Speakers at an ACA Group webinar last week warned that investment advisers should prepare for tougher SEC review of their use of expert networks due to the risks of receiving material non-public information during their analysts’ calls. The panelists, who are SEC alumni, discussed ways that advisers can prepare, such as their handling of notes and having compliance chaperones on calls.
The discussion centered on an April risk alert from the SEC’s Division of Examinations, which pertains to Section 204A of the Investment Advisers Act of 1940. The division said that it found cases of inadequate policies and procedures for usage of the networks and of alternative data – the latter, per the webinar, ranges from satellite imagery to geolocation data from people’s phones.
Jim Lundy, partner with Foley & Lardner, expects “a broadening” of the SEC’s approach to Section 204A. He also noted that the regulator recently used it to bring a standalone allegation, breaking from precedent in which it is used in conjunction with another allegation.
Recent history for expert networks
Usage of the networks has had its ups and downs, according to Jason Howard, who is general counsel and CCO for market intelligence company Tegus.
The usage took a hit due to hedge fund scandals during the mid-2000s, he said, and it “was essentially halted” as a result. Howard said activity picked up again about a decade ago after a speech from Carlo di Florio, who was then director of the exams division, then called the Office of Compliance Inspections and Examinations, in which he outlined back-end and front-end controls that firms could use to handle MNPI risks. Di Florio is now ACA’s chief services officer and moderated the webinar.
Since the speech, Howard said the regulator had “spoken relatively infrequently about the use of expert networks or research in general.” However, he added that the SEC’s approach changed with its April risk alert.
What the risk alert means for advisers
Offering his interpretation of the alert, Howard said the regulator expects companies to at least mandate logging and tracking of expert calls, and to retain “detailed notes” of them.
The alert covers experts who may have MNPI access or who have ties to publicly traded companies, he said. It also states that advisers should be watching the pertinent trading activities of “supervised persons.”
Howard said that this pertains to publicly traded companies operating in industries similar to companies talked about on calls. Examples of people covered, per the alert, include advisers’ employees and directors.
Lundy noted that although division risk alerts carry disclaimers stating they do not reflect SEC commissioners’ views, they have gained importance within the regulator due to their mention in communications to the agency’s enforcement staff, and they have been cited in deficiency letters. He urged firms to act promptly when they are issued, stating they should “as soon as is reasonably possible, take those risk alerts [and] apply them to your business.”
How advisers can adapt
Touching on best practices, ACA Director Dan Campbell said firms should “make sure they’re tailored to your business,” citing challenges for smaller companies. Compliance staff should also have a shared calendar containing scheduling for calls, he said, adding that schedules should be updated to reflect calls shortly after the fact if they weren’t included beforehand.
A growing practice that Campbell pointed to is chaperoning of consultations by compliance staff, noting it has been used as a “risk-based approach.”
Lundy said that chaperoning can help with understanding the cadence and discussion points of analysts’ calls, agreeing with Campbell about the practice being based on risk. However, Howard pointed out the impracticality of chaperoning every call, pointing to the difficulty of the practice for firms with limited resources.
Compliance staff should “kind of take a broad view” for what could be MNPI, Howard said.
“So, anything relating to revenues and financials, be very cautious,” he advised. “Anytime you see a number, especially if that number ends in billion.”
Speakers also discussed whether compliance staff should review all notes of expert calls or just perform sample checks.
Lundy said that sampling makes sense for firms with high call volumes and that it would be risk based. However, he cautioned that the SEC’s exams staff may come to expect that firms with low call volumes check all their notes.
Howard, whose company is a research vendor, cautioned that advisers should ensure that their vendors preserve call records for companies’ required periods.