Insight Analytical Note

Read

SEC Brings 204A Case on MNPI Obtained Through Participation in a Creditor Committee

Background:

  • On September 30, 2024, the Securities and Exchange Commission reached a settlement in an administrative proceeding involving an adviser who failed to adequately establish and implement MNPI policies and procedures concerning MNPI received when it participated on an ad hoc creditor committee.1
  • The adviser was charged with violations of Section 204A of the Investment Advisers act and Rule 206(4)-7. The adviser paid a $1.5 million, which is a large penalty.

Key Allegations:

Facts:

  • The adviser in question executes a strategy of investing in distressed debt and regularly participates in ad hoc creditor committees.
  • In 2020 a certain issuer publicly announced that it was exploring restructuring options and as one of the creditors, this adviser formed an ad hoc credit committee along with other investors and hire a financial advisory firm to assist the creditors.
  • The financial advisory firm entered into an NDA with the issuer, but the adviser did not want to do so because it wanted to continue to trade the issuer’s securities. The financial advisory firm received nonpublic information which could also have been material.
  • Before the adviser entered into an NDA with the issuer, the financial advisory firm, which was already under NDA issued reports labeled as being prepared “on the basis of information publicly available, disclosed by the relevant company(ies) or by third parties, none of which has been independently verified nor audited by” the financial advisory firm.
  • Eventually the adviser entered into an NDA with the issuer and began receiving reports labeled “Private Information included in this presentation.”
  • Over this “unrestricted” period of time, the adviser accumulated a large bond position.

Policy Deficiencies:

  • The SEC order cites MNPI policy deficiencies including (1) policies concerning receipt of MNPI while participating on ad hoc creditor committees; and (2) policies concerning diligence of financial advisory firms who may have access to MNPI.
    • Analysis:
      • While not stated directly, there appears to be an implication that the financial advisory firm which was hired by the creditors committee inappropriately included MNPI in its reports or otherwise provided MNPI to the adviser. The adviser failed to recognize this MNPI and restrict the securities of the issuer.
      • The adviser created a very risky situation by refusing to restrict the securities of the issuer while interfacing with a financial advisory firm which it knew had MNPI.

Takeaways and Analysis:

  • Recognition of MNPI and Training – Training investment professionals to spot material non-public information (MNPI) is a key part of compliance, and it may be even more important than surveillance and some insider trading control. This is because at large firms, MNPI can come from many sources and sometimes looks like regular analysis. Since it’s hard to predict where MNPI will appear, teaching professionals how to recognize it is the most effective way to remain compliant. In particular, it may be advisable to have trainings centered around ad hoc and formal creditor committees, if that is a significant part of your investment strategy.
  • Effectiveness of Representations – In this case, the financial advisory firm issued reports labeled as ‘public information,’ but which may have contained MNPI. In such situations, the recipient cannot rely solely on the firm’s claim that no MNPI was shared. They have a responsibility to identify any MNPI and restrict trading accordingly.
  • Vendor Diligence – For high-risk vendors like this financial advisory firm, it’s essential for customers to review their compliance policies, procedures, and programs. Doing so can help prevent situations like the one described in this order by ensuring that there are additional controls preventing the leakage of MNPI to clients which may not want to be restricted. The SEC Order suggests that advisers should obtain reps and warranties from key vendors, confirming that the vendor will not provide them with material non-public information (MNPI). However, these assurances cannot replace the need for advisers to conduct their own due diligence.
  • Policies and Procedures — While MNPI policies and procedures are important, we recommend having fewer, more focused policies rather than an overwhelming number that might be ignored. If your business includes participation on creditor committees, then appropriate policies and procedures should include creditor committee training and the requirement to vet and diligence financial advisors.

1 In the Matter of Marathon Asset Management, LP; File Number 3-22219