The SEC recently charged a large public accounting firm (Accounting Firm) with violations of its auditor independence rules (Independence Rules) in connection with more than 100 audit reports involving at least 15 audit clients, including several private funds. According to the SEC’s order, the Accounting Firm represented that it was “independent” in audit reports issued on the clients’ financial statements. However, the SEC found that the Accounting Firm or its affiliates provided prohibited non-audit services to affiliates of those audit clients (including to portfolio companies of the private funds), which violated the Independence Rules. The prohibited non-audit services included corporate secretarial services, payment facilitation, payroll outsourcing, loaned staff, financial information system design or implementation, bookkeeping, internal audit outsourcing and investment adviser services. The SEC also found that certain of the Accounting Firm’s independence controls were inadequate, resulting in its failure to identify and avoid these prohibited non-audit services.
Among the Accounting Firm’s clients impacted by its breach of the Independence Rules were several private funds, which engaged the Accounting Firm to audit their financial statements in order to satisfy the requirements of Rule 206(4)-2 (Custody Rule) under the Investment Advisers Act of 1940 (Advisers Act). However, consulting personnel of the Accounting Firm or its affiliates were also separately engaged to provide prohibited non-audit services to several portfolio companies of the funds in violation of the Independence Rules. The SEC found that the Accounting Firm failed to implement sufficient procedures to detect and prevent these types of violations of the Independence Rules, and that Accounting Firm personnel failed to correctly follow the procedures that were in place. As a result, the Accounting Firm not only violated the Independence Rules (and other federal securities laws), but also caused multiple registered investment advisers to violate Section 206(4) of the Advisers Act and the Custody Rule.
As part of its settlement with the SEC, the Accounting Firm (i) agreed to pay a $950,000 penalty, (ii) was censured and (iii) agreed to engage an independent consultant to evaluate its current quality controls for complying with the Independence Rules.
In light of this settlement, private fund sponsors (especially
those who rely on the audit provision of the Custody Rule) may want to speak
with their funds’ auditors to seek to ensure that such firms have procedures in
place to ensure compliance with the Independence Rules.
- The SEC order can be found at https://www.sec.gov/litigation/admin/2019/34-86770.pdf.↵
- The Custody Rule requires advisers registered with the SEC that have custody of client assets to take steps to safeguard those assets. A private fund adviser may comply with the Custody Rule by having the financial statements of its funds audited annually by an independent public accountant that is registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board. If the auditor is not independent, the adviser will not be in compliance with the rule. Exempt reporting advisers are not subject to the Custody Rule.↵
- For example, at one point consulting teams were not required to search for audit services provided to affiliates of their clients, and even after a requirement to conduct such a search was implemented, two consulting teams failed to complete the required forms, and a team that did complete the form inaccurately responded that its client was not majority-owned by the fund complex in question. Furthermore, on several occasions consulting personnel improperly entered their clients’ names into a client database and did not tag their clients as related to the adviser.↵