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Family Office Failed to Enforce Restricted List

 

A family office was censured and fined for failing to implement procedures to prevent the misuse of material nonpublic information.  The firm’s business model involved buying small cap stocks and conducting research through contact with insiders and investment bankers.  Because it frequently obtained material nonpublic information, the firm’s policies required the Chief Compliance Officer to maintain a restricted list of companies in which neither the firm nor its covered persons could invest.  The SEC asserts that the CCO did not maintain or timely update a restricted list, relying instead on ad hoc communications and changes to the order management system.  The SEC also faults the firm for relying solely on the CCO because nobody communicated restrictions when he was not in the office or failed to communicate.  Additionally, the SEC faults the firm because it relied on insiders reporting potential restricted securities rather than implementing a monitoring system.  The firm’s owner, founder and managing member owned 60% of the firm’s assets under management.

Compliance is a series of procedures and processes, not a person.  Just because your policies designate a person responsible doesn’t mean you have satisfied your compliance obligation to implement reasonable policies.  It is also notable that the SEC fined this firm for weak policies even though it did not allege that the firm or its principal actually engaged in insider trading. 

Investment Banker Used Wife’s Brokerage Account for Insider Trading Scheme

An investment banker agreed to pay over $360,000 (including disgorgement, a fine equal to his ill-gotten gains, and interest) for using his wife’s brokerage account to engage in insider trading.  As part of his settlement, the SEC dropped the charges against his wife, which it named as a relief defendant.  The SEC alleges that the defendant made trades through his wife’s brokerage account based on material non-public information learned while advising on acquisitions of two Chinese companies.  Although the alleged wrongdoing occurred outside the United States, the defendant was a United States citizen with a residence in California. 

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. 

Portfolio Manager Charged in Matched Trade Scheme

The SEC has commenced enforcement proceedings against the portfolio manager of a registered fund for engaging in a matched trade scheme that allowed him to generate $1.95 Million in profits at the fund’s expense.  The SEC alleges that the portfolio manager matched call options bought/sold from his personal brokerage account against matching options bought/sold by the fund in less liquid securities with relatively wide NBBO spreads.  These trades benefitted his brokerage account when he immediately sold the call options to third parties at more favorable prices.  The SEC maintains that the portfolio manager failed to disclose his personal brokerage account to his employer (for review under the Code of Ethics) and failed to disclose his employer to his broker-dealer.  The SEC charges violations of Investment Company Act Section 17(j) and Rule 17j-1 (Code of Ethics) as well as securities fraud.  The U.S. Attorney has filed a parallel criminal action.

OUR TAKE: The SEC will hold individuals liable for securities law violations they cause especially where they intentionally seek to evade compliance efforts by lying to their employers.  It is unclear at this point whether his employer will also suffer an action for failing to detect his unlawful trading.

 

Investment Consultant Lied about Code of Ethics Compliance

 

The SEC censured and fined an investment consultant and its principal $700,000 for lying about gifts received from recommended investment managers and performance information.  The respondent’s marketing material claimed that neither the firm nor its principals took “so much as a nickel” from any investment manager.  However, the firm’s Code of Ethics permitted gifts over $100 with pre-approval and under $100 without.  The SEC asserts that personnel in the firm received tickets to the Masters Golf Tournament and other smaller gifts over a 4-year period, even where such gifts violated the Code of Ethics but the firm never imposed discipline.  The SEC also accuses the firm of marketing hypothetical and back-tested performance without sufficient disclosure or backup.

OUR TAKE: Code of Ethics violations are an oft-cited SEC deficiency and should be remedied upon discovery (see Common OCIE Deficiencies).  However, this firm compounded the problem by boasting about its Code of Ethics compliance in marketing materials.  We do not recommend claiming 100% compliance with any rule as part of a marketing campaign.