SEC Takes Advisory Firm to Enforcement for Failing to Deem a Third Party Consultant as an “Access Person”

In the Matter of Federated Global Investment Management Corp (“FGIMC”), the SEC settled an administrative proceeding against FGIMC for a failure to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information in connection with FGIMC’s use of outside consultants as part of its securities research and analysis activities.  FGIMC agreed to cease and desist, censure and a $1,500,000 fine.

According to the SEC settlement order, from 2001 to 2010 FGIMC made use of third-party consultants, including one particular consultant (“Consultant”), who worked closely with FGIMC investment management professionals and provided FGIMC with  research and analysis, which included buy, sell and hold recommendations with respect to certain pharmaceutical and biotechnology stocks.  However, due to lack of procedures and controls, FGIMC was unaware that during the same time period the Consultant also sat on the Boards of four publicly traded biotech companies that were owned by certain mutual funds sub-advised by FGIMC.   Both roles provided the Consultant with access to non-public information.

Consultants as “Access Persons”

FGIMC had policies and procedures governing the handling of insider information, along with  a Code of Ethics that contained  personal trading restrictions, including preclearance and seven-day blackout periods, disclosure of conflicts-of-interest, and  pre-clearance requirements for certain outside business activity.  However, from 2001 to 2008 FGIMC did not have policies and procedures in place for identifying when outside consultants should be deemed “access persons” of the firm and subject to the requirements of FGIMC’s Code of Ethics and insider trading policy.    In late 2008, FGIMC expanded its definition of “Access Person” under the Code of Ethics to include any individual so designated by the compliance department, and stated that this may include “a Federated employee or temporary hire, vendor, service provider or other third party employee.”  Despite this addition, FGIMC did not apply its Code of Ethics to the Consultant.

Remediation by FGIMC

Prior to the SEC investigation,  FGIMC discovered that the Consultant  was serving as a board member of public companies and due to this position, had access to and possession of material, nonpublic information regarding such companies.  In response, FGIMC took the following steps:

  1. Terminated the Consulting Agreement with Consultant;
  2. Performed a review of their use of  the Consultant and trading activity by the sub-advised funds in the securities of the public companies for which Consultant served as a board member; and
  3. Implemented policies and procedures for determining whether any FGIMC third-party consultants had access to or were in possession of material, nonpublic information.

Despite the remedial steps taken by FGIMC, the SEC issued administrative proceedings against the firm, but did consider such steps when determining the settlement agreement.

Internal Controls

In light of this case, advisory firms should take time to ensure they have appropriate policies and procedures pertaining to the use of service providers.  Additionally, below are some internal controls steps that should be considered:

  1. Perform in-depth due diligence reviews on third party service providers both initially and periodically throughout the arrangement.
  2. Have a written agreement that outlines the terms of the arrangement, including adherence to the firm’s policies and procedures, Code of Ethics and insider trading policy, when applicable.
  3. Keep the Chief Compliance Officer informed regarding new business arrangements so appropriate compliance steps can be implemented when necessary.

CCLS Can Help

Insider trading has been a top enforcement priority for regulators for the past few years and firms need to have robust policies and procedures that remain geared for prevention. For information on how CCLS can assist you with drafting policies, procedures and implementing internal controls, along with more information on this enforcement action and other related subjects, please contact us at info@corecls.com or (619) 278-0020.