no action to ensure compliance.

According to SEC documents, Wayne delegated responsibility for the 2009 and 2010 surprise exam to someone who had no compliance training or experience.

He also delegated recordkeeping responsibilities to someone without the necessary skills and did not provide her with adequate support and training to accurately maintain Freedom One’s books and records, according to the SEC.

Wayne is now required to pay a civil money penalty of $40,000 to the US Treasury and is barred from acting as the chief compliance officer of any broker, dealer, or investment advisor for one year. Wayne must also undergo 30 hours of compliance training relating to the Advisers Act before being able to take on a compliance role again.