The Securities and Exchange Commission’s ill-defined and unsettled legal definition of insider trading is making it harder for advisors to understand how to comply with the rule—and advisors’ misunderstanding is likely resulting in more SEC enforcement actions.
On Oct. 13, the SEC charged a hedge fund advisor with failing to prevent insider trading in its funds based on information from one of its research analysts who received a tip from a friend employed at a public company.
The analyst made trade recommendations without the benefit of models, written reports, or research files—instead, he based his recommendations on information from his industry sources.
On two particular occasions involving a company where his friend was employed, the analyst provided information to the fund that resulted in profitable trades.
The SEC brought an enforcement action against the advisor, alleging that the advisor did not have or enforce policies and procedures reasonably designed to prevent insider trading.
While the adviseor had a policy requiring employees to report any material nonpublic information to the advisor’s CCO, the SEC faulted the analyst’s supervisor for not questioning the analyst about the source of his information and not asking the CCO to look into the matter despite purported “red flags.”
Further, the SEC faulted the advisor for not having policies that would have tracked and monitored the analyst’s interactions with employees of public companies.
The advisor paid $8.8 million in disgorgement and penalties to settle the case.
Hedge fund advisors in particular remember the high-profile government loss on appeal in the Newman case in 2014, overturning a criminal insider trading conviction against a couple of hedge fund portfolio managers because the prosecutors failed to prove that the insider tipper received a tangible pecuniary benefit for providing the tip.
In Newman, according to the appellate court, the government failed to properly understand insider trading.