ARTICLE
15 October 2024

Private Fund Adviser Fined For Insufficient MNPI Controls As SEC Continues To Scrutinize Ad Hoc Committee Participants

CM
Crowell & Moring LLP

Contributor

Our founders aspired to create a different kind of law firm when they launched Crowell & Moring in 1979. From those bold beginnings, our mission has been to provide our clients with the best services of any law firm in the world through a spirit of trust, respect, cooperation, collaboration, and a commitment to giving back to the communities around us.
On September 30, 2024, the SEC announced the settlement of an enforcement action against Marathon Asset Management, L.P. (Marathon) for failing to implement proper policies and procedures to prevent the misuse of material nonpublic information (MNPI).
United States Corporate/Commercial Law

What You Need to Know

  • Key takeaway #1

Tailored Compliance Policies and Procedures: Firms should expect SEC inquiries during examinations about their MNPI management policies and trading activities. Policies must be specifically tailored to reflect the risks of the firm's specific business practices considering the various ways in which a firm may receive MNPI.

  • Key takeaway #2

Formal Review Procedures: In both the Marathon action, and its prior Sound Point Capital action, the SEC has signaled that it expects advisers to consider potential sources of MNPI presented by the firm's business and to vet the materiality of information coming out of those sources.

  • Key takeaway #3

Use of Outside Advisers: The Marathon action also highlights the need to exercise caution when relying on outsiders for a materiality assessment. Reliance on another party will not, as a matter of law, negate the element of knowing or reckless misconduct that is required to establish insider trading liability. Firms should conduct due diligence on advisers' MNPI policies and procedures to prevent insider trading, as highlighted in the Marathon case, where insufficient MNPI controls led to an enforcement action. Firms should obtain representations from advisers concerning their MNPI policies and procedures.

On September 30, 2024, the SEC announced the settlement of an enforcement action against Marathon Asset Management, L.P. (Marathon) for failing to implement proper policies and procedures to prevent the misuse of material nonpublic information (MNPI). The issue stemmed from Marathon's participation in ad hoc creditors' committees, where the firm inadvertently received MNPI through its consultants and advisers. This enforcement action highlights the SEC's intense focus on the participation by investors in ad hoc creditors' committees and the importance of implementing robust MNPI controls when doing so.

Background and Findings

Marathon, a registered investment adviser and global alternative asset manager, has a significant focus on distressed corporate bonds and similar debt. As part of its business model, Marathon frequently participates in ad hoc creditors' committees for distressed companies exploring restructuring options.

From August to November 2020, Marathon joined an ad hoc committee for a foreign-based company experiencing financial distress. The committee retained a financial adviser, "Adviser A," who signed a non-disclosure agreement (NDA) with the issuer and received MNPI about the company's restructuring. The SEC found that while Marathon had general MNPI policies in place, these policies were insufficient to address the specific risks posed by participation in ad hoc committees. The policies did not require Marathon to conduct its own due diligence on the materiality of the information being released to Marathon by its advisers and consultants. This oversight may have resulted in the inadvertent receipt of MNPI by Marathon, creating significant risks of misuse.

SEC's Enforcement Action

The SEC determined that Marathon's policies and procedures violated Sections 204A and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7. These provisions require investment advisers to establish written procedures reasonably designed to prevent the misuse of MNPI. Marathon agreed to a cease-and-desist order and a civil penalty of $1.5 million. In addition, the firm committed to revising its compliance policies, enhancing due diligence on external advisers, and providing additional training to employees involved in restructuring discussions.

This action highlights the SEC's continued focus on the participation by credit investors in ad hoc creditors' committees. The Marathon action comes on the heels of the August 2024 enforcement action against Sound Point Capital, highlighted in Crowell & Moring's client alert Flag on the Play: SEC Fines Adviser for Insufficient MNPI Controls in CLO Trades, where the SEC found that the firm's compliance policies were insufficient because they failed to restrict trading in certain CLO securities after acquiring MNPI through an ad hoc committee related to a term loan held within the CLO. In both actions, the SEC took the position that MNPI-related compliance policies must account for the "special circumstances" presented by an adviser's participation in ad hoc creditors' committees.

Conclusion

Firms must implement robust compliance policies and procedures to ensure compliance with Sections 204A and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7, and to mitigate insider trading risks. Recent SEC enforcement actions against Marathon and Sound Point Capital highlight the importance of maintaining strong controls tailored to the adviser's specific business and adhering to best practices in managing MNPI.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Find out more and explore further thought leadership around Business Law and Corporate Law
See More Popular Content From

Mondaq uses cookies on this website. By using our website you agree to our use of cookies as set out in our Privacy Policy.

Learn More