A hedge fund advisory firm agreed to pay more than $4.6 million to settle charges that it failed to implement adequate controls for preventing insider trading. The SEC found that Deerfield Management Company L.P. ("Deerfield"), a registered investment adviser, failed to establish, maintain and enforce policies and procedures reasonably designed to prevent the misuse of material, non-public information in violation of Section 204A of the Investment Advisers Act.
The matter is linked to SEC insider trading charges against certain analysts and government employees for misuse of information about confidential government decisions at the Centers for Medicare and Medicaid Services (see previous coverage of the charges and settlement with one former analyst).
Section 204A requires, among other things, that an investment adviser's policies and procedures take into "consideration the nature of [that] investment adviser's business" in attempting to prevent the misuse of material, non-public information. Deerfield conducted extensive research in the healthcare sector to inform its investment decisions, and engaged research firms to gather intelligence regarding upcoming regulatory and legislative decisions. For that reason, its policies and procedures should have been tailored to address the specific risks presented by its business, particularly the risk that it would receive and trade on illegal inside information.
The SEC alleged that Deerfield's policies and procedures were inadequate because they required only an initial review of the research firms' own policies and procedures, and otherwise placed the burden on Deerfield's employees to police themselves and elevate potential misuses of material, non-public information. The SEC also alleged that Deerfield failed to enforce its own policies properly.
Deerfield will pay over $4.6 million in penalties ($3,946,267), interest ($97,585) and disgorgement ($714,110).
Commentary / Lex Urban
This case is a prime example of the SEC's required nexus between the nature of a registered investment advisers' business and its applicable policies and procedures related to the receipt of material, non-public information. Deerfield's own compliance manual acknowledged that its use of research firms would increase the likelihood that its analysts would have access to material, non-public information. However, its relevant policies and procedures did not adequately address or reflect that knowledge and the associated risks.
Deerfield established rigorous procedures for "experts" and "expert networks," but failed to apply those procedures to research firms, including those that employed political intelligence analysts. The sole procedure in place at Deerfield to prevent the receipt and misuse of material, non-public information from research firms was that the firms demonstrate that they "observe policies and procedures to prevent the disclosure of material, non-public information. . . ." That demonstration was to be "refreshed from time to time." Deerfield's policies provided no guidance regarding how its personnel should go about determining whether research firms sufficiently demonstrated compliance with their applicable insider trading policies.
This should serve as a warning to any investment adviser with similarly vague language in its compliance procedures. From "time to time" provides no clear, defined parameters for how often checks should occur and creates a friendly environment for non-compliance. Moreover, general mandates placing the burden of responsibility on employees without specific guidance on how to implement those directives will be viewed as inadequate by the SEC.
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