CURRENT MONTH (September 2024)
SEC Approves PCAOB Rule and Standards
By: Thomas W. White, Retired Partner, WilmerHale
The Public Company Accounting Oversight Board’s current strategic objectives include modernization of auditing and other professional standards and strengthening enforcement. Consistent with this agenda, in August and September, the Securities and Exchange Commission approved one new rule and three standards adopted by the PCAOB. The approved actions were:
- Contributory Liability. The PCAOB amended its Rule 3502 to loosen the liability standard for associated persons of registered public accounting firms whose actions or omissions “directly and substantially contribute” to the firm’s violation of relevant laws, rules, or standards. Previously, liability could only be imposed for knowing or reckless conduct; the revised standard also allows liability for conduct that is merely negligent. The SEC approved this rule change by a 3–2 vote.
- General Auditor Responsibilities. The PCOAB adopted a new Auditing Standard (AS) 1000, and related amendments. AS 1000 reorganizes and consolidates auditing standards that address general principles and responsibilities of the auditor in conducting an audit, such as the concepts of due professional care, professional skepticism, competence, and professional judgment. The SEC approved this standard unanimously.
- Technology. The PCAOB adopted amendments to auditing standards that address aspects of audit procedures that involve technology-assisted data analysis. The SEC approved these amendments unanimously.
- Quality Control. The PCAOB adopted a new Quality Control (QC) standard, QC 1000. QC 1000 establishes an integrated, risk-based quality control standard that will require all registered public accounting firms to identify specific risks to their practice and design a quality control system that includes appropriate responses to guard against those risks. The SEC approved this standard by a 3–2 vote. Notably, the final standard includes a requirement that firms that audit more than one hundred public companies establish an independent External Quality Control Function, which was not included in the proposed rule. The SEC rejected criticisms of the procedure by which PCAOB adopted this provision.
SEC’s Recent Enforcement Actions against Investment Advisers and Representatives
By: Karen Liu, Reid & Wise LLC
Early this month, the U.S. Securities and Exchange Commission (“SEC”) let pass the deadline for appealing the vacated private fund advisers rules to the U.S. Supreme Court. In July 2024, the SEC also elected not to seek en banc review at the Fifth Circuit. However, the SEC’s strategy towards the vacated private fund advisers rules does not necessarily indicate a shift in focus from regulating investment advisers and their representatives, whether or not they manage private funds. In fact, the SEC’s pervasive and intense enforcement actions against investment advisers and their representatives in recent months seem to signal the SEC’s efforts to enforce its way to compliance.
The following provides some examples of such enforcement actions taken by the SEC in September 2024. It is worthwhile for investment advisers and their representatives to be alert to the compliance deficiencies and traps identified in the SEC’s enforcement actions and learn from other firms’ remedial measures about how to avoid penalties.
- Books and records violation due to recordkeeping failures in handling off-channel communications:
- Eleven Firms to Pay More Than $88 Million Combined to Settle SEC’s Charges for Widespread Recordkeeping Failures, September 24, 2024. [Note: One additional firm will not pay a penalty because it self-reported, self-policed, and demonstrated substantial efforts at compliance.]
- Release No. 6719 / September 23, 2024. [Note: The SEC did not impose a penalty because the investment adviser self-reported the deficiencies in handling off-channel communications, took prompt steps to remediate the violations, and cooperated with the SEC staff with respect to its investigation of another entity.]
- Release No. 101141 / September 24, 2024. [Note: The dual registrant and its affiliated registered investment adviser were jointly ordered to pay $35 million as civil penalty.]
- Failure to register with the SEC as an investment adviser:
- Failure to comply with the Marketing Rule:
- Liability disclaimer violations involving hedge clauses and savings clauses:
- Misleading redemption practices due to failing to disclose informal shorter notice practices to all investors and failing to observe required notice periods:
- Limited partnership agreement breach due to failing to disclose related party transactions to limited partners and obtain LPAC (limited partnership advisory committee) approval:
- Breach of fiduciary duty of care due to failing to disclose conflicts of interest to advisory clients:
- Breach of fiduciary duty and compliance failures due to inadequate disclosures of structured notes and payment from a broker:
- Fraudulent advisory services due to exceeding clients’ designated investment limits:
- Fraudulent “cherry-picking”:
- Failure to supervise associated person to prevent “cherry-picking”:
- Custody rule failure due to failing to timely distribute annual audited financial statements to fund investors:
- Custody rule failure due to failing to maintain crypto securities with a qualified custodian:
- Failure to file Form 13F and/or Form 13H:
- Misstatements of regulatory assets under management and other information in Form ADV:
- Misleading information in quarterly newsletters sent to limited partners or investors:
- Failure to implement policies and procedures:
Most of the enforcement actions identified multiple compliance failures of a respondent/defendant. Among the compliance failures, books and records violations and policies and procedures failures are more frequent. In addition, off-channel communications, liability disclaimers, marketing and advertising, consistency between marketing and Form ADV, disclosures of conflicts of interest, and timely delivery of audited financials are common issues facing almost all investment advisers. Firm compliance officers may want to proactively revisit their compliance manuals and daily practices to identify possible loopholes and take necessary measures for better compliance.
On November 7, 2024, the SEC will host a virtual national seminar for investment companies and investment advisers on compliance-related topics. A link to the free live webcast will be made available the morning of November 7 on SEC.gov.
Recent SEC Leadership Remarks—Including Commissioner Testimony Before Congress—Discuss Crypto Assets, AI, and More
By: Rani Doyle
On September 24, 2024, all five SEC commissioners testified before the US House of Representatives Committee on Financial Services. The presence of all five is rather unusual. Here is a link to the written statement, which highlighted the SEC’s various divisions and their priorities and accomplishments. Divisions between the commissioners became apparent after scripted remarks ended, with a focus on the SEC’s regulation (or nonregulation as some commissioners would say) of crypto assets and congressional regulation of stablecoins. This conversation is ongoing, and increasingly politicized, and the legal and business issues are real.
SEC Chief Accountant Paul Munter gave remarks on September 9, 2024, at the 2024 AICPA and CIMA Conference on Banks and Savings Institutions titled “Accounting for Crypto-Asset Safeguarding Obligations—A Facts-Based Analysis.” His comments discussed recent Office of the Chief Accountant consultations regarding application of Staff Accounting Bulletin 121.
SEC Chair Gary Gensler’s engaging “Office Hours” YouTube series recently addressed AI’s potential use by financial institutions, which he says may lead to “monocultures,” potentially creating systemic risk in finance. He calls for all participants, from financial institutions to regulators, to work on AI models and data aggregators to maintain financial stability.
There are multiple channels for interested parties to thoughtfully contribute to potential lawmaking, as well as business self-regulation. Hopefully good work will prevail over politics.
