ACA INSIDER TRADING PANELFlorida, February 2011
Ivan HarrisPartner
Morgan Lewis & Bockius LLP
Marla RoeserDirector Compliance
Convergent Wealth Advisors
Marla.Roeser@Convergentwealth
.com
S. Brian FarmerVice Chairman of Business
Section
Hirschler Fleischer PC
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Agenda
Quick Primer on Insider Trading
Current Enforcement Environment
Potential Sources of Information
Policies and Procedures
Special cases: Expert Networks
Q & A
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Insider Trading Defined
Section 10b of the Exchange Act and Rule 10b-5prohibit manipulative or deceptive devices in transactingin securities
Rule 10b5-1 describes insider trading in this way– The purchase or sale of a security
– On the basis of material non-public information
– About that security or issuer
– In breach of a duty of trust or confidence owed directly,indirectly or derivatively to the issuer or any other person who isthe source of the MNPI
“on the basis of” means while aware of– “Use vs. possession”
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Enforcement Environment
Insider Trading Cases High Priority for SEC.
Heightened Concern with Conduct of MarketProfessionals.
Criminal and Civil Penalties Severe.
Expense and Reputational Damage fromInvestigations Not Recoverable.
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All Advisers Should Pay Attention
Section 204A – requires advisers to establish, maintain,and enforce written policies and procedures reasonablydesigned, taking into consideration the nature of suchinvestment adviser's business, to prevent the misuse . .. of material, nonpublic information.
Section 21(a) report in The Retirement Systems ofAlabama: “We issue this Report to remind investmentmanagers, public and private, of their obligation tocomply with the federal securities laws and the risksthey undertake by operating without an adequatecompliance program.”
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Typical Insider Trading Policy
Trading securities while in possession of material,non-public information about a security or issuer, orimproperly communicating that information to othersis a violation of Firm policy and may constitute aviolation of federal and state securities laws.
Employees must notify the Chief Compliance Officer ifthey have come into possession of material,nonpublic information or they have reason to believethat a violation of this policy has occurred or is aboutto occur.
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Hypothetical #1
You receive a call from an investment bankerabout an investment opportunity. The bankersays he will share it with you as long as youagree to keep it confidential.
You purposely say nothing, but he tells youanyway that Company A is going to do a PIPEdeal.
Can you short Company A?
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Sources of Information
Sell Side: sales and trading, investment bankers,research analysts.
Buy Side: hedge funds, private equity firms,institutional investors.
Third Parties: friends, family, employees of issuers,consultants, credit committee members, lawyers andother professionals.
Clients: public company officers/directors, broker-dealer employees
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Sources of Potential InsiderInformation – Convergent Example
Clients Who Are Insiders– Evaluated where potential exposure to inside information existed
and determined many of our clients were officers/directors ofpublicly traded companies. We created a restricted list based onthese results, and we utilize software that flags employees’personal trades of the securities on this list.
Clients With Inside Information– Risk: A client may tip our employees about inside information by
either sharing it, or by asking us to place trades for their account.
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Sources of Potential InsiderInformation -- cont’d
– We are a manager of managers - not a broker/dealer. Ourpolicy is that all individual security trades should be placeddirectly with a custodian by the client themselves.
– Employees who suspect they have received inside informationmust inform compliance – we add it to the restricted list.
Managers with Inside Information– RED FLAG: Managers who try to give our research group
inside information.
– We know inside information is out there, but we don’t investwith people who use it.
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Due Diligence on Managers
Factors We Consider While Performing Due Diligenceon Potential Managers:
– We look for a culture of compliance. Distinguish betweenreputation and trust - even with a manager’s great reputation,you shouldn’t invest with them if you don’t trust them.
– A Manager’s Policies and Procedures (Compliance Manual &Code of Ethics).
– Review portfolio and its top performers.
– Is trading consistent with the stated strategy?
Is the turnover rate in securities within the norm?
We raise yellow/red flags for atypical trading within theportfolio if it’s not consistent with the stated strategy.
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Due Diligence on Managers --cont’d
– Are there multiple decision makers in the portfolio managementteam? Or just one person? Is there an Investment Committeethat makes decisions? Are there portfolio manager checks andbalances in place?
– Investor Reference Checks – we scope out investors, not justones a firm provides as references.
Does the Firm use Expert Consulting Networks(ECNs)? If so:
– Does the Firm have a written policy on evaluating the ECNs? Does the Firm keep extensive documentation of each
conversation/communication with ECNs? Does the Firm keep an “Approved ECN List”?
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Sample Policies
Pre-clear opportunities involving public companiesthrough legal and compliance.
Includes mergers, PIPEs, takeovers, asset sales,others.
Banks should be instructed to contact members ofLegal and Compliance as a general matter.
If you receive a call about an opportunity involving apublic company, the caller should be redirected toLegal and Compliance.
Legal and Compliance will contact relevant personneland provide limited information.
You should not attempt to identify the issuer or sharethe limited information with others.
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Hypothetical #2
Your Friend Steve said he knows from areliable source that Company B’s sales areway down this year, and the company mayhave to shut down some of its product lines.
You check and see that Company B has notmade a public announcement of thisinformation.
What Do You Do?
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Confidentiality Agreements
Frequently sought in connection with PIPES,convertible debentures, and other private transactions.
Don’t agree to confidentiality without carefulconsideration and understanding of the consequences.If unsure, check with Compliance.
All confidentiality agreements must be in writing andapproved by Compliance.
If the caller starts to give details -- particularly name ofissuer -- call Compliance immediately.
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Confidentiality Agreements --cont’d
Confidentiality Agreements may create a duty wherenone existed before, thereby creating potential insidertrading liability
– Example: Creditor committees
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Restricted Lists/InformationBarriers
Restricted lists include issuers about which theAdviser has material non-public information or hasotherwise agreed to keep information confidential.
Different lists for public and private issuers.
Firmwide restriction vs. trading desk restriction
– Debt vs. Equity
– Public debt vs. private debt
– Securities tied to specific streams/assets - ABS
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Expert Networks/Mosaic Theory
Material information is information that a reasonableperson would want to know in making an investmentdecision
Non-public means it has not yet been effectivelycommunicated to the market place, i.e., is available to thegeneral investing public
Analysts may use non-public pieces of immaterialinformation to develop a material mosaic
A skilled analyst with knowledge of a company and anindustry may piece together seemingly immaterial datatogether with publicly available information into a mosaicthat reveals material non-public information
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Role of Expert Networks
Find, engage, and manage experts across a broadrange of industries and disciplines
Role is to provide expertise or research data in amanner that does not convey MNPI illegally
Many, but not all, such firms provide training to theirexperts and have compliance programs
– In-house legal and compliance personnel
– Terms and conditions for consultants
– No public company employees
– Do not call list
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Due Diligence on Potential Experts
Do firm’s consultants have other employment? Are industry contacts:
– Introduced?– Paid?
What is firm’s work product, and how delivered? Does the firm have written policies and procedures
concerning MNPI and consultants? Does the firm offer mandatory compliance training for
consultants? Does the firm or its employees or consultants allow
trading in the companies about which they provideresearch?
Are employees of public companies contacted?
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Agreements with Expert Networks
Specific representations– Match to due diligence– Public companies do not prohibit their employees from
consulting as industry contacts– Information provided by industry contacts doesn’t violate any
obligations to the contact’s employer or other contractobligations
– No litigation or investigations related to information/researchprovided
– Investor does not want, and consultants will not divulge, MNPI– Consultants understand that the investor intends to trade
based on the information– Confidentiality of relationship– Prompt notification of any changes to accuracy of
representations
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Remain Alert
As with all information received, portfolio managers andanalysts must evaluate information they receive from anexpert consultant to determine whether it is MNPI
This regulatory obligation cannot be delegated
Recommended follow-up:– Remind employees that consultants must pass a compliance
review before they are approved for use
– Educate employees as to MNPI issues and remind them toescalate any possible issues to legal or compliance
– Consider surveillance of firm’s communications with consultants
– Refresh due diligence periodically
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Q&A
ANY QUESTIONS?
