As the Securities and Exchange Commission continues its investigation of New York-based celebrity adviser Kenneth Starr and his alleged $30 million fraud, custody is emerging as a central issue.
Filed last week, the SEC complaint charges Starr Investment Advisors LLC — a registered investment adviser since June 2006 — with having failed to comply with custodial rules in 2006-09 that require an independent public accountant to perform a surprise examination of client assets over which the firm had custody.
In addition, the SEC found that some client assets were held in a safe in the Starr offices.
The watchdogs had been on the trail for several months. According to a BrokerCheck report on the website of the
Financial Industry Regulatory Authority Inc., an SEC investigation was opened on July 23, 2009, and was described as a “fact-finding inquiry” in which Mr. Starr was subpoenaed by the commission to disclose documents relating to his business at Starr Investment Advisors. No further details were given on the website because the investigation was not public.
Mr. Starr was a principal of Diamond Edge Capital Partners, a broker-dealer, through March, when the firm's registration ended.
In addition, Mr. Starr also controlled Starr & Co., a firm offering concierge services such as tax preparation and bill payment. That firm has roughly 175 clients, according to the complaint filed by the SEC last Thursday.
Press accounts have put the assets managed by Starr Investment Advisors at $700 million, but in a revised ADV form filed May 25 with the SEC, the firm said it managed roughly $1.3 billion. According to RIA Database, Starr Investment Advisors manages $1.26 billion in assets in 35 accounts.
Lawyers and advisers noted last week that the Starr case presents an opportunity for advisers to educate clients about best practices in the advisory business, especially third-party custody.
One adviser, Jeffrey McClure at The Personal Wealth Coach in Salado, Texas, said he's going to be using Mr. Starr's alleged fraud as a starting point for several conversations about custody.
“I'm going to tell everyone and anyone about it,” Mr. McClure said. “I always tell my clients very frankly that they should not
trust me to have custody of their funds, nor should they
trust anybody who's advising them to have custody of their funds.”
One attorney noted that advisers should make a point of detailing how their practices and procedures protect clients.
“An advisory firm can take steps to provide transparency around how it complies with the SEC's custody rule,” said K. Susan Grafton, an attorney specializing in regulation and compliance in the Washington office of Gibson Dunn & Crutcher.
“Advisers should explain how they choose a custodian, what their processes are for ensuring that funds and securities are secure, how they transfer clients' funds and securities, and what their general procedures and controls are,” she said.
James McCarney, a hybrid adviser whose firm, HW Financial Advisors, in Meadville, Pa., is affiliated with Commonwealth Financial Network, has been educating clients about custodians for years, especially when it comes time for clients to write a check.
“When clients want to know why they make out their checks to National Financial Services [LLC], I use their question as an opportunity to explain the importance of having an independent, financially strong custodian, and as a chance to explain my role, the roles of a custodian and a broker-dealer, and the interconnection between us.”
Advisers also should bring up the subject of their custodial practices in conversations with clients, said attorney Scott P. Hilsen.
“The more open a business is about their processes and controls, the less likely it is that they're hiding anything,” said Mr. Hilsen, a partner at Alston & Bird LLP and a certified fraud examiner. “Good companies should advertise what they do to prevent fraud.”
Clients, of course, also must do their part.
“Anyone can be a victim of financial fraud, whether you are an ordinary citizen or a savvy businessman or a sophisticated celebrity,” U.S. Attorney Preet Bharara of the Southern District of New York said at an SEC news conference last week.
Last week, the staff of the U.S. Attorney Office was looking through Mr. Starr's office and working to freeze 23 bank accounts in its search for more victims of his scheme. Mr. Starr's alleged victims include Hollywood producer Martin Scorsese, actors Wesley Snipes and Uma Thurman and New York's Jacob “the Jeweler” Arabov, a high-profile jewelry store owner known as the “King of Bling.”
“The bottom line is that if a deal sounds too good to be true, it probably is,” Mr. Bharara said.
E-mail Hilary Johnson at
[email protected].
