Investment Advisers And Funds Must Remain Vigilant To Prevent Insider Trading Violations

The SEC continues to actively investigate individuals it believes traded on material nonpublic information purloined from an "insider." As a result, investment advisers and investment funds must stay vigilant and act to ensure that material nonpublic information is not misused by their officers and employees. Failure to stay vigilant will result in time, financial, and emotional costs that are best avoided.

Investment advisers and investment funds should review their compliance policies to make clear that relationships with friends, consultants, outside experts, or business contacts are not to be used to obtain insider information, and to provide appropriate training to employees who routinely work with consultants or other outside experts. Officers and employees need to understand that insider trading laws apply to individuals who trade based on nonpublic information received from insiders, and they need to understand that the penalties for violating insider trading laws can include civil injunctions, disgorgement of profits, monetary penalties, and fines and imprisonment.

The SEC civil case against the general partner of a venture capital firm provides a good example of the risks involved with insider trading. The general partner had a friend whose wife worked for a company that was in discussions to acquire a publicly traded company (the Target Company). The SEC claimed that the wife shared with her husband information about the ongoing merger developments related to the Target Company, and, in turn, the husband shared this information with the general partner of the venture capital firm.

Specifically, the SEC alleged that the general partner purchased approximately $2.5 million worth of Target Company stock and out-of-the-money options in several accounts leading up to the merger announcement. When the two companies announced the acquisition of the Target Company for $35 per share, a price more than 42 percent higher than the Target Company's closing price of $24.56 immediately prior to the announcement, the general partner liquidated his holdings. This allegedly generated more than $1.1 million in illegal profits.

These actions resulted in a civil complaint by the SEC and the arrest of the general partner on charges of criminal securities fraud, and caused reputational damage to the venture capital firm. Investment advisers and investment funds with strong insider trading compliance programs have the best chance of avoiding these negative outcomes for themselves, their officers, and employees. At the very least, evidence of a strong compliance program should prevent such firms from facing liability for breaches of insider trading by their officers and employees.

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