Buzz Article:
Increase in Insider Trading Enforcement Affecting Private Funds

by Attorneys at Kirkland & Ellis LLP, 7/14/2010

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Introduction

By Margaret A. Gibson, Robert M. Hayward, Scott A. Moehrke, Robert W. Pommer III and Andrew Wright of Kirkland & Ellis LLP

Recent enforcement activities by the U.S. Securities and Exchange Commission (SEC), the Department of Justice (DOJ) and the Federal Bureau of Investigation (FBI) reflect a renewed, more systematic and aggressive approach by federal authorities to investigating and prosecuting alleged insider trading, in particular by persons associated with private investment funds.^[1]

Sound off on this buzz in the Comments Section.

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Recent examples include:

• Indicting at least 20 individuals and firms, including several hedge funds, in some of the most sweeping insider-trading cases ever brought by federal regulators;

• Using undercover techniques, including informants, front businesses and, for the first time ever, court-authorized wiretaps to target insider trading on Wall Street;

• Developing and applying new technological tools to track and analyze securities trading, including a data-mining project to uncover clusters of correlated trades;

• Expanding the SEC's enforcement activities beyond traditional equity securities, focusing on swaps and other non-equity securities; and

• Pursuing expanded theories of insider-trading liability.

In addition, today virtually every SEC civil insider trading investigation carries substantial risk of a parallel criminal investigation and prosecution.

When the government pursues charges of insider trading (or other illegal activity) by a private fund's employee, a private fund that has adopted — and followed— good insider trading/compliance policies and procedures and cooperates with law enforcement should in most cases incur reduced or no penalties. For example, in a recent enforcement action involving a CFO's alleged selective disclosures violating Regulation FD, the SEC did not charge the employer where (1) the employer cultivated an environment of compliance with training, policies and controls; (2) the CFO was alleged to have acted alone and in violation of company policies and controls; (3) the employer immediately self-reported the conduct to the SEC and cooperated with the investigation, and (4) the employer adopted remedial measures and additional controls.

While a private fund manager's approach will vary depending on the nature and complexity of its business, all such firms should consider the following:

• Written Insider Trading Policies. A firm with no written policy ^[2] should promptly adopt and implement written policies and procedures designed to identify, contain and prevent the intentional or inadvertent misuse of non-public information in its possession. Examples include requiring all personnel to (1) check a "restricted list" of public companies about which the firm has confidential information before making personal or firm-related securities trades, or (2) pre-clear with the firm's chief compliance officer (or person with similar authority) a personal securities trade.

A firm with a written policy should review and, if necessary, revise its policies and procedures, taking into account (among other things) whether the firm has added new lines of business, investment products or strategies presenting potential compliance issues not covered in existing policies and procedures.

• Application of Policies and Procedures. A firm should also assess how its insider trading/compliance policies/ procedures are operating in practice. For example: Do firm personnel comply with specific contractual obligations relating to the handling of confidential information, such as written confidentiality agreements? If the firm maintains a "restricted list," is it being updated and properly utilized? Has the firm taken appropriate steps in cases of any discovered violations? Does the firm have regular compliance training for and annual certifications of compliance by all firm personnel?

• Third Party Sources of Information. A firm using third parties such as "information brokers" or similar consulting organizations as part of its research efforts should analyze the type of information conveyed by such sources and whether to adopt specific policies and procedures relating to these resources.

• Information Technology. A firm should evaluate the costs and benefits of using technology to aid in detecting and preventing insider trading, such as compliance software that identifies and prevents a firm from trading in any security on a restricted list. In addition, a firm should evaluate its information security procedures, including safeguards limiting physical and electronic access to information, as well as policies relating to use of various communications protocols, such as e-mail, voicemail, telephone, instant messaging and cell phone, many of which have provided valuable information to investigators in recent enforcement actions.

• Tone at the Top. One of the most important steps a firm can take is setting an ethical "tone at the top" by encouraging awareness of and compliance with all legal and regulatory obligations, and good faith reporting of misconduct.

The possibility of insider trading by rogue employees of private equity and hedge funds has always existed, but the legal and business risks and liabilities for those firms are greater in today's emboldened enforcement environment. Media attention generated by recent high-profile insider trading cases, and the adverse consequences that can result from the mere allegation of insider trading, demonstrate the benefits of strong compliance programs.

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Margaret A. Gibson, P.C., Partner,

Meg Gibson is a partner in the corporate group concentrating on business transactions and counseling, with particular focus on private equity, mergers and acquisitions, leveraged buyouts, restructurings and private fund formations.

Robert M. Hayward, P.C., Partner,

Robert M. Hayward is a partner in the corporate transactional group at Kirkland & Ellis. His practice primarily involves counseling publicly-traded corporations, underwriters and leveraged buyout and private equity funds and their portfolio companies in all aspects of transactional, securities law, corporate governance, executive compensation, stockholder activism and general corporate matters. Mr. Hayward has extensive experience representing both issuers and underwriters in public and private offerings of debt and equity securities, buyers and sellers in public and private M&A and leverage buyout transactions and issuers and investors in PIPE, venture capital and other private financing transactions.

Scott A. Moehrke, P.C., Partner,

A partner in Kirkland's Corporate Practice Group, Scott A. Moehrke leads the Firm's Investment Management Practice Group, where he practices in securities and corporate law with significant experience representing financial services companies, such as investment advisers, investment companies, business development companies and broker-dealers. His practice focuses on complex business transactions, including registered and exempt fund formations and ongoing operations, mergers, acquisitions and joint ventures of funds and fund managers, public and private securities offerings, novel product design and structuring, SEC compliance, board of directors and governance matters and institutional shareholder rights matters.

Robert W. Pommer III, Partner,

Robert W. Pommer is a partner in the Washington, D.C. office of Kirkland & Ellis, LLP. His practice focuses on a broad range of issues related to regulatory enforcement, corporate governance, and financial reporting. An experienced trial attorney, Mr. Pommer represents individuals and companies in enforcement investigations and litigation conducted by the U.S. Securities and Exchange Commission and other governmental entities and financial services regulators. In addition, Mr. Pommer conducts internal investigations and counsels companies on regulatory compliance, corporate governance and other SEC-related issues.

Andrew Wright, Partner,

Andrew Wright focuses his practice on the formation and operation of private investment funds, including private equity and venture capital funds, hedge funds, real estate funds and other private investment funds. Mr. Wright's practice also includes assisting fund sponsors in connection with the organization and documentation of their internal firm arrangements and compensation structures. He also counsels clients on a wide range of matters relating to the structuring of fund investments, as well as legal and regulatory compliance matters for funds and their investment advisers. Mr. Wright also assists clients in connection with a wide range of extraordinary events involving private investment funds, including "key person" events, parent bankruptcies, investor defaults, strategic investments in a fund sponsor, and other significant transactions.

Kirkland & Ellis LLP

Kirkland & Ellis has a 100-year history of providing exceptional service to clients around the world in complex corporate and tax restructuring, litigation, and intellectual property, and technology matters. The groundwork has been established for another century of superior legal work and client service. The Firm has offices in New York, Chicago, London, Los Angeles, Munich, New York, Palo Alto, San Francisco, Shanghai and Washington, D.C.

^[1] See remarks by the SEC's Director of Enforcement directed to investment advisers. (October 16, 2009, press conference by Robert Khuzami at http://www.sec.gov/news/speech/2009/spch101609rk.htm.)

^[2] An SEC registered private investment fund adviser is required to adopt procedures reasonably designed to deter insider trading and procedures to monitor and in certain cases pre-clear employee securities transactions.

© 2010 KIRKLAND & ELLIS LLP. All rights reserved.

Comments

On Wednesday, July 14, Matthew E. Abrams, CRCP wrote...

I read with great interest the referenced article. I was especially enthused by the overall message that well developed compliance policies and procedures coupled with good execution can mitigate a firm’s liability should an employee engage in questionable trading activities. My sermon exactly. It’s been my experience that demonstrating the execution of the monitoring program and the ability to produce detailed data on demand may even lessen the level of scrutiny exercised during the exam process.

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