The SEC settled charges against a firm that provides administrative services to private funds (the "administrator"). The agency found that the firm failed to respond to red flags and correct faulty accounting related to two clients.
The SEC specified that the administrator either ignored or missed red flags that included the following: undisclosed brokerage and bank accounts, related party transactions, inter-series and inter-fund transfers in violation of fund offering documents, and undisclosed margin or credit agreements.
Despite these red flags, the administrator failed to correct the accounting reports and capital statements it had prepared and issued previously to one client, and it continued to provide that client with reports and statements that were materially false. The SEC determined that the client used these false reports and statements to communicate inaccurate financial positions and performance to its investors and independent auditors.
The SEC also asserted that the administrator's other client made materially false and misleading statements to investors and prospective investors by failing to disclose withdrawals it made of over $1 million directly from the funds. The SEC found that the client materially overstated the value of the investors' holdings in the funds because the firm incorrectly characterized the withdrawals as receivables due to the funds. Almost two years after it began working with the client, the firm disclosed the existence of the withdrawals to investors. By that time, asserted the SEC, the investors had suffered significant losses.
The SEC stated that even though the administrator is not subject directly to the Adviser's Act, the SEC may impose a cease-and-desist order under Advisers Act Section 203(k) on any person who is, was or would be a cause of another's violation due to an act or omission that the person knew or should have known would contribute to such violation of any provision of the Advisers Act. Additionally, the SEC found that the administrator was a cause of the advisers' violations of Sections 206(2) and 206(4) of the Advisers Act.
The administrator agreed to retain an independent consultant and pay a total of $352,449 consisting of (i) a disgorgement of $96,800 plus interest of $8,813, and a penalty of $75,000, for its role in the first client's fraud, and (ii) a disgorgement of $89,050 plus interest of $7,786, and a penalty of $75,000, for its role in the second client's fraud.
Commentary
This case sends a powerful message to service providers and other entities that are not directly regulated by the SEC: they still may be subject to sanction whenever their misconduct or negligence allows another entity to violate a requirement to which the other entity is subject directly.
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