On May 27, 2016, the SEC sanctioned an investment adviser (the "Adviser") for failing to establish and maintain policies and procedures reasonably designed to prevent the misuse of material nonpublic information.1 Specifically, the Adviser failed to adopt and implement policies and procedures for identifying outside consultants who, based on their functional roles and access to confidential information regarding the Adviser's transactions, should be subject to the Adviser's policies and procedures, including its code of ethics.
For nine years, the Adviser used third party consultants in connection with its securities research and analysis activities. One particular consultant ("Consultant") provided the Adviser with research and analysis and investment recommendations on securities of pharmaceutical and biotechnology companies. Consultant at times organized and attended in person meetings with the Adviser and pharmaceutical and biotechnology company executives. By virtue of his role with the Adviser, Consultant had access to nonpublic information regarding client portfolio holdings and the opinions of the Adviser's investment personnel on securities held or considered for purchase by the Adviser's clients.
Consultant was also a member of the board of directors of a number of publicly traded pharmaceutical and biotechnology companies, and possessed material nonpublic information regarding those companies, including four companies in which the Adviser's clients invested. Consultant also traded in his personal accounts the securities of the same pharmaceutical and biotechnology companies held by clients.
In 2010, the Adviser became aware of Consultant's service on the boards of public companies, including companies in which the Adviser's clients invested. Following an internal investigation into Consultant's role, the Adviser terminated its relationship with Consultant.
According to the SEC's order, the Adviser had written policies and procedures regarding material nonpublic information and personal trading under which Consultant's activities would not have been permitted, but the Adviser did not apply those policies and procedures to Consultant. In addition, the Adviser did not have policies and procedures to identify outside consultants, such as Consultant, who should be subject to the Adviser's oversight and controls. As a result of this conduct, the SEC concluded that the Adviser willfully violated Section 204A of the Investment Advisers Act of 1940.2 The Adviser was ordered to cease and desist from any future violations of Section 204A, censured and fined $1.5 million.
This SEC administrative proceeding and settlement emphasizes the importance to investment advisers of adopting and implementing written policies and procedures designed to identify third parties providing services to them, such as outside consultants, temporary employees and interns, and assessing whether – based on their functional roles and access to nonpublic client information – such third parties should be subject to some or all of the adviser's compliance policies and procedures, including its code of ethics. An investment adviser should also consider adopting procedures to identify conflicts of interests presented by prospective and existing outside consultants, including conflicts that may arise from the consultant's outside business activities, personal relationships and former employment.
Click here to access the Order.