The Securities and Exchange Commission today sanctioned a Massachusetts-based investment advisory firm, along with two others in New York and Minneapolis, for violating the "custody rule" that mandates they meet certain standards when maintaining custody of their clients’ funds or securities.
SEC investigations following referrals by agency examiners found that Massachusetts-based GW & Wade, as well as New York-based Further Lane Asset Management and Minneapolis-based Knelman Asset Management Group, failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct surprise exams. The firms also committed other violations of the federal securities laws. Each firm has agreed to settle the SEC’s charges.
The SEC issued orders instituting settled administrative proceedings against the three firms for deficiencies related to the custody rule – Rule 206(4)-2 under Section 206(4) of the Investment Advisers Act of 1940.
According to the SEC’s order against GW & Wade, the firm was subject to the custody rule in part due to its practice of using pre-signed letters of authorization and then transferring client funds without always obtaining contemporaneous client signatures. The firm did not have proper safeguards as a custodian of client funds, and failed to identify itself as a custodian to its independent auditors or in public disclosures. This practice exposed clients to potential harm and ultimately contributed to a third-party fraud in one client account in June 2012, when someone hacked into the client’s e-mail account and posed as the client. The imposter requested that GW & Wade wire the client’s funds to a foreign bank, and the scheme was not discovered until three separate wires totaling $290,000 had been sent to the foreign bank. The firm reimbursed the client.
According to the SEC, GW & Wade additionally made inaccurate Form ADV disclosures about the amount of client assets in custody and its custody arrangements. In consenting to a censure and cease-and-desist order, GW & Wade agreed to pay a $250,000 penalty.
The SEC’s investigation of GW & Wade was conducted by Asset Management Unit members Mayeti Gametchu and Kevin Kelcourse in the Boston Regional Office. The preceding SEC examination was conducted by Raymond Tan, Matthew Keating, John Clark, and Melissa Clough of the Boston office.
The majority of investment advisers do not maintain custody of client assets, which are instead held by qualified third-party custodians like a bank or broker-dealer. Investment advisers must comply with the custody rule if they have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets. The commission amended the custody rule in 2010 to strengthen investor protections by requiring all advisers with custody to undergo an annual "surprise exam" to verify the existence of client assets. Advisers also must have a reasonable basis to believe that a qualified custodian is sending account statements to fund investors at least quarterly. Advisers with custody of hedge fund or other private fund assets may alternatively comply with the custody rule through fund audits by a PCAOB-registered auditor, after which financial statements must be delivered to investors.
