ACA INSIDER TRADING PANEL

Transcription

1 ACA INSIDER TRADING PANEL Florida, February 2011 Ivan Harris Partner Morgan Lewis & Bockius LLP Marla Roeser Director Compliance Convergent Wealth Advisors S. Brian Farmer Vice Chairman of Business Section Hirschler Fleischer PC

2 Agenda Quick Primer on Insider Trading Current Enforcement Environment Potential Sources of Information Policies and Procedures Special cases: Expert Networks Q & A 2

3 Insider Trading Defined Section 10b of the Exchange Act and Rule 10b-5 prohibit manipulative or deceptive devices in transacting in 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 is the source of the MNPI on the basis of means while aware of Use vs. possession 3

4 Enforcement Environment Insider Trading Cases High Priority for SEC. Heightened Concern with Conduct of Market Professionals. Criminal and Civil Penalties Severe. Expense and Reputational Damage from Investigations Not Recoverable. 4

5 All Advisers Should Pay Attention Section 204A requires advisers to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser's business, to prevent the misuse... of material, nonpublic information. Section 21(a) report in The Retirement Systems of Alabama: We issue this Report to remind investment managers, public and private, of their obligation to comply with the federal securities laws and the risks they undertake by operating without an adequate compliance program. 5

6 Typical Insider Trading Policy Trading securities while in possession of material, non-public information about a security or issuer, or improperly communicating that information to others is a violation of Firm policy and may constitute a violation of federal and state securities laws. Employees must notify the Chief Compliance Officer if they have come into possession of material, nonpublic information or they have reason to believe that a violation of this policy has occurred or is about to occur. 6

7 Hypothetical #1 You receive a call from an investment banker about an investment opportunity. The banker says he will share it with you as long as you agree to keep it confidential. You purposely say nothing, but he tells you anyway that Company A is going to do a PIPE deal. Can you short Company A? 7

8 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 and other professionals. Clients: public company officers/directors, brokerdealer employees 8

9 Sources of Potential Insider Information Convergent Example Clients Who Are Insiders Evaluated where potential exposure to inside information existed and determined many of our clients were officers/directors of publicly traded companies. We created a restricted list based on these 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. 9

10 Sources of Potential Insider Information -- cont d We are a manager of managers - not a broker/dealer. Our policy is that all individual security trades should be placed directly with a custodian by the client themselves. Employees who suspect they have received inside information must 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 invest with people who use it. 10

11 Due Diligence on Managers Factors We Consider While Performing Due Diligence on Potential Managers: We look for a culture of compliance. Distinguish between reputation 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? 11 Is the turnover rate in securities within the norm? We raise yellow/red flags for atypical trading within the portfolio if it s not consistent with the stated strategy.

12 Due Diligence on Managers -- cont d Are there multiple decision makers in the portfolio management team? Or just one person? Is there an Investment Committee that makes decisions? Are there portfolio manager checks and balances in place? Investor Reference Checks we scope out investors, not just ones 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? 12

13 Sample Policies 13 Pre-clear opportunities involving public companies through legal and compliance. Includes mergers, PIPEs, takeovers, asset sales, others. Banks should be instructed to contact members of Legal and Compliance as a general matter. If you receive a call about an opportunity involving a public company, the caller should be redirected to Legal and Compliance. Legal and Compliance will contact relevant personnel and provide limited information. You should not attempt to identify the issuer or share the limited information with others.

14 Hypothetical #2 Your Friend Steve said he knows from a reliable source that Company B s sales are way down this year, and the company may have to shut down some of its product lines. You check and see that Company B has not made a public announcement of this information. What Do You Do? 14

15 Confidentiality Agreements Frequently sought in connection with PIPES, convertible debentures, and other private transactions. Don t agree to confidentiality without careful consideration and understanding of the consequences. If unsure, check with Compliance. All confidentiality agreements must be in writing and approved by Compliance. If the caller starts to give details -- particularly name of issuer -- call Compliance immediately. 15

16 Confidentiality Agreements -- cont d Confidentiality Agreements may create a duty where none existed before, thereby creating potential insider trading liability Example: Creditor committees 16

17 Restricted Lists/Information Barriers Restricted lists include issuers about which the Adviser has material non-public information or has otherwise 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 17

18 Expert Networks/Mosaic Theory Material information is information that a reasonable person would want to know in making an investment decision Non-public means it has not yet been effectively communicated to the market place, i.e., is available to the general investing public Analysts may use non-public pieces of immaterial information to develop a material mosaic A skilled analyst with knowledge of a company and an industry may piece together seemingly immaterial data together with publicly available information into a mosaic that reveals material non-public information 18

19 Role of Expert Networks Find, engage, and manage experts across a broad range of industries and disciplines Role is to provide expertise or research data in a manner that does not convey MNPI illegally Many, but not all, such firms provide training to their experts and have compliance programs In-house legal and compliance personnel Terms and conditions for consultants No public company employees Do not call list 19

20 Due Diligence on Potential Experts 20 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 provide research? Are employees of public companies contacted?

21 Agreements with Expert Networks 21 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 contract obligations No litigation or investigations related to information/research provided 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

22 Remain Alert As with all information received, portfolio managers and analysts must evaluate information they receive from an expert 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 to escalate any possible issues to legal or compliance Consider surveillance of firm s communications with consultants Refresh due diligence periodically 22

23 Q&A ANY QUESTIONS? 23