SEC Targets Insider Trading Compliance Failures
In light of Cady’s recent IA compliance gala celebration, I thought I would spend a post discussing In re Janney Montgomery Scott LLC, Admin. Proc. File No. 3-14459 (July 11, 2011), a compliance matter involving a broker-dealer.
The case was based in Section 15(g) of the Exchange Act, which requires all registered broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by the B-D or its employees. More briefly, the statute requires broker-dealers to maintain and enforce insider trading compliance programs. Those programs are often written partly to deal with risks that arise from housing research analysts and investment bankers under the same roof. In short, broker-dealers have to make sure that the I-bankers don’t take unfair advantage of inside information learned from the B-D’s research analysts. Broker-dealers often do this by keeping a Watch List of companies the investment bankers are advising to identify securities that hold the potential for insider trading.
As the case begins, the initial facts describe a fairly healthy compliance situation. At least once the firm got a manual written for its Equity Capital Markets division, the manual required investment bankers to seek Research Department comment on proposed transactions only in the presence of compliance personnel. Starting in January 2005, Janney’s primary compliance counsel required any banker wanting such a meeting to send her an email requesting a chaperoned meeting and detailing the substance of the proposed discussion. She prepared herself for the meetings by familiarizing herself with the companies to be discussed and the companies in the market segments covered by the research analyst. But she left Janney in August 2005, and the SEC says then things sort of fell to pieces. All of the allegations that follow are from the SEC’s administrative order. Maybe they’re not true! But . . .
Compliance counsel’s successor was less rigorous in his work. He didn’t take any steps to learn about the deals on the Watch List. He was generally unaware of what industry segments the research analysts covered, and did not gather any information about potential companies to be discussed before meetings. This was only the beginning. As time went on, the firm suffered from these failures as well:
In Fall 2005, when Janney began using research analysts’ expertise to help investment bankers explore new business opportunities, the compliance manual was not revised to take this development into account.
In January 2006, a junior investment banker advising a biometric company on a pending merger had a chaperoned conversation in which he asked a research analyst for “color” regarding the quarter-to-quarter earnings histories of two companies. The compliance counsel chaperone did not know the investment banker was advising the biometric company, or that the research analyst specifically covered both companies being discussed. It’s possible that nothing said in the meeting meant anything in particular to the chaperone.
During the pendency of that deal, the investment banker and research analyst had at least one 14-minute phone call outside the chaperone’s presence.
At times, in contravention of the compliance manual, the respective head of research and investment banking chaperoned inter-departmental meetings. No one monitored contacts between investment bankers and research staff unless a chaperoned meeting was specifically requested.
Janney failed to maintain and enforce its email communication firewall procedures, and investment bankers were able to email research analysts directly.
Janney failed to adequately monitor trading in the securities of firms on the Watch List.
Even though the compliance manual required employees to keep their own trading accounts, at Janney, they frequently asked for and were granted permission to hold the accounts elsewhere, making monitoring much more difficult.
Janney didn’t collect annual employee questionnaires that would have at least alerted the firm to outside brokerage accounts.
In some cases, even though the firm was aware of outside accounts held by employees, Janney didn’t review any trading activity in those accounts.
The Commission censured Janney and imposed a cease-and-desist order, as well as an $850,000 civil money penalty.
It's important to understand the context of this case. Insider trading has become an area of intense focus for the SEC and the Justice Department. Bruce Carton at Securities Docket recently explained the virtues of an insider trading compliance program for publicly-traded companies. The case is even stronger for broker-dealers, who are statutorily required to have such a program. Broker-dealers should take care to stay out of those agencies’ crosshairs by tightening up compliance with Section 15(g). And while Janney’s particular failures were somewhat complex, the general lessons from this case are relatively simple. Specifically, firms should (1) keep a close watch on communications between investment bankers and research staff; (2) document any communications that do happen, with reference to companies at issue; (3) and keep a close watch on employees’ trading, which ideally will happen inside the firm.