On December 12, 2024, the Securities and Exchange Commission (“SEC”) filed a litigated complaint (the “Complaint”) in United States District Court for the District of Connecticut against a hedge fund manager (the “Firm”) registered with the SEC as an investment adviser alleging that the Firm violated Section 204A and 206(4) of the Investment Advisers Act of 1940 (“Advisers Act”) by failing to maintain and enforce policies and procedures reasonably designed to prevent the misuse of material non-public information (“MNPI”), particularly as to a consultant the Firm utilized who allegedly acted upon both the public and private side of the Firm’s information barriers in connection with information received from creditors’ committees.
SEC v. Silverpoint Capital L.P., 24-cv-2018 (D. Conn.). This Complaint comes on the heels of a
settled SEC order from earlier this fall that found a separate investment adviser violated the same provisions by failing to address adequately the MNPI risks of participating on ad hoc creditors’ committees, and is likely to present a key opportunity for a federal court to provide guidance on the contours of these provisions.
Section 204 of the Investment Advisers Act of 1940 requires every investment adviser to establish, maintain, and enforce written policies and procedures designed to prevent the misuse of MNPI, taking into account the nature of the adviser’s business.
According to the SEC’s Complaint, the Firm, like many investment banks and hedge funds, divided its business into a public side and a private side, with information barriers in place between the two. The Firm’s public side invested in debt markets for the funds it managed, and the private side consisted of representatives generally serving on creditors’ committees to advocate for the recoveries of the debt the Firm (and others) was holding and/or currently trading. The Firm implemented an information barrier (the “barrier policy”) between their public and private sides, which applied to its “directors, partners, employees, temporary employees, and other affiliated persons[.]” And the Firm’s compliance department was to designate each individual employee as public, private, or administrative to determine the level of surveillance that was required to protect MNPI. The SEC alleged that certain central requirements of the barrier policy were that (i) private side employees wanting to communicate with public side employees (and vice versa) about investment-related matters must have been preapproved by compliance and (ii) compliance was to maintain a list to track the Firm’s investments and level or knowledge and physical separation between public and private side employees within the Firm’s office.
The SEC’s Complaint does not challenge the Firm’s structure generally or suggest that it lacked any information barriers between its public and private side employees. Instead, the Complaint focuses on a single consultant (the “Consultant”) that the Firm repeatedly appointed on retainer, to work on the private side of investments and restructurings, a role in which the Consultant often received MNPI. The SEC acknowledges in its Complaint that the Firm’s policy was broad enough to cover consultants (noting that it “may” extend to them), and also acknowledges that the Consultant at issue agreed to be bound by the Firm’s barrier policy labeled as a “private side” employee. But the SEC contends that the actual implementation of this, and the guidance provided to compliance, was inadequate, leading to consistent opportunities for the Consultant to have unmonitored communications with public side employees while in possession of MNPI.
In terms of specifics, the SEC alleges that from September 2019 to February 2020, the Consultant acted as the Firm’s sole representative in confidential mediations between the Firm and Puerto Rico bondholders. During this time, the Consultant allegedly received information constituting or marked as MNPI about Puerto Rico’s financial position. On numerous occasions throughout the period, including while in mediations where he was allegedly receiving such MNPI on behalf of the Firm, the SEC claims that the Consultant held phone calls with public side employees that compliance did not know about or preapprove, leaving compliance unable to determine if these calls needed to be monitored. Additionally, the SEC claims that throughout this period, the Consultant was physically present in the Firm’s office on various occasions and was allowed to move freely throughout, even though the barrier policy required physical separation of public and private side employees. In total, the SEC claims that the Consultant had over 100 calls with different public side employees and executives while in possession of MNPI about Puerto Rico bonds, none of which were preapproved or monitored by compliance.
Notably, the SEC does not allege that the Consultant ever in fact passed MNPI to public side employees, let alone that the Firm misused such MNPI, and does not yet demand a specific financial amount in relief. The Consultant passed away in 2021, which may have limited the SEC’s ability to investigate and develop evidence; but given the fact that the Firm is contesting the claims, it is possible that additional evidence will come out suggesting a very different purpose for the many calls cited in the Complaint.
Regardless of how the facts develop through the course of this litigation, however, it will provide an important opportunity for a federal court to weigh in on what level of policies and procedures are required to be “reasonably designed” to prevent against the misuse of MNPI, which could lead to meaningful guidance for investment advisers and broker-dealers alike.
