SEC Warns Public Pension Funds and Other Unregistered Investment Advisers on Insider Trading

Last Thursday, the SEC warned public pension funds and other unregistered investment advisers on the need for vigilance and adoption of policies and procedures to address potential insider trading issues. The same topic was recently addressed in a February 27, 2008 conference sponsored by Morgan Lewis on advanced topics in hedge fund practices. During the Hedge Fund Enforcement and Litigation Round-Up session, Morgan Lewis partners and former SEC enforcement lawyers Anne Flannery and Ivan Harris expressed our view that insider trading likely will remain a hot enforcement topic and that the SEC staff likely will focus on registered investment advisers’ compliance with Section 204A of the Investment Advisers Act of 1940, which requires firms 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, non-public information by such investment adviser or any person associated with such investment adviser.”

During the presentation, Anne and Ivan suggested that even firms that are not registered as investment advisers should consider the concept behind Section 204A and institute procedures to detect and prevent insider trading activity. Although unregistered investment advisers are not subject to Section 204A, they remain subject to liability for insider trading under the federal securities laws. Therefore, even though an unregistered adviser has no affirmative duties under Section 204A, creating a framework consistent with its business model that evidences its good-faith efforts to detect and prevent insider trading would aid a firm in demonstrating to the SEC an absence of scienter in the event that the firm or any of its investment professionals is investigated for possible insider trading.

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