SEC Proposes Rule Amendments to Strengthen Safeguards of Investor Funds Controlled by Investment Advisers
The Securities and Exchange Commission today proposed rule amendments to substantially increase protections for investors who entrust their money to investment advisers.
The SEC is seeking public comment on the proposed measures, which are intended to ensure that investment advisers who have "custody" of clients' funds and securities are handling those assets properly. In some recent SEC enforcement actions, firms and principals have been charged with misusing clients' money and covering up their illicit activities by distributing false account statements showing non-existent funds. The additional safeguards proposed by the SEC include a yearly "surprise exam" of investment advisers performed by an independent public accountant to verify client assets. In addition, when an adviser or an affiliate directly holds client assets, a custody control review would have to be conducted by a PCAOB registered and inspected accountant.
"These new safeguards are designed to decrease the likelihood that an investment adviser could misappropriate a client's assets and go undetected," said SEC Chairman Mary Schapiro. "That's because an independent public accountant will be looking over their shoulder on at least an annual basis."
Andrew J. Donohue, Director of the SEC's Division of Investment Management, added, "The amendments proposed by the Commission today would significantly strengthen controls over client assets held by registered investment advisers - especially when those assets are held directly by the adviser itself or a related person of the adviser."
Unlike banks or broker-dealers, investment advisers generally do not have physical custody of their clients' funds or securities. Instead, client assets are typically maintained with a broker-dealer or bank (a "qualified custodian"), but the adviser still may be deemed to have custody because the adviser has authority to withdraw their clients' funds held by the qualified custodian. Or the qualified custodian may be affiliated with the adviser, which may give the adviser indirect access to client funds.
The SEC's proposed rule amendments, if adopted, would promote independent custody and enable independent public accountants to act as third-party monitors.
One proposed amendment would require all registered advisers with custody of client assets to undergo an annual "surprise exam" by an independent public accountant to verify those assets exist.
Another proposed amendment would apply to investment advisers whose client assets are not held or controlled by a firm independent of the adviser. In such cases, the investment adviser will be required to obtain a written report - prepared by a PCAOB-registered and inspected accountant - that, among other things, describes the controls in place, tests the operating effectiveness of those controls, and provides the results of those tests. These reports are commonly known as SAS-70 reports. This review would have to meet PCAOB standards - providing an important level of quality control over the accountants performing the review.
The proposed measures also would include reporting requirements designed to alert the SEC staff and investors to potential problems at an adviser, and provide the Commission with important information for risk assessment purposes. An adviser would be required to disclose in public filings with the Commission, among other things, the identity of the independent public accountant that performs its "surprise exam," and amend its filings to report if it changes accountants. The accountant would have to report the termination of its engagement with the adviser and, if applicable, any problems with their examination that led to the termination of its engagement. If the accountants find any material discrepancies during the surprise examination, they would have to report them to the Commission.
The proposed amendments also would require that all custodians holding advisory client assets directly deliver custodial statements to advisory clients rather than through the investment adviser, and that advisers opening custody accounts for clients instruct clients to compare account statements clients receive from the custodian with those received from the adviser. These additional safeguards would make it more difficult for an adviser to prepare false account statements, and more likely that clients would find discrepancies.
Public comments on today's proposed rule amendments must be received by the Commission within 60 days after their publication in the Federal Register. (Press Rel. 2009-109)
Securities and Exchange Commission Orders Hearing on Registration Revocation or Suspension Against Four Public Companies for Failure to Make Required Periodic Filings
The Commission today instituted public administrative proceedings to determine whether to revoke or suspend for a period not exceeding twelve months the registration of each class of the securities of four companies for failure to make required periodic filings with the Commission:
In this Order, the Division of Enforcement (Division) alleges that the four issuers are delinquent in their required periodic filings with the Commission.
In this proceeding, instituted pursuant to Exchange Act Section 12(j), a hearing will be scheduled before an Administrative Law Judge. At the hearing, the judge will hear evidence from the Division and the respondents to determine whether the allegations of the Division contained in the Order, which the Division alleges constitute failures to comply with Exchange Act Section 13(a) and Rules 13a-1 and 13a-13 or 13a-16 thereunder, are true. The judge in the proceeding will then determine whether the registrations pursuant to Exchange Act Section 12 of each class of the securities of these respondents should be revoked or suspended for a period not exceeding twelve months. The Commission ordered that the Administrative Law Judge in this proceeding issue an initial decision not later than 120 days from the date of service of the order instituting proceedings. (Rel. 34-59922; File No. 3-13471)
Former Massachusetts Investment Adviser Sentenced to Ten Years for Defrauding Investment Advisory Clients
The Securities and Exchange Commission announced today that on May 11, 2009, in a case prosecuted by the United States Attorney for the District of Massachusetts, a federal judge sentenced investment adviser Amit Mathur, age 38, of Shrewsbury, Massachusetts, to ten years in federal prison on federal mail and wire fraud for defrauding his investment advisory clients. Upon release from imprisonment, Mathur will be placed on supervised release for three years. The Court also ordered Mathur to pay restitution in the amount of $12,572,237.28 and a special assessment of $2,000.00. Mathur, who operated an advisory firm called Entrust Capital Management, Inc., in Worcester, Massachusetts, is also a defendant in a Commission civil action filed in April 2005.
Mathur was initially indicted on criminal charges on Sept. 28, 2006. At Mathur's two-week long criminal trial in May 2008, evidence was presented that Mathur, beginning in 2001, raised several million dollars in investor funds and dissipated millions in investor funds through undisclosed trading losses, unauthorized use of investor funds, and use of client funds for Mathur's personal expenditures. According to evidence presented at the criminal trial, Mathur used investor funds to, among other things, buy a Porsche Cayenne, purchase Mercedes Benz luxury vehicles, and fund gambling trips to Las Vegas for Mathur and his friends. A federal jury found Mathur guilty on May 16, 2008.
The Commission filed its action against Mathur and Entrust on April 12, 2005, and filed an Amended Complaint adding Rajeev Johar as a defendant on Sept. 14, 2005. The Commission's Amended Complaint alleged that, from 2000 through 2005, the defendants engaged in a scheme to defraud investors in a purported hedge fund run by Mathur and Johar at Entrust. The Amended Complaint alleged that approximately twenty clients invested over $16 million with Entrust. The Commission alleged that the defendants made material misrepresentations to investors about, among other things, their assets under management and returns that the fund generated. According to the Amended Complaint, the defendants dissipated most of the $16 million invested through undisclosed trading losses and misappropriation of investor funds for the defendants' personal use. The Commission's action against Mathur, Entrust, and relief defendant AMR Realty, LLC, is pending. A Final Judgment by consent was entered against Johar in the Commission action on June 4, 2007, which, among other things, ordered him to pay over $600,000 in disgorgement of ill-gotten gains, prejudgment interest, and penalties. In separate administrative proceedings, the Commission issued an Order by consent on June 26, 2007, barring Johar from association with any investment adviser. In separate administrative proceedings following Mathur's criminal conviction, the Commission issued an Order by consent on July 14, 2008, barring Mathur from association with any investment adviser. [SEC v. Amit Mathur, et al. (United States District Court for the District of Massachusetts, C.A. No. 05-10729 (MLW)] (LR-21037)
Approval of Proposed Rule Changes
The Commission approved a proposed rule change (SR-FINRA-2007-012), as modified by Amendment Nos. 1 and 2 thereto, filed by the Financial Industry Regulatory Authority pursuant to Rule 19b-4 under the Securities Exchange Act of 1934 to amend trade reporting rules to require a related market center indicator on certain non-tape reports submitted to FINRA. Publication is expected in the Federal Register during the week of May 18. (Rel. 34-59905)
The Commission approved a proposed rule change (SR-FINRA-2009-013), filed by the Financial Industry Regulatory Authority to amend the tolling provisions of the rules of the Codes of Arbitration Procedure for Customer Disputes and Industry Disputes. Publication is expected in the Federal Register during the week of May 18. (Rel. 34-59906)
Proposed Rule Change
The Commission issued notice of a proposed rule change submitted by NASDAQ OMX BX (SR-BX-2009-021) pursuant to Rule 19b-4 under the Securities Exchange Act of 1934 to amend its Restated Certificate of Incorporation and By-Laws. Publication is expected in the Federal Register during the week of May 18. (Rel. 34-59908)
Immediate Effectiveness of Proposed Rule Changes
A proposed rule change filed by the International Securities Exchange relating to changes to the fee schedule (SR-ISE-2009-26) has become effective pursuant to Section 19(b)(3)(A) of the Securities Exchange Act of 1934. Publication is expected in the Federal Register during the week of May 18. (Rel. 34-59912)
A proposed rule change (SR-NASDAQ-2009-040) filed by the NASDAQ Stock Market to the Nasdaq Listing Rules to conform those rules with the prior marketplace rules and make certain technical corrections has become effective under Section 19(b)(3)(A) under the Securities Exchange Act of 1934. Publication is expected in the Federal Register during the week of May 18. (Rel. 34-59915)
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