March 9, 1994
TO: COMPLIANCE COMMITTEE NO. 4-94
INVESTMENT ADVISER ASSOCIATE MEMBERS NO. 12-94
INVESTMENT ADVISER MEMBERS NO. 11-94
RE: SEC SANCTIONS INVESTMENT ADVISER FOR CUSTODY VIOLATIONS
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The Securities and Exchange Commission recently sanctioned a registered
investment adviser for violating certain provisions of the Investment Advisers
Act of 1940. According to the SEC's order, a copy of which is attached, the
adviser failed to follow required safeguard procedures with respect to its client
assets over which it had constructive, and in some cases direct, custody.
Specifically, the SEC found that certain of the adviser's managers served
as sole or co-trustees of various trust accounts that were custodied at either
banks or broker-dealers. The adviser had received a no-action letter from the
Division of Investment Management in 1983 stating that the adviser would not be
deemed to have custody, possession or control of the funds or securities of the
trusts, provided that it followed certain safeguards. In the attached order, the
SEC found that the adviser failed to comply with the conditions of the no-action
letter and other required safeguards pertaining to transfers of assets from
custodians to the adviser and others.
In addition, the SEC found that the adviser maintained direct custody or
possession of clients' funds or securities in certain instances because of its
employees' signing authority as trustee over four trusts' checking accounts,
unilateral authorization to wire funds from one institutional client's custodial
account, and assumption of custody or possession of clients' securities
certificates.
According to the SEC's order, through these activities, the adviser used
the mails and means and instrumentalities of interstate commerce to engage in
fraudulent, deceptive and manipulative acts, practices and courses of business
in violation of Section 206(4) of the Investment Advisers Act and Rule 206(4)-
2(a)(5) thereunder. The adviser also failed to have an independent accountant
perform at least once annually a surprise audit of custodied funds and securities
and file a certificate with the SEC concerning such audit.
Finally, the SEC found that the adviser violated Section 204 of the
Advisers Act and Rule 204-1 thereunder by failing to amend its Form ADV to
reflect its custody and possession of client funds and securities, failing to
file a balance sheet within 90 days of its fiscal year's end for certain years
and failing to file annual reports on Form ADV-S for those years. The adviser
also violated Section 203 of the Advisers Act and Rule 203-1 thereunder by making
untrue statements of material facts and omitting to state material facts required
to be stated in Forms ADV and ADV-S regarding its custody of advisory client
funds and obligation to file an audited balance sheet.
The SEC ordered the adviser, among other things, to pay a civil penalty of
$25,000 and to retain an independent consultant to review the adviser's policies
and procedures and monitor its activities for five years.
Frances M. Stadler
Associate Counsel
Attachment