This is why the definition of beneficial ownership for Code of Ethics reporting includes members of the immediate family sharing the same household. Also, we question the wisdom of implicating your unknowing spouse in an insider trading scheme.
OUR TAKE: Private equity firms registered as investment advisers should ensure that portfolio company officers and consultants comply with the Code of Ethics, including reporting of securities transactions and the obligation to maintain the confidentiality of material nonpublic information.
OUR TAKE: We call this “compliance voodoo” whereby a firm appears to write detailed compliance policies and procedures that allow behavior that the policies should be designed to prevent. In this case, there was no good reason to treat “research firms” different from “expert networks” when conducting insider trading due diligence.
The SEC filed insider trading charges against an investment bank VP who worked in the risk management department and received material nonpublic information as part of his duties to provide technical information to support internal committees. According to the SEC, the defendant learned inside information about a pending going-private transaction when he was copied on an email intended for the firm’s Debt Loan Committee and those that supported its functioning. The SEC alleges that the risk management VP used undisclosed personal brokerage accounts in his name and his wife’s name to trade call options and stock in the target, thereby collecting over $40,000 in ill-gotten gains. In addition to the SEC’s civil charges, the U.S. Attorney has filed a parallel criminal action.
OUR TAKE: It hurts all compli-pros when a risk management professional misuses his position and access to engage in unlawful activity. Who can you trust? Presumably nobody, which is why nobody should be exempt from oversight and testing.
The Supreme Court expanded insider trading liability by holding that a tippee can be convicted even if the tipper receives no specific pecuniary benefit. In the case, the defendant received the inside information from the brother of the tipper, who worked for an investment bank. The investment banker received no benefit other than the psychic benefit of helping his brother. The defendant asserted the Newman defense, arguing that he could not be prosecuted because he did not receive something of “pecuniary or similarly valuable nature.” The Court rejected that narrow interpretation, instead relying on the pre-NewmanDirks standard, which allows a finding of insider trading where the tipper provided information to a trading relative or friend.
OUR TAKE: This is a big win for federal prosecutors, because it significantly limits the Newman case and allows an inference of personal benefit without proving a specific pecuniary benefit. However, insider trading law remains somewhat murky and fact-specific. For example, what if the tipper provided information to a third cousin, once removed? Would that be close enough of a relationship? Or would Newman apply? Because of this lack of clarity, our advice is to go nowhere near the line. Refrain from trading if you have any suspicion that you have obtained material, nonpublic information.
A hedge fund firm agreed to pay nearly $9 Million in disgorgement, interest and penalties and a senior research analyst was fined and barred from the industry for failing to reasonably supervise an analyst convicted of insider trading. The SEC alleges that the firm and the supervisor ignored red flags including receiving confidential information that preceded public announcements, allowing the analyst to work out of his home, and the absence of any documentary support for recommendations. Moreover, the supervisor violated the firm’s policies by failing to report the red flags to the firm’s Chief Compliance Officer for further investigation and testing. The SEC asserts that the firm should have implemented heightened supervision including requiring reporting conversations with employees of public companies, requiring heightened information, and tracking recommendations.
OUR TAKE: The SEC properly placed responsibility on the firm and its line management (and not the CCO) for failing to supervise and report concerns to the CCO for further investigation. Management should have accountability for regulatory compliance, while the compliance department owns the drafting and testing of procedures and advising management on regulatory issues.