SEC risk alert flags deficiencies in handling nonpublic information

The alert, published April 26, said the most common deficiencies related to the code of ethics rule contained in Section 204A of the Investment Advisers Act of 1940. The code of ethics rule sets a standard of business conduct for so-called “supervised persons,” who are “employees, officers, partners, directors, and other persons who provide advice on behalf of the adviser and are subject to the adviser’s supervision and control,” as well as “access persons,” who are supervised persons required under the law to report their personal securities transactions and holdings to the firm’s chief compliance officer (CCO) or other designated person.

The issues found by examination staff were laid out in deficiency letters to the firms, and many firms acted to correct the problems, the alert said.

One area of concern for examiners was the way firms handled potential MNPI derived from alternative data, which is defined as information about a company’s performance found outside of financial statements, company filings, and press releases. Some forms of alternative data include “information gleaned from satellite and drone imagery of crop fields and retailers’ parking lots, analyses of aggregate credit card transactions, social media and internet search data, geolocation data from consumers’ mobile phones, and email data obtained from apps and tools that consumers may utilize.”

Some firms’ policies and procedures for handling MNPI from alternative data were ad hoc and inconsistent, the alert said. Terms, conditions, and other legal obligations were not reviewed regularly, and some advisers did not apply due diligence processes uniformly on all types of alternative data.

Examiners found some firms did not have clear policies and procedures for MNPI that came into the possession of so-called “value-add investors,” like clients or fund investors that are corporate executives or financial professional investors, or of “expert networks,” which consist of professionals paid for their specialized information and research services, the risk alert said.

The alert said some firms did not accurately identify whom within the firm would be classified as access persons under the rule. That meant the holdings and transaction reports of those people were not being submitted to or regularly reviewed by the firm’s compliance staff, and those people had not signed forms acknowledging they understood the ethics code. The oversight also led to such persons being able to purchase initial public offerings and limited offerings without requisite preapproval.

Some other issues examiners found with firms’ compliance with Section 204 and its code of ethics rule was some employees were still able to trade on investments that were on the firm’s restricted list and investment opportunities were not being offered to clients before firm employees, which led to situations where firm employees purchased investment opportunities at better prices than those offered to clients.