The Securities and Exchange Commission (SEC) recently brought settled enforcement actions against two registered investment advisers for failing to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information (MNPI), in violation of Section 204A of the Investment Advisers Act of 1940 (Advisers Act) and the Compliance Rule. The cases appear to be messaging actions, intended to communicate that advisers should more specifically tailor their policies and procedures to the circumstances in which they may receive MNPI. The SEC did not allege in either action that the investment adviser illegally traded on MNPI, or that the adviser failed to adopt any procedures regarding the use of MNPI. Instead, the actions challenge the content of the policies and procedures as not sufficiently specific to the adviser’s business. In the first enforcement action, the SEC charged the adviser for failing to maintain adequate written policies and procedures relating to its trading of collateralized loan obligations.¹ In the second enforcement action, the SEC charged the investment adviser for failing to maintain adequate written policies and procedures relating to its participation on ad hoc creditors’ committees.² Significantly, and as explained further below, the SEC alleged that the investment advisers had insider trading policies and procedures at the time their activities came under scrutiny but neither adviser tailored its policies to the particular circumstances of its business activities when designing their MNPI policies and procedures.

Section 204A and the Compliance Rule

Section 204A requires investment 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 by such investment adviser or any person associated with such investment adviser” in violation of the Advisers Act or the Securities Exchange Act of 1934 or its rules or regulations. Separately, Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which is known as the Compliance Rule, require registered investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder, and to review, at least annually, the adequacy of those policies and procedures. Violations under Section 204A or Rule 206(4)-7 do not require an underlying violation of the Advisers Act to support a violation predicated on an adviser’s policies and procedures.

In the Matter of Sound Point Capital Management, LP

On August 26, 2024, the SEC announced settled charges against a registered investment adviser for failing to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of MNPI concerning its trading of collateralized loan obligations (CLOs).³ The order alleged that the adviser had inadequate written policies and procedures “aimed at preventing the misuse of MNPI about underlying loans in its CLO trading” and that its compliance manual failed to “address the possibility that MNPI [ ] obtained about a company’s loans could impact [the adviser’s] CLO trading if a CLO contained such loans.”⁴

In an example highlighted in the order, the investment adviser sold two CLO equity tranches that included loans made to a media services company.  At the time of the sale, the media services company was likely to need rescue financing as a result of the expected failure of a major asset sale. The adviser did not have policies and procedures for considering the impact of MNPI about a corporate borrower on the value of the CLO tranche that contained a loan to that borrower.⁵ The SEC alleged that the investment adviser’s personnel had advance knowledge of the likely failure of the asset sale because of the firm’s membership in an ad hoc lender group for the media services company.⁶ The day after the investment adviser’s sale of the CLO equity tranches, the MNPI concerning the company became public and the value of the media services company’s loans dropped by over 50%, materially decreasing the value of the CLO equity tranches.⁷

Here, the SEC did not allege that the investment adviser illegally traded on MNPI. The adviser’s compliance manual included an insider trading policy that generally prevented the adviser from trading in the securities of a company while in possession of MNPI. Moreover, the CLO portfolio manager consulted with Sound Point’s compliance department and obtained approval to sell the portions of the two equity tranches of Sound Point CLOs that contained loans by the company.⁸ Nonetheless, the SEC concluded that the investment adviser willfully violated Section 204A and Rule 206(4)-7 because it had no written policies and procedures aimed at preventing the misuse of MNPI about underlying loans in its CLO trading. Although similarly drafted policies have previously been sufficient to avoid regulatory action, this order faulted the adviser for the failure to adopt policies and procedures specifically concerning its possession of MNPI about underlying loans held by a CLO, whether adviser-managed or third party-managed.

In the Matter of Marathon Asset Management, L.P.

On September 30, 2024, the SEC announced settled charges against a second registered investment adviser for failing to establish, maintain and enforce written policies and procedures reasonably designed, taking into consideration the nature of its business, to prevent the misuse of MNPI relating to the adviser’s participation on ad hoc creditors’ committees.⁹ The SEC’s order found that the adviser’s participation on ad hoc committees required the adviser to adopt policies and procedures that “take into account the special circumstances presented by such participation regarding potential MNPI, which included the retention of and consultation with, among others, financial advisers who had access to MNPI.”¹⁰

As an example of this alleged deficiency, the order stated that the investment adviser was a member of an ad hoc committee that received guidance on restructuring the debt of a foreign company from a third-party restructuring adviser but failed to maintain policies and procedures to address the risk of inadvertently receiving MNPI “resulting from participation on ad hoc creditors’ committees, including interactions with financial advisers or other consultants.”¹¹ During the period in which the investment adviser participated in the committee, it built a significant position in the foreign-based company and sold €22 million in credit default swaps referencing the company before restricting trading. According to the SEC’s order, the third-party adviser that provided guidance to the committee had executed a nondisclosure agreement (NDA) with the foreign-based company, and possessed materials marked “Private Information included in this presentation” and “Restricted Information included in the document.” The investment adviser had not initially entered into a similar NDA with the company. Consistent with this, it informed the restructuring adviser and the other members of the committee that it did not wish to restrict trading until it entered into an NDA with the issuer. The written materials it received from the restructuring adviser before it entered into its own NDA with the issuer reflected that they had been prepared on the basis of publicly available information.

While these actions previously may have been sufficient to avoid regulatory action, the SEC’s order alleged that the adviser failed to receive “any written representations regarding [the third-party adviser’s] handling of any MNPI received from [the issuer] in connection with the retention of [the third-party adviser].” The SEC further alleged that “there [was] no evidence that [the investment adviser] performed any due diligence around [the third-party adviser’s] handling of any MNPI.”¹² According to the order, there were no MNPI policies or procedures “to conduct due diligence concerning advisers’ evaluation or handling of any potential MNPI or for obtaining a representation from advisers concerning their policies and procedures for handling of any MNPI.”¹³

The SEC’s order found that the investment adviser had adopted insider trading policies and MNPI procedures. The MNPI procedures listed several “examples of situations where [it] may become deemed to be in possession of non-public Information and will require the relevant [ ] employee(s) to consider including the relevant company on the Watch List or the Restricted List,” such as where the employee was “serving on a creditors’ committee of a restructuring.”¹⁴ The SEC alleged, however, that the investment adviser did not maintain policies and procedures “for monitoring or supervision specifically addressing the risk of receiving or misusing the MNPI during participation in an ad hoc creditors’ committee.”¹⁵ As a result, the SEC determined that the investment adviser willfully violated Section 204A and Section 206(4) and Rule 206(4)-7 thereunder.

Analysis and Takeaways

The SEC’s ability to use Section 204A to prevent MNPI misuse goes back to the section’s inclusion in the Investment Advisers Act in 1988. In that year, amid heightened concerns about insider trading, Congress added Section 204A to the Advisers Act through the passage of the Insider Trading and Securities Fraud Enforcement Act. Section 204A was part of the “tighter and tougher legal framework” designed to address what then-Rep. Ed Markey, the principal author of the statute, called on the floor of the House of Representatives the “litany of Wall Street horrors” of the 1980s.¹⁶ Rep. Markey, who was then chairman of the Subcommittee on Telecommunications and Finance, explained that the statutory requirement to establish procedures to prevent the misuse of MNPI under Section 204A was the legislation’s “backbone of increased firm responsibility.”¹⁷

The two recent cases follow a number of earlier cases charging stand-alone violations of Section 204A, albeit on very different facts, and the SEC’s Division of Examinations’ April 2022 risk alert describing deficiencies related to MNPI compliance issues.¹⁸ For example, in December 2023, the SEC charged and settled against an investment adviser that allegedly failed to enforce its written policies and procedures designed to prevent the disclosure of merger-related MNPI to investors and industry contacts.¹⁹ Though the investment adviser had written MNPI policies and procedures, it did not enforce them, and senior personnel sent emails that disclosed MNPI concerning public companies, typically in a marketing context. The SEC imposed a civil penalty of $4 million.

The EXAMS 2022 risk alert that preceded the cases discussed above contains guidance about maintaining and establishing appropriate MNPI policies in three particular areas: 

• “Alternative Data”: EXAMS staff observed that advisers used data from nontraditional sources, such as satellite or drone imagery, analyses of aggregate credit card transaction data, and internet search data, without having first adopted or implemented relevant policies and procedures designed to address the potential risk of receipt and use of MNPI through these sources.
• “Value-Add Investors”: EXAMS staff also observed that advisers did not have specific policies and procedures regarding “value-add” investors more likely to possess MNPI, such as officers or directors at a public company, principals or portfolio managers at asset management firms, and investment bankers.
• “Expert Networks”: EXAMS staff observed that advisers did not appear to have or implement adequate policies and procedures with respect to expert network consultants who may be “related” to publicly traded companies or have access to MNPI, including by tracking and logging calls with expert network consultants and reviewing detailed notes from expert network calls.

The clear message in these recent enforcement actions is that the SEC expects advisers to understand how their business might receive MNPI and design their policies and procedures to specifically address those risks. Generalized MNPI and insider trading policies may not be deemed sufficient. For example, in the Marathon order, the SEC indicated that policies and procedures concerning MNPI must be tailored to an adviser’s “core strategies” and that the adviser must take into account the “nature of this business” as well as its clients’ holdings.²⁰ Similarly, in the Sound Point order, the SEC indicated that the policies and procedures concerning MNPI must be tailored to “a significant component of its business.”²¹ Together, these enforcement actions demonstrate the Staff may recommend an enforcement action when it perceives that an investment adviser’s MNPI policies and procedures are not sufficiently tailored to its business, even absent misuse and in some cases absent actual receipt of MNPI. Moreover, following the SEC’s recent victory in the SEC v. Panuwat “shadow trading” case, the SEC may expect advisers in possession of MNPI about a company to consider whether that same information could be material not only to companies involved in agreements or relationships with the company in question but also to similarly situated peers or competitors of that company. This would be an aggressive reading of Panuwat. Whether an adviser should be expected to consider if the possession of MNPI affects the propriety of trading in similarly situated peers or competitors should, at a minimum, take into account the adviser’s own policies and procedures.

While Staff comments and guidance suggest that we can expect continued review of MNPI policies and procedures and aggressive enforcement of Section 204A in the future, the next administration’s approach to these issues remains unclear.