[co-author: Chloe Fischetti]
There is a noticeable trend in the fund services industry that is creating increased exposure and legal liability for fund administrators. More and more, fund administrators are now being looked to as gatekeepers in order to protect fund investors and monitor for compliance by fund managers. The SEC is increasingly holding fund administrators liable for the primary misconduct of others. Similarly, investors have been naming fund administrators in civil suits involving misconduct and fraud by fund managers. As such, fund administrators should be more sensitive to this exposure, and to their duties or alleged responsibilities. Several such cases are highlighted below.
In 2013, the SEC instituted a settled administrative proceeding against Northern Lights Compliance Services (“Northern Lights”),[1] among others, in connection with certain alleged disclosure, reporting, recordkeeping and compliance violations. Under Section 15(c) of the Investment Company Act of 1940, before entering into or renewing an advisory contract, directors of registered investment companies are required to request information that is reasonably necessary to evaluate that contract. The directors are to evaluate the information and, under Rule 30e-1, disclose in detail the basis for approval or renewal of the contract in a shareholders report. Under Rule 31a-2, funds are also required to retain copies of the written materials used in the evaluations. Additionally, Rule 38a-1 requires funds to implement policies that are reasonably designed to prevent violations of federal securities laws. The SEC alleged that Northern Lights made disclosures in shareholder reports in relation to advisory contracts that were materially untrue or misleading. Northern Lights was also found to have violated Rule 38a-1 in failing to implement the proper systems and policies necessary to prevent violations of the law.
Gemini Fund Services, LLC (“Gemini”), the fund administrator, was additionally named as a respondent for its part in the alleged violations. According to the SEC, Gemini was contractually responsible for ensuring that the fund maintained the proper Section 15(c) files in compliance with Rule 31a-2. According to the SEC, these files were on many occasions incomplete, thereby failing to comply with the rule. Gemini was also responsible for preparing the shareholder reports. Those reports, however, were alleged to have been missing material information in relation to the advisory contract evaluation process. As such, the SEC found that Gemini caused the violations of Rules 31a-2 and 30a-1. Without admitting or denying the allegations, Gemini agreed to the cease-and-desist order, to hire an independent compliance consultant and to pay a civil penalty in the amount of $50,000.
Similarly, in 2015, the SEC instituted a settled administrative proceeding against Deloitte & Touche, LLP (“Deloitte”),[2] arising from its alleged involvement in an independence-impairing relationship. According to the SEC, a Deloitte affiliate, Deloitte Consulting LLP, purchased intellectual property rights for a business methodology from Andrew Boynton and his business partners and hired Boynton as a consultant for the methodology for the purposes of training employees. Simultaneously, Boynton was serving on the boards of three funds for which Deloitte served as an outside auditor, which the SEC alleged caused a significant independence issue unbeknownst to any of the parties. Although Deloitte policies required an independence evaluation before entering into a new business relationship, the SEC alleged no such evaluation was performed. As a result, the SEC claimed that Deloitte violated Rule 2-02 of Regulation S-X, which requires independence from auditors, and Rule 102 of the Securities Exchange Act of 1934, which prohibits improper professional conduct. In addition, Deloitte was also found to have caused the three funds to violate Sections 30(a) and 20(a) of the Investment Company Act, both of which require independence.
ALPS Fund Services, Inc. (“ALPS”), the fund administrator for the three funds, was also charged. ALPS was contractually obligated to assist the three funds in complying with Rule 38a-1 of the Investment Company Act by implementing policies designed to prevent violations of federal securities laws. ALPS did draft policies for the funds, and developed questionnaires that were in part designed to detect independence issues. The SEC alleged, however, that the policies at all times were insufficient, constituting a Rule 31a-1 violation. It was further alleged that ALPS should have known that its conduct would cause a Rule 38a-1 violation. As part of a settlement, both Deloitte and ALPS agreed to cease and desist from future violations and to pay penalties in the amounts of $500,000 and $45,000, respectively, without admitting to or denying the allegations.
The most recent SEC enforcement actions against a fund administrator were against Apex Fund Services (US), Inc. (“Apex”). The SEC instituted two separate administrative proceedings against Apex on the same day for its work with ClearPath Wealth Management, LLC (“ClearPath”),[3] and EquityStar Capital Management, LLC (“EquityStar”).[4] In 2015, the SEC filed a civil complaint against ClearPath and its...
