2018 SEC enforcement action involving independence for custody rule & broker-dealers

In September 2018, the Securities and Exchange Commission (SEC) settled charges with the firm Holthouse, Carlin & Van Trigt, LLP (HCVT) for failure to comply with SEC independence rules under Rule 206(4)-2, known as the "custody rule" under the Investment Advisers Act of 1940, and in connection with audits of six (6) broker-dealer clients performed over a two-year period. The custody rule audits related to fifty-seven (57) private funds of four (4) investment adviser clients performed over a four (4) year period.

Applicable Independence Rules

As noted in the SEC release, the four (4) adviser clients held the assets of several private investment funds they advised, which required them to comply with the Custody Rule’s independent asset verification requirement, either through a surprise asset verification of client funds and securities in the adviser’s custody or a scheduled annual audit of each fund’s financial statements. According to the SEC, the advisers engaged HCVT to perform annual audits for their respective private investment funds. The Custody Rule requires auditors to comply with the independence standards of Regulation S-X, Rules 2-01(b) and (c). Similar to the Custody Rule, Section 17(a) and Rule 17a-5 of the Securities Exchange Act of 1934 require auditors to comply with the independence standards of Rules 2-01(b) and (c) of Regulation S-X when auditing broker-dealer financial statements.

Firm Actions

Despite this fact that HCTV was required to be independent under SEC independence rules for these engagements, the firm provided bookkeeping or other services related to the accounting records or financial statements for these clients, which impaired its independence. The SEC noted that HCVT's policies, procedures, controls and training incorrectly referenced AICPA, and not SEC, independence standards. AICPA independence rules in this area are less restrictive than the SEC's, and allow auditors to perform accounting services for clients under more circumstances than the SEC rules allow. The SEC also noted that no one in the firm or on any of the custody rule audits questioned the use of AICPA independence standards in these engagements.

The firm's accounting services to the private funds and broker-dealer clients included: 

  • Preparing the fund's financial statements and the notes
  • Conversion of cash basis financial statements to GAAP financial statements
  • Creating journal entries underlying the financial statements that the firm later audited
  • Making significant adjustments and edits to the client's financial statements and notes
  • Providing financial statements and notes the firm prepared for the client's approval
  • Supplementing and adding notes to the client's financial statements

Improper Professional Conduct

Rule 102(e)(1)(iv) and Section 4C(b) define “improper professional conduct” to include one of two types of negligent conduct: a single instance of highly unreasonable conduct that results in a violation of applicable professional standards in circumstances for which heightened scrutiny is warranted; or repeated instances of unreasonable conduct, each resulting in a violation of applicable professional standards, that indicate a lack of competence to practice before the Commission. Questions regarding an auditor’s independence always warrant heightened scrutiny. HCVT was found to have engaged in improper professional conduct under Rule 102(e) because it repeatedly failed to exercise due professional care by failing to comply with the SEC independence rules.

Settlement Terms

  • Firm ordered to cease and desist from committing or causing violations or future violations of the previously-mentioned SEC rules
  • Firm censured
  • Civil money penalty of $300K
  • HCVT ceased performing engagements concerning Custody Rule audits, broker-dealer audits, public company audits, or any other assurance service arising from a Commission rule for a period of one (1) year from the date of entry of the Order. The SEC stipulated that HCTV would need to meet several requirements if after one year, the firm wished to engage in any of the aforementioned engagements.