“Is your fund administrator your gatekeeper? They should be.”

Service providers to investment funds are facing more scrutiny in their role as a gatekeeper.  Recent settlements and penalties levied on auditors and a private fund administrator within the past few months are just the start of what is going to be a tougher environment for service providers in the alternative asset space. The SEC and other regulatory agencies are building their staff to focus more on not just the fund managers but the industry as a whole to bolster the accountability of the various gatekeepers and confidence of investors.

With our focus on emerging managers, Tower comes across great new managers who are looking to build a sustainable business and do right by their investors by surrounding themselves with quality attorneys, auditors and administrators. We also see those who are not so well intended and attempt to use these established firms as a false gatekeeper to hide behind.  Some of these managers use the gatekeeper name as a sole purpose of gaining potential investor trust by “selling” the idea that they have oversight and control over the investors’ capital.  However, the manager does not give the administrator and auditor direct access to the accounts and documents they need to do fulfill this function.

As much as there are fund managers who are “bad actors”, there are services providers such as those who were found guilty of failing their gatekeeper responsibilities that perpetuated fraud in their clients that could fall into that category. Either driven by complacency, lack of professional skepticism, or placing fees over everything else caught these firms exposed to scrutiny and punishment. One key element found in these cases is that they knew of the wrong doing but decided to ignore it and continue with a “business as usual” approach. The tone at the top usually sets the atmosphere that breeds this virus and I expect more suits to follow.

Regulators often use the term “gatekeepers” to refer to those within the organizational hierarchy who have fiduciary or professional obligations to spot and prevent potential misconduct, and respond to any problems that do occur.

A series of specific regulatory developments over the last year combine to increase the personal liability concerns of gatekeepers:

“Operation Broken Gate.” The SEC’s Enforcement Division, through its “Operation Broken Gate” initiative, is also formally focused on the accountability of “gatekeepers who fail to carry out their duties and responsibilities consistent with professional standards.” While this particular initiative focuses on identifying wrongdoing by auditors, Division staff will also review the conduct of attorneys and other gatekeepers who have special duties and responsibilities to ensure that the interests of investors are safeguarded.

Here are some excerpts from recent SEC staff discussions, and settlements:

Directors Forum 2016 Keynote Address
Andrew Ceresney, Director, Division of Enforcement
San Diego, California, Jan. 25, 2016

“I start with the proposition that the importance of aggressively pursuing financial reporting deficiencies cannot be overstated. Comprehensive, accurate, and reliable financial reporting is the bedrock upon which our markets are based. Materially false or incomplete financial reporting saps investor confidence and erodes the integrity of our markets. The Commission is committed to holding accountable those whose actions prevent investors from receiving timely and reliable information that enables them to make informed investment decisions.
Given the importance of financial reporting and auditing to the integrity of our markets and the protection of investors.”

The Importance of Gatekeepers

“Let me now turn to gatekeepers in the financial reporting process. In the financial reporting area, like in many others, gatekeepers are critical to helping ensure that issuers make timely, comprehensive, and accurate disclosure. Audit committee members and external auditors in particular are among the most important gatekeepers in this process, and each has a responsibility to foster high-quality, reliable financial reporting.”

Administrators and auditors need to demand objective evidence and investigation when they come across situations which suggest inaccuracies in the company filings.

Private Fund Administrator Charged With Gatekeeper Failures
Washington D.C., June 16, 2016 —
The Securities and Exchange Commission today announced that a firm providing administrative services to private funds has agreed to pay more than $350,000 to settle charges that it failed to heed red flags and correct faulty accounting by two clients.

SEC investigations found that Apex Fund Services (US) Inc. missed or ignored clear indications of fraud while contracted to keep records and prepare financial statements and investor account statements for funds.

“Fund administrators are responsible for ensuring that fund records provide accurate information about the value and existence of fund assets,” said Andrew Ceresney, Director of the SEC’s Division of Enforcement. “Apex failed to live up to its gatekeeper responsibility and essentially enabled the schemes to persist at each of these advisory firms until the SEC stepped in.”

• Apex failed to correct previously issued accounting reports and capital statements and continued to provide materially false reports and statements to investors and the funds’ independent auditor.
• Apex sent monthly account statements to investors that it knew or should have known materially overstated the investors’ true holdings in the funds.

SEC Charges BDO and Five Partners in Connection With False and Misleading Audit Opinions.  The full SEC press release can be found here: https://www.sec.gov/news/pressrelease/2015-184.html.

BDO’s settlement with the SEC, which also saw it paying $2.1 million in penalties and disgorgement, is the latest exercise of the agency’s authority to force respondents to admit wrongdoing in settlements. It also was the first time such a demand was placed on an audit firm.

“I hope that the message of this case will be that audit firms need, when they see red flags, to ensure that they receive reasonable and coherent answers from the client before they “sign off” on financial statements, Ceresney said.

The alternative asset space has been a focus of many negative campaigns in recent years relating to bad managers, as industry service providers we should make sure we collectively step up to be gatekeepers of our industry in addition to our clients.