Last week at the Coping With Regulatory Failure conference, representatives from Securities and Exchange Commission repeated the SEC’s line that the SEC is not after compliance officers. But yet another case of CCO liability came out and this one kicks the CCO out of the industry and levels a $60,000 fine.
The SEC panelists repeated the line that the SEC only goes after CCOs in three circumstances:
- The CCO participated in the fraud
- The CCO hinders the exam or investigation
- Wholesale failure of the CCO
It’s the “wholesale failure” standard that has left many CCOs wondering if the SEC understands that term.
With a new enforcement action ruling out that pins liability on the CCO I thought it was worth a look to see if it meets the SEC standard.
The SEC announced charges against Sands Brothers Asset Management last year. The charge itself was a fairly technical violation of the Custody Rule. Sands Brothers managed private funds. According to the SEC’s order instituting an administrative proceeding, Sands Brothers was at least 40 days late in distributing audited financial statements to investors in 10 private funds for fiscal year 2010. The next year, audited financial statements for those same funds were delivered anywhere from six months to eight months late. The same materials for fiscal year 2012 were distributed to investors approximately three months late.
That’s not good. But it is a bit technical.
The really bad part is the SEC has been after the firm to fix this problem for years. Sands Brothers and its co-founders first landed in trouble in 1999. The exam noted a deficiency for custody rule procedures. The firm thought it did not have custody, but as a manager of a private fund, it does have custody.
Sands Brothers landed in trouble again 2010 when the firm was the subject of an enforcement action for custody rule violations. The firm failed to submit an adequate audit and did not timely distribute audited financial statements.
“There is no place for recidivism in the securities markets… so now they [the Firm] face more severe consequences,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.
So it’s hard to have any sympathy for the firm for the Custody Rule violations.
But what about the CCO? These are the factors that apparently caused the CCO to be a “wholesale failure.”
- The CCO knew or was reckless in not knowing about, and substantially assisted,
SBAM’s violations of the custody rule. (The CCO had executed the notarized offer of settlement to enter into the 2010 Order on behalf of Sands Brothers.) - The compliance manual tasked the CCO with “ensur[ing] compliance with the restrictions and requirements of Rule 206(4)-2 adopted under the Advisers Act.”
- Kelly engaged the auditors for full audits (but not surprise examinations)
- The CCO signed representation letters to, and was a principal contact for, the auditors.
- The CCO knew that the audited financial statements were not being distributed on time.
- The CCO implemented no policies or procedures to ensure compliance with the custody rule – even after the 2010 Order and after Sands Brothers continued to miss its custody rule deadline year after year.
- The CCO simply reminded people of the custody rule deadline without taking any more substantial action.
- The CCO did not make any attempt to notify the staff of the Commission of any difficulties Sands Brothers was encountering in meeting the custody rule deadlines.
It’s hard to have much sympathy for the CCO in this situation. The Principals of the firm were also subject to bar and monetary fines, so the CCO was not singled out.
The ALJ decision had blamed the CCO for being “reckless” for not doing more to prevent the custody violations. The Settlement Order with the COO also said that he “knew or was reckless in not knowing about” the custody violations.
If we go by the SEC’s earlier standard, then the SEC is equating “reckless” with “wholesale failure.” It would have been much better for the SEC to use the standard is has been espousing: “wholseale failure”; rather than using the “reckless” standard in the order.
Sources:
- Custody Rule Violators Settle Charges
- SEC order – Kelly
- CCO Part of Custody Settlement but Firm Owners Take the Heavy Hit in IA Watch
- Custody Rule Enforcement
Failure is from Graphic Leftovers under license
