Alert September 13, 2022

SEC Sends Message to Private Fund Sponsors on Audit Obligations Under Custody Rule Through Enforcement Actions

On September 9, 2022, the SEC announced settlements with nine SEC-registered investment advisers to private funds with respect to alleged violations of Rule 206(4)-2 under the Investment Advisers Act of 1940 (the “Custody Rule”) and related Form ADV violations.[1] Specifically, these settlements included three types of violations: (i) the failure to have a private fund audited in accordance with the annual audit exemption under the Custody Rule, (ii) the failure to timely deliver the audited financial statements as required under the Custody Rule, and (iii) the failure to amend Form ADV, Part 1A, Schedule D, Section 7.B.23.(h) to reflect the receipt of the audit opinion following the annual amendment of the Form ADV.

A summary chart of the enforcement actions is below. It is notable that, in one instance, the sole alleged violation was the failure to amend the Form ADV in a timely fashion and, in two other instances, the sole alleged violation was the failure to deliver the audited financial statements within the time requirements of the Custody Rule. There is not, however, sufficient information in the releases relating to these enforcement actions to know the specific facts and circumstances, including whether there were other aggravating factors.

The SEC Division of Examinations had previously indicated that compliance with the annual audit exemption would be an examination priority this year.[2]

SEC-registered private fund sponsors should review their compliance policies and procedures with respect to the Custody Rule, including, in particular:

  • Update Form ADV after receipt of audit opinion. Question 23(h) of Section 7.B.(1) of Schedule D of Form ADV Part 1A requires a private fund adviser to report whether the auditor provided an unqualified opinion with respect to the private fund’s audit. It has three options: “Yes”, “No”, and “Report Not Yet Received”. A private fund sponsor that reports “Report Not Yet Received” is required by the instructions to promptly file an amendment upon receipt of an audit opinion. A private fund sponsor should consider policies and procedures to ensure that (i) Question 23(h) is appropriately answered “Yes” or “No” for any audit opinion received prior to the filing of the annual amendment and (ii) amend the answer to Question 23(h) promptly upon receipt of the audit opinion if it arrives after the annual amendment.
  • Ensure timely delivery of audited financial statements. A private fund sponsor relying on the annual audit exemption in the Custody Rule is required to ensure that the audited financial statements are delivered within 120 days of the end of the fund’s fiscal year (with an allowance for certain longer time periods for funds of funds). Private fund sponsors should consider policies and procedures (i) to ensure the timely delivery of audited financial statements, (ii) to identify circumstances where the audited financial statements may not be delivered in a timely fashion and attempt to mitigate any such delay, and (iii) after any failure to deliver the audited financial statements in a timely fashion, identify the reasons for such failure and take steps to reduce the likelihood of a similar failure in the future.
  • Identification of entities that need to be separately audited. Private fund sponsors should consider policies and procedures to review whether newly created entities are required to be audited under the Custody Rule, including the various entities created below and above the main fund or funds (e.g., special purpose vehicles formed to facilitate one or more investments, aggregators, feeder funds, tax blockers). These entities may be created at the fund formation stage or at the investment stage (e.g., to facilitate one or more investments). As a general rule, a separate audit may be required if either (i) the assets of the vehicle are not considered within the scope of the audit of another vehicle (e.g., the main fund) or (ii) the vehicle has an owner that is not the (a) adviser, (b) its related persons, or (c) a pooled investment vehicle client that is controlled by the adviser or its related persons. For example, if a private fund adviser forms a special purpose vehicle that invests in a portfolio company and an unaffiliated third party co-invests into that special purpose vehicle, that special purpose vehicle may need to be audited separately to comply with the Custody Rule, depending on the facts and circumstances. It is important in these circumstances to distinguish between an investment-oriented special purpose vehicle (which may be a special situation investment company) and a holding company of a portfolio company (i.e., the holding company is engaged in a non-investment business directly or indirectly through its subsidiaries).
  • Identification of investors that need to receive the audited financials. The delivery requirement of the audited financial statements under the Custody Rule is not considered to be satisfied if the financial statements are sent to vehicles (e.g., limited partnerships, limited liability companies, or other pooled investment vehicles) that are related persons of the adviser. Therefore, in connection with the process for identifying which entities need to be separately audited (discussed above), a private fund sponsor should also determine where it is required to deliver the audited financial statements of the entity not just to its direct beneficial owners but also to the beneficial owners of affiliated pooled investment vehicles that have invested in the entity.

We will continue to monitor the developments coming out of the SEC and provide further updates. Please reach out to the authors of this alert or the Goodwin lawyer with whom you typically consult if you have any questions.


[1] https://www.sec.gov/news/press-release/2022-156.
[2] See Client Alert: Spotlight To Get Brighter On Private Fund Advisers For SEC Exams In 2022

Investment Adviser Name Violations Penalty Detail of Violations
BiscayneAmericas Advisers L.L.C.

Timely Delivery

Failure to Amend Form ADV

$135,000
  • 1 fund failed to timely deliver the audited financials in 4 years
  • 1 fund failed to timely deliver the audited financials in 3 years
  • 1 fund failed to timely deliver the audited financials in 2 years
  • Failed to update Form ADV, Question 23(h) for 1 fund in three years
Garrison Investment Group LP

Failure to Audit

Timely Delivery

Failure to Amend Form ADV

$330,000
  • 1 fund failed to be audited for 2 years
  • 1 fund failed to timely deliver the audited financials in 2 years
  • Failed to update Form ADV, Question 23(h) for seven funds in 2019 and 1 fund in 2020 and 2021
Janus Henderson Investors US LLC Timely Delivery $150,000
  • 1 fund failed to timely deliver the audited financials in 3 years to 10% of the investors
Lend Academy Investments

Failure to Audit

Timely Delivery

Failure to Amend Form ADV

$75,000
  • 1 fund failed to timely deliver the audited financials in 2 years
  • 1 fund failed to be audited for 3 years
  • 1 fund failed to be audited for 4 years
  • Failed to update Form ADV, Question 23(h) for 1 fund in 1 year
  • Failed to amend Form ADV to reflect fund was no longer subject to annual audit
Polaris Equity Management, Inc.
Timely Delivery $50,000
  • 1 fund failed to timely deliver the audited financials in 3 years
QVR LLC
Failure to Amend Form ADV
$50,000
  • Failed to update Form ADV, Question 23(h) for 2 funds in 1 year
Ridgeview Asset Management Partners LLC

Timely Delivery

Failure to Amend Form ADV

$70,000
  • 3 funds failed to timely deliver the audited financials in 1 year
  • Failed to update Form ADV, Question 23(h) for 1 fund in 2 years
Steward Capital Management, Inc.

Timely Delivery

Failure to Amend Form ADV

$75,000
  • 2 funds failed to timely deliver the audited financials in 4 years
  • Failed to update Form ADV, Question 23(h) for 2 funds in 3 years
Titan Fund Management, LLC

Timely Delivery

Failure to Amend Form ADV

$95,000
  • 1 fund failed to timely deliver the audited financials in 2 years
  • 1 fund failed to timely deliver the audited financials in 1 year
  • Failed to update Form ADV, Question 23(h) for 1 fund in 1 year