SEC Cautions Advisers on Insider Trading and Employee Trading Issues
Commentary by Steven Lofchie
In a new risk alert, the SEC Division of Examinations highlighted observed compliance deficiencies by investment advisers on rules preventing the misuse of nonpublic information ("IAA Section 204A") and ethical rules ("IAA Rule 204A-1)
The deficiencies concerned:
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the potential that investment advisers may be receiving material nonpublic information ("MNPI") from a variety of sources and making use of that information in their trading activities; and
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weakness in the controls over trading by advisory personnel.
The potential risks of MNPI identified by SEC staff were (i) "alternative data," (ii) institutional investors and other investors, such as officers of public firms that might themselves have access to MNPI and (iii) expert networks.
As to trading by employees ("access persons"), the staff faulted advisers for:
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not identifying all relevant employees as access persons;
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access persons not obtaining the required preapproval for investments such as beneficial ownership in IPOs and limited offerings; and
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not providing evidence of either transaction reports or holdings reviews.
The SEC recommended that firms (i) include "restricted lists" that would enable them to prohibit issuers on the list from trading in securities and (ii) incorporate procedures that give clients the chance to participate in investment opportunities before advisers.
Commentary
The SEC had, for a time, focused considerable regulatory attention (and brought enforcement actions) on the use of expert networks. Firms may want to go back and look at those prior enforcement actions and see whether their procedures should be refreshed.
As to alternative data, determining the bona fides of it can be a difficult task. However, if a firm is not able to demonstrate that it has made a reasonable effort to confirm that all such data has been obtained from a source that has the right to the data, the firm is at risk of an SEC charge that the firm's buy and sell decisions were tainted by the use of MNPI.