SEC sanctions firm over custody rule

The Securities and Exchange Commission (SEC) sanctioned Knelman Asset Management Group (KAMG) and its chief executive and chief compliance officer Irving Knelman for breaking its custody rule.

The firm was not immediately available 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, 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).

However, according to the SEC, KAMG had custody of a fund of funds named Rancho Partners I which was not subject to an annual surprise examination and Rancho investors did not receive quarterly account statements from a qualified custodian.

Rancho’s financial statements were also not audited or distributed to its investors. Furthermore the SEC's order details other violations, including improper discretionary cash distributions, failure to adopt and implement controls designed to safeguard client assets, and failure to conduct annual compliance reviews.

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”. Firms will also rebuked for not sending the audited statements to investors within 120 days of the funds’ fiscal year ends (or 180 days for fund of funds). The lawyer said simply setting up a calendar noting the compliance dates would help with timeliness issues.

KAMG and Knelman agreed to a censure and a cease-and-desist order. KAMG also agreed to pay a $60,000 penalty and Knelman a $75,000 penalty and be barred from acting as a chief compliance officer for at least three years. KAMG and Knelman also consented to compliance training.

In March the SEC warned registered investment advisors that it was on the look out for custody rule violations. The alert said that not all registered private equity firms were even aware of their duty to comply with the rule.