Compliance and Regulatory Alerts | 05-05-22

SEC Exams Division Warns Firms to Tighten Up Compliance on the Misuse of Material Non-Public Information

On April 26, 2022, the SEC Division of Examinations (“the Division”) urged investment advisers to revisit their compliance policies, practices, and procedures concerning the misuse of non-public information (“MNPI”). In the Risk Alert, the SEC (i) reviewed the applicable Investment Adviser Act rules and ethical code considerations and (ii) described compliance deficiencies observed by the Division during its recent examinations.

The General rule (204A) requires advisers to have and enforce reasonably tailored written policies to prevent MNPI. The Code of Ethics rule (204A-1) requires advisers to have a code of business conduct applicable to certain “supervised persons”—identified as “access persons” (e.g., those with access to non-public information regarding client transactions, fund holdings, securities recommendations and the like, including officers, directors and partners)—who must report their “personal securities transactions and holdings to the adviser’s chief compliance officer.”

Deficiencies

The Division found compliance deficiencies related to both rules. Regarding the general rule, the Division highlighted process and procedure insufficiencies related to:

(i) “alternative data,” (i.e., information obtained through non-traditional means like big data transaction analysis, social media, internet search, mobile phone geolocation or from consumer apps);

(ii) “value-add investors,” (i.e., clients or fund investors that are corporate executives or financial professional investors who are likely to possess MNPI); and

(iii) “expert networks,” (i.e., professionals and consultants who are paid for specialized information and research).

In each case, the Division observed gaps in how firms might cover the increasing array of information that may lead to the rule violation.

With regard to the Code of Ethics rule, the Division found deficiencies concerning the identification of “access persons,” failures to ensure access persons obtained prior approval before personally investing (including as to beneficial ownership in IPOs), and other reporting failures on personal securities transactions and holdings. In each case, the Division found additional provisions that might be incorporated into a firm’s ethics rules to address personal trading by access persons.

The Division recommended that advisers develop “restricted lists” of issuers and prohibit trading in securities of those issuers. The Division also recommended that advisers consider adopting a policy that would require clients be given investment opportunities before advisers or employees.

Conclusion

Compliance issues related to MNPI are challenging. Compliance departments need to consider how to cover an increasingly broad set of data and new sources of information that might be deemed material and non-public. And, they must apply those considerations to an increasingly large pool of access persons while continuously updating their ethics code.