New York Securities Lawyer Blog
On October 29, 2014, the Securities and Exchange Commission’s (“SEC”) Enforcement Division, in an Order Instituting Administrative and Cease-And-Desist Proceedings (“Order”), alleged that Sands Brothers Asset Management, LLC (“Sands Brothers”), its co-founders Steven Sands and Martin Sands, and its Chief Compliance Officer and Chief Operating Officer Christopher Kelly, violated Section 206(4) of the Investment Advisers Act of 1940, which prohibits a registered investment adviser from engaging in fraudulent, deceptive or manipulative conduct, and the ‘custody rule’ in 17 CFR §275.296(4)-2, which requires an adviser to implement procedures to safeguard customer funds and securities. See 17 CFR §275.296(4)-2. Sands Brothers is a New York limited liability company that was formed in 1998, with offices in Connecticut, New York and California, and provides investment advisory services. As of July 2014, Sands Brothers had approximately $64 million under management.
The custody rule outlines the requirements for how a SEC registered investment adviser must maintain custody of client accounts and securities in order to ensure that the investment advisers do not engage in fraud, deceptive, or manipulative acts, when holding their clients’ assets. Although most investment advisers engage third-party custodians to hold their clients’ assets, the firms that do not utilize a third-party custodian, and instead maintain custody of their clients’ assets, create increased concerns for the SEC, as there is a larger chance the investment adviser could engage in fraud. For example, the $65 billion Ponzi scheme perpetrated by Bernard L. Madoff was partially attributed to the fact that Madoff’s firm maintained custody of his clients’ assets, rather than holding the clients’ assets at a third-party custodian. In light of these concerns, the SEC’s National Examination Program (“NEP”) conducted an examination of investment advisers’ compliance with the ‘custody rule’ and found widespread non-compliance in over 140 advisory firms.
Specifically, the ‘custody rule’ requires that a qualified custodian maintain the funds or securities in a separate account for each client under that client’s name or in accounts that contain only clients’ funds and securities, under the adviser’s name as agent or trustee for the clients. Further, if an account is opened with a qualified custodian on the client’s behalf, either under the client’s name or under the adviser’s name as agent, the client must be notified in writing by the adviser of the qualified custodian’s name, address, and the manner in which the funds or securities are maintained, promptly when the account is opened and following any changes to this information. If account statements are sent to a client to whom the adviser is required to provide this notice, the adviser must include in the notification provided to that client, and in any subsequent account statement sent to that client, a statement urging the client to compare the account statements from the custodian with those from the adviser. If the adviser has a reasonable basis, after due inquiry, for believing that the qualified custodian sends at least a quarterly account statement to each of the adviser’s clients for which it maintains funds or securities, identifying the amount of funds and each security in the account at the end of the period and setting forth all transactions in the account during that period, then the adviser satisfies his obligation of ensuring that customers are receiving those statements. The ‘custody rule’ also requires the distribution of audited financial statements to clients within 120 days of the end of the fiscal year.
According to the Order, Sands Brothers distributed the audited financial statements to their clients for 10 private funds eight (8) months late in 2010, 2011, and 2012. Andrew M. Calamari, Director of the SEC’s New York Regional Office, stated that, “Sands Brothers and its senior-most officers have persistently disregarded their obligations under the law and left their clients waiting for months at a time to have the materials they need to verify the existence and value of fund assets.”
In 2010, the SEC filed a Cease and Desist Order, Censure, and Fine which charged Sands Brothers $60,000 for similar ‘custody rule’ violations.
Lax & Neville LLP has nationally represented small broker-dealers, financial services professionals, registered investment advisers and securities industry companies in regulatory matters and securities-related and commercial litigation. Additionally, Lax & Neville has extensive experience in successfully prosecuting claims on behalf of customers who have suffered losses. Please contact our team of attorneys for a consultation at (212) 696-1999.