On May 26, 2020, the Securities and Exchange Commission (“Commission”) entered a settled order (“Order”) against a global alternative asset manager (“Manager”) for failure to implement and enforce policies and procedures designed to prevent the misuse of material nonpublic information (“MNPI”) in violation of the applicable requirements under the Investment Advisers Act of 1940, as amended ( “Advisers Act”).¹ Under the terms of the settlement the Manager was censured and required to pay a $1,000,000 penalty. It is worth noting that, according to the Order, the Manager followed many of its written policies and procedures pertaining to MNPI. However, it appears the Commission took issue with the fact that its policies, as applied, afforded its compliance personnel too much discretion and left it to investment personnel to self-evaluate the materiality of particular information. The Commission also noted the Manager’s failure, at times, to document adequately trade approvals for the restricted securities at issue.

The Manager invested several hundred million dollars in a publicly-traded portfolio company’s debt and equity securities. Under the investment terms, the Manager received the right to appoint two directors to the company’s board. The Manager appointed a senior member of the deal team (“Representative”) that spearheaded its investment in the portfolio company. The Representative regularly received potential MNPI (summarized in the Order) in connection with his role as a director. The Representative continued to participate in the Manager’s investment decisions concerning the company’s publicly traded stock. The Manager also received potential MNPI under the loan agreement which remained subject to confidentiality obligations. At various times while these arrangements remained in place, the Manager acquired additional company securities.

The Manager’s policies and procedures included several relevant requirements designed to address MNPI issues. These policies and procedures provided, among other provisions, that:

• Any company for which an employee served on the board of directors must be placed on the restricted list.
• Trades in restricted list company securities were prohibited until reviewed and approved by the compliance department.
• If any employee served on a portfolio company’s board, prior to granting trading approval, compliance personnel were required to confirm with the company that its trading window was open and to check whether relevant personnel were aware of potential MNPI with respect to the company.
• Compliance personnel were required to document approvals via entries in an electronic order management system.

While acknowledging in the Order that the Manager generally followed these procedures, the Commission concluded that it did not do so as thoroughly or consistently as required under these circumstances. Among the key deficiencies cited in the Order were the following:

• The policies and procedures left too much interpretation and discretion to the Manager’s compliance personnel. For example:
  • Compliance personnel were required to check with the Representative about potential MNPI, but whether to inquire with additional deal team members, with whom, according to the Order, the Representative, at times, shared potential MNPI, was left to their discretion.
  • Compliance personnel also had the discretion to determine how they would follow up with relevant employees and how in-depth potential MNPI issues were discussed with them.
• Compliance personnel frequently allowed investment professionals to assess for themselves whether they had received MNPI.
• The compliance department failed, on numerous occasions, to sufficiently document its inquiries with investment professionals concerning potential MNPI.
• Inquiries that were documented lacked consistency and detail.

Overall, in the Commission’s view, the Manager had an obligation to enhance its policies and procedures relating to the treatment of MNPI to meet the heightened risk posed by the Representative’s dual role as a decisionmaker for the Manager and portfolio company director. Taken together with what it viewed as the Manager’s inadequate implementation of the existing policies, the Commission concluded that the Manager failed to implement and enforce policies and procedures reasonably designed to prevent the misuse of MNPI as it was required to do under the Advisers Act.

S&K Observations

This is the second recent Commission enforcement action addressing an adviser’s failure to establish and implement MNPI policies and procedures reasonably designed to address its business-specific risk factors, without related insider trading or fraud charges.² These enforcement actions demonstrate that an adviser whose business results in regular access to potential MNPI (e.g., by having board representatives, regular communication with issuer insiders) is expected to have and implement commensurately robust policies and procedures. In particular, depending on the circumstances, advisers should note that:

• Relying on portfolio company open trading windows often will not be sufficient on its own.
• Compliance personnel should be directly involved in reviewing the substance of potential MNPI rather than allowing investment professionals to conclude they have “no MNPI” on their own.
• Compliance personnel should consistently document MNPI reviews and related decisions consistently and with appropriate detail.

We recommend you take this opportunity to review your MNPI policies and procedures, and restricted list controls, to ensure they are reasonably designed to address your firm’s risk factors, including all sources of potential MNPI intrinsic to your investment strategy.

Please contact your primary attorney at Seward & Kissel if you have any questions or want any assistance with a review of your firm’s MNPI policies and procedures.