SEC Sanctions Adviser For Failing To Follow Its Procedures
It is axiomatic that investment advisers are required to the follow dictates of firm operating documents, internal procedures and disclosed policies and procedures. OCIE, when conducting inspections, focuses on such issues. The SEC has brought a series of cases centered on failures to conform to the dictates of these documents. Nevertheless, advisers continue to run afoul of their own documents and procedures. The result is an enforcement action as in In the Matter of Potomac Asset Management Company, Adm. Proc. File No. 3-18168 (Sept. 11, 2017).
Potomac Asset is a registered investment adviser. Its founder, control person, and president, Goodloe Byron, Jr. is also named as a Respondent. He controls the general partner of Fund I and Fund II.
Potomac Asset provides advisory and management services to Fund I and Fund II. The LPA for each Fund dictates that certain capital contributions be made in a timely manner. Those LPAs also set the amount of management fees paid by the Funds and Potomac Assets’ obligation to pay the operating expenses. The LPAs do permit Potomac to provide services to portfolio companies held by either of the Funds in return for remuneration. The Fund involved, however, is entitled to receive a 50% reduction in management fees.
Between 2012 and 2013 Potomac Asset provided services that resulted in $2.2 million in charges to a portfolio company of Fund I. Potomac Asset, however, charged the fees to Fund I rather than the portfolio company. This was not authorized by the LPA; no disclosure was made. Ultimately the portfolio company reimbursed the cost of the fees. Potomac Asset failed to reduce the management fees as required.
During the period, Potomac Asset also improperly charged certain expenses to the Funds. First, certain operating expenses as well as investigative expenses from an OCIE inspection and staff investigation were improperly charged in violation of the terms of the PPM. Second, the cost of work done by Individual A, supposedly a Principal, who functioned as an employee, were also improperly charged to the Funds. There was no disclosure of these improper charges in the Forms ADV.
The improper expense charges also resulted in a violation of the custody rule. Since the charges were among related parties, they had to be disclosed in the audited financial statements for the funds as related party transactions. The failure to make those disclosures resulted in the financial statements not being prepared in accord with GAAP – they could not be used to secure an exemption from the custody rule.
Finally, Mr. Bryon failed to make his capital contributions in accord with the dictates of the LPAs. And, the firm failed to properly implement its compliance policies and procedures. The Order alleges willful violations of Advisers Act Section 206(2), 206(4) and 207.
To resolve the matter, Potomac Asset undertook certain remedial actions. Each Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm also consented to the entry of a censure. Respondents will, jointly and severally, pay a penalty of $300,000.