On September 5, 2023, a series of enforcement actions by the Securities and Exchange Commission (SEC) reiterated its stance on audit obligations in the private-fund sphere. The SEC announced settlements with five registered investment advisors, marking an escalation in its crackdown on alleged violations of Rule 206(4)-2 under the Investment Advisers Act of 1940 (the Custody Rule) and related Form ADV violations. The actions, coming almost a year after a similar wave of enforcement, underline the SEC’s ongoing commitment to uphold regulatory standards in the inherently complex world of private funds.
The enforcement actions are significant in the larger backdrop of regulatory scrutiny. Privately sponsored funds, principally hedge funds and private equity funds, are complex by nature, entail a different risk profile, and require a certain degree of regulatory oversight. The SEC’s enforcement actions send a clear message to profit-driven private funds that compliance with existing regulations, especially those relating to financial audits, is non-negotiable.
The Custody Rule, cited in these charges, outlines the obligations of registered investment advisors concerning client funds and securities. Advisors must have a reasonable basis for believing that the custodian is sending quarterly account statements to the client, or ensure clients receive an annual surprise examination by an independent public accountant. Any failure by fund sponsors to comply with audit obligations under the Custody Rule could lead to severe repercussions, if the latest enforcement actions are any indication.
The settlement of these charges reaffirms the SEC’s position that custodial misconduct and non-compliance with regulatory obligations would not be overlooked. This recent wave of enforcement underscores the SEC’s readiness to use its powers to ensure the integrity of the financial marketplace and protect retail investors.
As a legal professional or a stakeholder in the private funds industry, these enforcement messages from the SEC should be seen not only as punitive actions but as a clear signal to reassess and tighten compliance procedures. Compliance is not just a legal obligation, but it’s an essential part of risk management strategies and a key driver of the long-term success for registered investment advisors.