We’ve discussed multiple times in previous blogs the recent crackdowns the SEC’s Office of Enforcement has been making on registered investment advisers (“RIAs”) and brokers since the beginning of 2023. Even the SEC’s enforcement head, Gurbir Grewal, recently suggested more exam sweeps were on the way which may lead to more enforcement actions. The enforcement train is rolling and seems to show no signs of stopping. As a compliance consulting firm, we pay particular attention to enforcement actions and rulings to determine any potential opportunities for improvement or reminders for clients of our own. A recent case of note for us was the SEC’s enforcement action against Sciens Diversified Managers, LLC.
At the end of May, the SEC announced it had settled charges against New York-based RIA to private funds, Sciens Diversified Managers, LLC, and its predecessor, Sciens Investment Management, LLC (“Sciens”). The SEC had charged Sciens with “failure to adopt and implement reasonably designed written policies and procedures concerning the valuation of fund portfolio investments.” Improper valuation of client assets could quickly lead to issues such as the incorrect calculation of fees or inaccurate performance reporting.
An Order of Compliance Failures
As a firm, Sciens charges management fees to the client private funds quarterly based on determinations of a fund’s net asset value. Primarily, these funds invest in various assets for which there is often no readily available market pricing information or significant observable inputs. Due to a lack of readily available information, Sciens would make valuation determinations on its own accord. But, according to the SEC’s order, from as early as 2016, Sciens violated the “Compliance Rule” (Rule 206(4)-7) within Section 206(4) of the Advisers Act by “failing to adopt and implement reasonably designed written compliance policies and procedures relating to valuation.”
When dealing with financial statements and documents, investment advisers like Sciens are required to follow Generally Accepted Accounting Principles (“GAAP”). Through GAAP, there is a generally accepted definition and framework for measuring fair value of assets and securities. Based on the SEC’s findings, Sciens’ written compliance policies and procedures were not designed to actively prevent violations of the Advisers Act regarding the nature of the investment mandates of the funds managed by Sciens. These compliance policies and procedures, therefore, gave only minimal guidance on how to value these types of investments in accordance with GAAP, leaving room for errors, miscalculations, or other issues that could negatively impact clients and their investments. Simply put, the compliance procedures were not designed for Sciens’ current business practices.
The SEC's Verdict
Without admitting or denying the SEC’s findings, Sciens consented to multiple undertakings from the SEC. While consenting to a cease-and-desist order and censure, Sciens will pay a civil penalty of $275,000. Sciens has also been ordered to retain an independent compliance consultant to assist in a full review of Sciens’ current policies and procedures, including the full calculation of Sciens’ management fees charged or accrued, and implementation of any retroactive adjustments, because of valuation errors from the last seven years of client business.
Key Takeaways
Compliance isn’t a “one-size-fits-all” process. What works for one firm likely will not work for another. Therefore, it’s important to make sure that your compliance policies and procedures are tailored specifically to your business practices and client base. In a situation like that of Sciens, where investment advisers are dealing with complex securities and assets and working in a space where some information may not be readily available, it’s imperative to lay out policies for any scenario that may arise. RIAs have a Duty of Care to ensure they are making the best possible decisions for their clients. The proper valuation of assets falls within these duties and any issues in this space can be mitigated with proper policies and procedures for firms to follow.
As the SEC continues to issue enforcement actions and focus on compliance failures or shortcomings, the need for robust compliance policies continues to grow. As your clients’ needs adjust, so should your compliance procedures. Whenever needed, a veteran compliance firm like Joot can help you elevate your compliance policies in a way that fits your needs.
