Gatekeepers in SEC Crosshairs

Ever since the enforcement cases were announced as part of the SEC’s “Operation Broken Gate,” the SEC enforcement division has continued to ramp up scrutiny of gatekeepers including third-party service providers and directors who have been charged with the obligation to spot and prevent potential misconduct.

SEC Chairperson Mary Jo White addressed the importance of gatekeepers in her keynote address at the Mutual Fund Directors Forum 2016 Policy Conference, specifically highlighting the important role that fund directors serve.


There is absolutely a pattern. The SEC often launches initiatives, communicates them to the industry and then drives it home with related enforcement actions.  Therefore, it should come as no surprise when the SEC recently brought enforcement actions against a fund administrator and auditor for failing to satisfy their duties as “gatekeepers.” 

In one case, the SEC charged an administrator for “fail[ing] to heed red flags and correct faulty accounting by two clients … [the fund administrator] missed or ignored clear indications of fraud while contracted to keep records and prepare financial statements and investor account statements for funds managed by [two of their advisory firm clients].”  In that case Andrew Ceresney, director of the SEC’s division of enforcement, stated that “[the fund administrator] failed to live up to its gatekeeper responsibility and essentially enabled the schemes to persist at each of these advisory firms until the SEC stepped in.”

In what might be considered surprising to some, the SEC charged the fund administrator with violations of the Investment Advisers Act of 1940 (“Advisers Act”). The application of the Advisers Act to the actions of a non-adviser will certainly raise more than a few eyebrows, but these latest cases highlight the expansion of responsibilities of third-party service providers.  While the Advisers Act does not explicitly regulate third-party service providers, Section 203(k) of the Advisers Act grants the SEC authority to impose a cease-and-desist order upon any person that is, was, or would be a cause of another’s violation, due to an act or omission the person knew or should have known would contribute to such violation of any provision of the Advisers Act. 

In another case, according to the SEC’s order in which the charged auditor settled with the SEC, the failed audit pertained to a publicly-traded company that claimed to sell internet services to companies. The executives of that publicly-traded company were subsequently charged by the SEC for allegedly implementing procedures which would overstate revenue through fraudulent sales.  

The order stated that during the audits of the publicly-traded company, the auditor and one of its partners failed to implement procedures necessary to detect the fraudulent sales in the company’s financial statements.  The auditing firm and partner were deemed to have failed in obtaining “sufficient audit evidence over revenue recognition and accounts receivable, identify related party transactions, investigate management representations that contradicted other audit evidence, perform procedures to resolve and properly document inconsistencies, and exercise due professional care,” as per the SEC press release

The SEC applied Sections 10A(a)(1) and 10A(a)(2) of the Securities Exchange Act of 1934 (“Exchange Act”), and Rules 102(e)(1)(ii) and (iii) of the Commission’s Rules of Practice (“CRP”). Section 10A(a) of the Exchange Act is violated by an auditor when they fail to include audit procedures that, in accordance with generally accepted auditing standards, are: (1) designed to provide reasonable assurance of detecting illegal acts that would have a direct and material effect on the determination of financial statement amounts, and; (2) designed to identify related party transactions that are material to the financial statements or otherwise require disclosure therein.  The pertinent sections of the CRP allow the Commission to deny the privilege of appearing or practicing before the Commission to any person found who is found to have engaged in improper professional conduct and/or and person found “[t]o have willfully violated, or willfully aided and abetted the violation of, any provision of the Federal securities laws or the rules and regulations thereunder.”

David Glockner, Director of the SEC’s Chicago Regional Office, sent out a strong message reminding the industry that auditors remain important gatekeepers who are charged with protecting the markets integrity.

Enforcement focus on gatekeepers should prompt them to thoroughly double check their current responsibilities to ensure that they have controls in place to identify and prevent fraudulent activity which can potentially harm shareholders and investors.  A lack of proper policies and procedures, as well as a failure to implement those policies and procedures can be met with harsh consequences as the SEC continues to hold gatekeepers responsible.  Despite the regulators interest in gatekeepers however, expect the primary responsible parties to continue to be held accountable as well.