SEC ALLEGES INVESTMENT ADVISER KEPT CUSTODIAL FUNDS WITH BROKER-DEALER COUNTERPARTIES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission  charged an investment adviser to several alternative mutual funds for maintaining millions of dollars of the funds’ cash collateral at broker-dealer counterparties instead of the funds’ custodial bank.  The violations were uncovered during an SEC examination of the firm and the funds it manages.

Water Island Capital LLC agreed to pay a $50,000 penalty to settle the SEC’s charges.

According to the SEC’s order instituting a settled administrative proceeding, an investment company that maintains its securities and similar investments in the custody of a qualified bank must likewise keep in the bank’s custody other cash assets of the investment company.  The SEC’s order finds that Water Island Capital did not ensure that roughly $247 million in cash collateral held by broker-dealer counterparties was maintained with the funds’ custodial bank.  The cash collateral related to the funds’ investments in certain total return and portfolio return swaps.  

“Mutual funds must ensure that all fund assets are properly protected,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.  “Water Island Capital failed to implement the required policies and procedures to ensure all cash collateral was held in the custody of the funds’ bank.”

The SEC’s order finds that in addition to causing violations of the custody requirements of Section 17(f)(5) of the Investment Company Act, Water Island Capital caused violations of Section 12 and Rule 12b-1(h) due to its failure to implement the funds’ directed brokerage policies and procedures, which required the firm to create and maintain an approved list of executing brokers for the funds as well as to monitor with documentation the funds’ compliance with the directed brokerage requirements.  Water Island Capital failed to create the list and failed to maintain documentation reflecting monitoring of the funds’ compliance pursuant to the funds’ policies and procedures.  The SEC’s order further finds that Water Island Capital caused the funds’ violations of Rule 38a-1 under the Investment Company Act.        

Water Island Capital consented to the SEC’s cease-and-desist order without admitting or denying the findings.

The SEC’s investigation was conducted by Celeste Chase and Osman Nawaz of the New York office, and the case was supervised by Amelia A. Cottrell.  The examination that led to the investigation was conducted by Joy Best, Melissa Dahle, William Maldonado, Edward Moy, and Dawn Blankenship of the New York office’s investment adviser/investment company examination program.