iIn a rare move, the Securities & Exchange Commission has assessed penalties against a political intelligence firm for failing to adopt adequate policies to prevent the flow of inside governmental information to the firm’s clients. The enforcement action is particularly noteworthy because all the factual allegations took place in 2010, before Congress passed the STOCK Act which clarified that the insider trading rules applied to inside government information.
The enforcement action involved Marwood Group Research, LLC, a political intelligence firm, registered broker-dealer and state registered investment adviser that provides “research notes” to hedge funds and other financial industry clients addressing likely outcomes of future government actions. To compile these research notes, its analysts would sometimes receive information from government officials which presented a substantial risk of being material and non-public. The order states that Marwood sometimes conveyed this information to clients via the “research notes” and in other calls and meetings.
Marwood had written policies prohibiting the dissemination of material, non-public information and requiring information be brought to the attention of the Chief Compliance Officer if there was any doubt as to whether it was material and nonpublic. “Material nonpublic information” was expressly defined to include information about “any pending but not yet publicly proposed or approved action by a regulatory or other government agency.” Research notes were required to be reviewed beforehand by the company’s compliance department for possible inappropriate dissemination of material nonpublic information.
Nevertheless, the SEC indicated that these policies and procedures were inadequate as they were not reasonably designed to prevent the misuse of material, non-public information given the nature of Marwood’s business. It was not enough for the policy to require compliance department review of the research notes. Rather, the SEC suggested that the policy must “expressly require the compliance department to be advised as to the source of the information included in the research note or about communications with government sources, if any.” The failure to require the compliance department to be apprised of this back-up information, the SEC concluded, resulted in a violation of the Exchange Act and Advisers Act as Marwood’s policies and procedures did not adequately address the risk its employees would obtain and disseminate material, non-public information from government officials.
As a result, the SEC ordered Marwood to retain an independent consultant to conduct a review of the company’s enforcement of its policies related to the obtaining or use of material non-public information, to submit the report to the SEC, and to adopt any recommendations. It also slapped Marwood with a $375,000 civil fine.
Based on this enforcement action, hedge funds, political intelligence firms and other financial industry participants would be well-advised to take a close look at their insider trading policies to ensure they adequately capture the risks associated with their business, and that those policies are being complied with on a firm-wide basis. As underscored in the order, a firm’s policies and procedures may be insufficient if the compliance department is not apprised of the sources for predictions conveyed to clients or relied upon to make investment decisions, or provided with additional information to ensure that the CCO or other gatekeeper has a sufficient appreciation for the facts to determine whether the information received from the government source is material and non-public.
