On May 26, 2020 the United States Securities and Exchange Commission (“SEC”) filed an order instituting administrative cease-and-desist proceedings to a registered investment adviser and private equity firm for allegedly participating in insider trading. Click here to read the SEC’s Cease and Desist Order.
According to the cease-and-desist order by the SEC, the investment adviser, which manages private equity funds, invested several hundred million dollars in a publicly traded company (“Portfolio Company”) in 2016. Pursuant to the investment, the investment adviser was entitled to appoint one of its senior employees to the board of directors of the Portfolio Company. Through this representative, the investment adviser allegedly obtained material non-public information (“MNPI”) regarding the operation and strategic decision making of the Portfolio Company, which was then shared within the investment adviser firm.
Contrary to a confidentiality agreement and the investment adviser firm’s own compliance policies, the investment adviser subsequently made a number of trades, ultimately purchasing more than a million shares of the Portfolio Company’s publicly traded stock, accounting for approximately 17% of the then-available publicly available stock.
According to the SEC, the dual role maintained by the representative as a senior employee of the investment and board member of the publicly traded company placed the investment adviser at a higher risk of obtaining material nonpublic information. In this case, the investment adviser firm’s policies and procedures did not adequately address the special circumstances arising from this dual role.
The SEC’s investigation further found that the investment adviser firm’s compliance policies and procedures did not require its compliance personnel to “sufficiently inquire and document” whether the individuals making the trades on behalf of the investment adviser had material non-public information. In its order, the SEC noted that by merely asking its employees whether they had any material nonpublic information rather than conducting a thorough, independent inquiry, the firm was relying on those individuals to “self-evaluate whether particular information could be “material” within the context of [its] policies and for purposes of the federal securities laws.”
All investment advisers have an obligation to have compliance policies and procedures in place to prevent and detect insider trading by their representatives and the firm. In instances where the investment adviser’s representatives occupy dual roles or where circumstances otherwise heighten the risk of insider trading, the investment adviser must develop and implement robust compliance policies and procedures tailored to those specific risks. Such policies and procedures should contain detailed instructions to avoid unwanted compliance variations due to the “initiative, discretion, and interpretation” of the individual implementing the policies, as the SEC alleged in this case.
RIA Compliance Consultants has developed an Insider Trading – Identify and Mitigating Risk Checklist. Click here to purchase this checklist. We have also developed an annual questionnaire for use with supervised persons affiliated with a publicly traded company. Click here to purchase the “Insider Trading – Annual Questionnaire of Firm’s Supervised Person’s Affiliation with Public Company”.
If your investment adviser firm is an existing client of RIA Compliance Consultants and would like assistance developing customized policies and procedures regarding insider trading, we encourage you to speak with your compliance consultant. Or, if you are not an existing client of RIA Compliance Consultants, click here to set up an introductory call with our Business Development Team.