TMI at Canell Capital
TMI at Canell Capital
Complying with your regulatory obligations can be tough when you’re a small entity. It’s true! You’re sitting their managing $490 million, and that sounds like a lot, but it sure could be more to afford a bunch of compliance staff running around. Then the SEC comes asking questions, and boom, there you are. Or there Canell Capital was yesterday when the SEC hit it with a cease-and-desist order for allegedly not taking proper care of its material, nonpublic information.
Allegations
Canell’s Business Model
Canell, based in Wyoming near Jackson Hole, is an investment adviser that generally focuses on trading the equity of thinly traded, small market cap public companies with little or no sell side analyst coverage. To research and understand these securities, Canell did a lot of things. It (i) communicated with issuer insiders, (ii) entered into nondisclosure agreements with issuers to gain access to financial information and engage in strategic communications, (iii) communicated with investment bankers, (iv) participated in confidentially offered deals such as secondary offerings and PIPE transactions, and (v) published its own research articles on the internet.
Things Canell Did Right
All of this meant that Canell would frequently find itself in possession of material, nonpublic information (“MNPI”) that, because of Advisers Act Section 204A, it had to handle with care. To protect against the misuse of this MNPI, that Canell’s covered persons might encounter, Canell actually did a lot right. I can count at least six things: (1) The firm maintained a written compliance manual that contained an insider trading policy that prohibited insider trading. (2) The policy defined MNPI and gave examples of it. (3) The policy directed covered persons who thought they might be in possession of MNPI regarding an issuer not to trade but to contact Canell’s chief compliance officer so the CCO could make the determination. (4) If the CCO decided it was MNPI, the issuer would go on a Restricted List and Canell would not trade it until the restriction was lifted. (5) The policy also prohibited covered persons and their family household members from such activity in their own accounts. (6) To enforce this rule, Canell’s code of ethics required preclearance for most securities transactions by covered persons.
Things Canell Allegedly Did Wrong
But . . . the SEC says the policy did not specify when, how, or what information was supposed to be added to the Restricted List, other than the name of the issuer. The policy was silent on where the list was located or how the list was shared with covered persons. Also, the Restricted List wasn’t really a list. Instead, Canell had more of a patchwork system that relied on some combination of restrictions within an electronic order management system, documents saved to the compliance sharedrive, emails, and verbal conversations to communicate restrictions on trading to covered persons. At times Canell used an electronic order management system to block trading in securities, but this wasn’t consistent or effective. When the CCO wasn’t in the office, no one updated the system to block trading. Even when a security was blocked, the system was unreliable because the security was often entered into the system days after the CCO made the MNPI determination. The sharedrive was less reliable because it was sometimes months or years out of date.
The SEC says the firm’s policy didn’t address:
the risks posed by Canell being owned, controlled, and managed by a single person. Instead of drafting procedures to minimize the impact of that risk, the MNPI Policy failed to include any written guidelines regarding the parameters the CCO would use to determine whether information “constitutes MNPI that might expose the Firm or any of its affiliates to liability for ‘insider trading.’ ”
any of Canell’s business-specific risk factors. Because Canell’s covered persons had frequent communications with issuers and investment bankers, relying entirely on covered persons self-reporting MNPI to the CCO could not reasonably protect against the heightened risk of misuse of MNPI at the firm.
The Upshot
The SEC says Canell’s failure to implement a reasonably designed Restricted List impaired its ability to identify potentially problematic trading and heightened the risk of misuse of MNPI. Canell is paying a $150,000 penalty for this alleged violation of Section 204A.
What We Don’t Get / Lessons
The SEC’s Office of Compliance Inspections and Examinations addressed Canell’s Restricted List in 2017. In response to a deficiency letter back then, Canell updated its MNPI Policy to require that “[a]ny time there is a change to the Restricted List or every seven calendar days, whichever happens first, the CCO will circulate an updated Restricted List.” To implement this new policy, Canell created and circulated a Restricted List to covered persons via email every Monday. But because the new Restricted List was only circulated on Mondays, rather than at the time of the change to the Restricted List, the firm basically failed this policy update.
Look, it’s hard out there. Canell did a lot right. But if you get a deficiency letter from the SEC’s exam staff, follow the terms of the letter. Not half the letter. The whole thing. Also, if your business model regularly incorporates a lot of material, nonpublic information, develop a process for letting the compliance staff know about it. Build a system, and stick to the system.