Challenges Facing a CCO Supervising Against Insider Trading

One of the hardest responsibilities for an investment adviser firm’s chief compliance officer (“CCO”) is to prevent and detect insider trading by its supervised persons. The perils of such an undertaking (assuming underlying allegations are true) were highlighted in a news story last week. The industry press reported that a broker-dealer agreed to settle a lawsuit with its former CCO, who alleged she was fired for investigating the chief executive officer (“CEO”) over possible insider trading; the news article noted that the broker-dealer denied the CCO’s allegations and argued the lawsuit was a meritless action by a disgruntled employee.

Investment Adviser Required to Prevent Misuse of Material, Non-Public Information

The Securities and Exchange Commission (“SEC”) has explained that “Section 204A of the [Investment] Advisers Act [of 1940 as amended] requires investment advisers (whether SEC-registered or not) to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by the investment adviser or any of its associated persons.” See https://www.sec.gov/divisions/investment/iaregulation/memoia.htm . Similarly, Rule 204A-1 requires investment adviser registered with the SEC to maintain a code of ethics requiring supervised persons to comply with federal law and report personal securities transactions to the investment adviser firm. See https://www.law.cornell.edu/cfr/text/17/275.204A-1 . As a result, insider trading should be considered and incorporated into an investment adviser’s code of ethics and personal securities transaction (“PST”) reviews. Moreover, the SEC requires that the investment adviser reasonably design the code of ethics and personal securities transaction policies and procedures to reflect the particular insider trading risks associated with the investment adviser firm’s business model. See https://www.sec.gov/litigation/admin/2020/ia-5441.pdf .

Rule 10b5-1 Plans Under Scrutiny

To the extent that the investment adviser has a supervised person who is an officer or member of the board of directors with access to inside information of the publicly traded company and maintains a Rule 10b5-1 plan for purchasing/selling such securities, the CCO of the investment adviser should be aware that several members of the U.S. Senate Banking Committee have recently raised issues of whether some executives and directors of publicly trading companies are abusing the Rule 10b5-1 plans in order to obtain windfalls at the expense of ordinary investors. See at https://www.banking.senate.gov/newsroom/majority/warren-brown-van-hollen-sec-insider-trading-rule . The lawmakers noted that “[a]lthough trades made under 10b5-1 plans are intended to be set months in advance, it is not unusual for the plans to be modified days or hours before a major public announcement” and urged the SEC to remedy these abusive practices associated with the Rule 10b5-1 plans. As a result of these revelations, the CCO should consider additional scrutiny and investigation associated with the use of Rule 10b5-1 plans by its supervised persons who are officers or directors of a publicly traded company.

Resources

RIA Compliance Consultants has developed for investment adviser’s CCO an Insider Trading – Identify and Mitigating Risk Checklist. Click here to purchase this checklist. We have also developed an annual questionnaire for use with an investment adviser’s supervised persons affiliated with a publicly traded company. Click here to purchase the Insider Trading – Annual Questionnaire of Firm’s Supervised Person’s Affiliation with Public Company.

Contact Us

If your investment adviser firm needs assistance with establishing or updating its code of ethics and personal securities transaction policies and procedures, click here to set up an introductory call with our Business Development Team.

Disclosures

Please note that RIA Compliance Consultants, Inc. has not independently investigated or otherwise verified the accuracy of the reported allegations and other legal claims raised in the case referenced in the first paragraph of this blog.

Investment Advisers Must Develop Strong Insider Trading Policies and Procedures

SEC Initiates Charges for Insider Trading

Personal Securities Transactions – Supervising for Insider Trading Checklist

Insider Trading – Annual Questionnaire of Firm’s Supervised Person’s Affiliation with Public Company