Since the COVID-19 pandemic caused market turmoil in mid-March 2020, we have seen increased trading volumes in liquid credits and public equities and an increasing number of debt deals featuring equity sweeteners and board seats. The Securities and Exchange Commission (SEC) is increasingly prioritizing the risks associated with the interplay between debt and equity in the investment held by our asset manager clients and their peers. A risk alert issued by the SEC’s Office of Compliance Inspections and Examinations (OCIE) on June 23, 2020, provides particularly timely and relevant insights into recent audits of private fund advisors with multiple investments and relationships with the same portfolio companies. The alert focuses on three areas: (i) conflicts of interests, (ii) fees and expenses, and (iii) material non-public information (MNPI). It was issued on the heels of the SEC’s settlement with Ares Management LLC (Ares) relating to Ares’ handling of MNPI in connection with a public company in which Ares held equity and debt.1 While the SEC has not officially endorsed the OCIE alert, we view the two publications as an indication that the SEC is focusing on asset managers’ and private funds’ treatment of MNPI.
- Investment advisors need to have not only up-to-date written policies and procedures in place to address MNPI and trading by advisory personnel, but they also need to enforce those rules and consistently and clearly document their policies and remediation practices. The alert and the SEC’s enforcement action against Ares underscore the importance of investment advisors adopting and enforcing written policies and procedures relating to potential MNPI obtained through board membership or confidentially from credit documents.
- Employee-directors nominated by funds to serve on a portfolio company’s board owe duties both to the fund that employs them as part of its investment team and the portfolio company itself. In such cases, investment advisors (and their compliance staff) need to identify those relationships as presenting heightened risk of access to MNPI and ensure that they establish, maintain, and enforce written policies and procedures reasonably designed to address how roles should be separated to prevent the misuse of MNPI by the adviser as well as any associated persons. Such procedures may include erecting information walls with respect to publicly listed companies in the fund’s investment portfolio on whose boards it has an employee-director and placing such companies’ stock on a “restricted list” that requires any trades in the stock to be preapproved by the investment advisors’ compliance staff.2 Additionally, the investment advisor’s compliance staff must document consistently and in detail their inquiries with the directors or investment team members as to whether anyone has received potential MNPI, as well as any findings that support the staff’s trading approvals.