Investment Advisers Should Review Insider Trading Policies & Procedures

March 08, 2008

Reading time : 4 minutes

Although the recent report concerning possible insider trading by a public pension plan administrator conducted by the Division of Enforcement of the U.S. Securities and Exchange Commission (“SEC”) involves an essentially unregulated money manager which is not subject to the Investment Advisers Act of 1940, it still offers an excellent opportunity for each registered investment adviser to review its policies and procedures regarding trading activity based upon material, non-public (“insider”) information.

The Retirement Systems of Alabama (“RSA”) administers approximately 20 public pension funds for various state and local government employees in Alabama. It utilized an in-house investment staff to manage approximately $30 billion of assets under management, and during the period in question, RSA had no policies, procedures or training to ensure compliance with federal securities laws including prohibitions against trading based upon insider information.

According to the SEC’s report, during June 2005 through August 2005, RSA acquired non-public information of a prospective acquisition of Liberty Corporation by Raycom Media, Inc. for a substantial premium over Liberty’s current market price. RSA obtained this insider information in connection with the possibility of RSA arranging to serve as a source of funding to Raycom for the acquisition. After acquiring this insider information and before it was known to the public, RSA purchased shares of Liberty, which resulted in a profit of approximately $700,000 to pension funds administered by RSA. While the SEC investigated this matter, RSA determined the identity of these sellers of Liberty shares and offered these sellers rescission, which included lost interest.

The SEC noted that most of RSA’s personnel and officials did not understand their duties and responsibilities under federal securities laws including the prohibition against trading based upon insider information and failed to consult with its outside legal counsel who had federal securities law expertise. The SEC concluded that RSA could have prevented this trading activity if it had adequate policies, procedures and training to assure compliance with federal securities laws and the prohibitions against insider trading.

The SEC’s reminder to investment managers of public and private pension plans should not go unheeded by registered investment advisers. Under Section 204A of the Investment Advisers Act of 1940, a registered investment adviser “… shall establish, maintain and enforce written policies and procedures reasonably designed … to prevent the misuse … of material, nonpublic information by such investment adviser or any person associated with such investment adviser.” Has your registered investment adviser established and implemented such written policies and procedures?

Here are some issues that should be considered by your registered investment adviser:

  • Has your registered investment adviser designated in writing a staff person, such as the chief compliance officer (“CCO”), to be responsible for establishing, implementing and enforcing written insider trading policies and procedures?
  • Does your registered investment adviser’s insider trading policy require a supervised person to report acquisition of insider information or suspected insider information to the CCO and likewise require the CCO to determine and communicate the appropriate course of action for the supervised person?
  • Does your registered investment adviser’s insider trading policy require the CCO to confidentially document such disclosure of the acquisition of insider information and the communicated course of action?
  • To the extent that the supervised person needs to communicate such insider information to other supervised person, doe your registered investment adviser have procedures to limit such disclosures and document such disclosures.
  • Has your registered investment adviser held training concerning its insider policy and procedures with its supervised persons? Can your supervised persons correctly identify what constitutes potentially insider information and how such situations should be handled?
  • Does your registered investment adviser have any clients that are a publicly traded company, a board director of publicly traded company, or a high level executives of a publicly traded company with significant concentrated positions within the company? If so, are the personal securities transaction by your supervised persons within such companies subject to an exception report, restricted securities list, pre-clearance procedure, or black-out period? Likewise, does the investment committee of your registered investment adviser use similar supervisory tools with respect to making investment recommendations or decisions for client accounts or proprietary funds or accounts?

RIA Compliance Consultants can help your registered investment adviser develop written insider trading policies and procedures so as to minimize the risk of its supervised person’s misusing material, non-public information. Please contact us at 877-345-4034 if you’re interested in discussing such services.

Posted by Bryan Hill
Labels: Insider Trading, Pensions, SEC