The vast majority of private funds use the audited financial statements alternative for compliance with the Custody Rule. Fund managers have custody of the fund assets. Fund investors typically demand audited financial statements from their fund managers. So the audited financial statement work well with the Custody Rule and provides some third-party verification that the manager is not misusing or misappropriating client funds or assets.
The audited financial statements alternative under the Custody Rule has three main requirements:
- Have the audit done by an independent public accountant that is registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board,
- Distribute the audited financial statements to all investors in the fund, and
- Deliver the audited financial statements within 120 days of the end of the fund’s fiscal year.
The SEC just brought an action against a New Jersey fund manager for failing to meet these three requirements of the Custody Rule.
TSP Capital in Summit, New Jersey, has been registered with the SEC as an investment adviser since 2004. TSP Capital was the manager of two private funds. The largest was Cameroon Enterprises.
According to the SEC Order, TSP Capital relied on the Audited Financials Alternative to the Custody Rule but failed to comply with the requirements from 2014 through 2018. For 2014, the audit report was mailed to investors 686 days late; for 2015, the audit report was mailed to investors 927 days late. For the following years, TSP Capital did not succeed in engaging an audit firm to audit the Cameroon Fund’s annual financial statements.
This was likely easy to catch by the SEC. On the Form ADV filing, TSP Capital had to provide information about the fund in question 7.B.(1) Private Fund Reporting. Question 23(a)(1) asks :
“Are the private fund’s financial statements subject to an annual audit?”
TSP Capital answered this as “No.” I’m sure that checking “no” instead of “yes” is a red flag for the SEC.
The SEC made no claim of misuse of clients funds in the order. This was treated merely as a footfault.
Sources:
- Order Against TSP Capital
- TSP Capital Form ADV Filing
- PF Adviser fined $60k for failing to secure audits (Regulatory Compliance Watch)
- Private Fund Sponsor Fined for Failing to Deliver Audited Financials Cipperman’s Our Take Blog
- Custody Rule – Staff Response to Questions
