By: Eva Marie Carney, Partner and Margot Laporte, Associate at Richards Kibbe & Orbe LLP
The U.S. Securities and Exchange Commission recently brought enforcement actions that we believe underscore asset managers’ critical duties to maintain the confidentiality of both the managers’ own and their clients’ valuable information. These actions, in our view, call for in-house counsel and compliance staffs to reexamine within their own firms the practice among investment analysts of sharing confidential information, such as their investment theses and strategic views about issuers, with counterparts at other asset managers. From a U.S. regulatory perspective, we consider that this reexamination should lead to confirmation of firm policy, through training and other measures, that the firm’s and clients’ confidential information must be well-guarded and that any disclosure of an asset manager’s confidential information must be consistent with the firm’s fiduciary duty to its investors.
This Fall, the SEC brought insider trading proceedings against two defendants, alleging that certain options trading was fueled by a tip of an asset manager’s confidential information. Matter of Filip Szymik (Sept. 2014). The SEC alleged that one of the defendants was told by his roommate, an analyst at an activist hedge fund manager, of confidential information relating to the manager’s negative views about the American public company Herbalife and the manager’s undisclosed $1 billion short position in the company’s securities. In violation of an understanding with the roommate that the roommate keep the manager-related information confidential, the defendant tipped a friend, who then purchased a series of Herbalife put options and also was charged. The proceedings against these defendants underscore two principles. First, that undisclosed research analyses and undisclosed investment positions of asset managers may be material non-public information under the U.S. federal securities laws. Second, that sharing such confidential proprietary information with others, who in turn tip and trade, may be a basis for enforcement action for U.S. insider trading.
In light of these Herbalife trading cases, it is vital that asset managers emphasize to their personnel the need to maintain the confidentiality of the asset manager’s and its clients’ information. These cases further illustrate the need to ensure that the asset manager has in place robust procedures that support that confidentiality policy.
The question that follows is when, if ever, personnel of the asset manager may share the manager’s and its clients’ confidential information with others and what safeguards are appropriate. For investment managers operating in the United States, information sharing policies are consistent with U.S. legal principles if they recognize expressly that information sharing that is undertaken in furtherance of the manager’s fiduciary duty to its clients is a legitimate part of investment analysis.
It is not uncommon for a U.S.-based analyst to desire to share with an analyst at another asset manager who is knowledgeable about the issuer her asset manager’s investment thesis with respect to that issuer. The analyst’s interest in disclosing is that she believes that doing so will refine the investment thesis and strategic thinking. To reach a reasonable conclusion that the sharing she contemplates is in furtherance of the manager’s fiduciary duty to its clients, she will need to consider all the facts and circumstances – not only the potential benefits from disclosure, but also any potential client harm that could result from the information being shared outside the asset manager (e.g., will it harm the client if the analyst to whom she shares her thesis decides to take a position in the issuer’s securities?). Of course, where an asset manager holds a third party’s information, such information may not be shared absent consent from the third party or an onward agreement to protect the confidentiality of the third party’s information, even if disclosure would be deemed to be in the interest of the third party.
We consider that, to best ensure that all the facts and circumstances surrounding a contemplated disclosure of confidential information are evaluated, information sharing policies should include the general condition that Legal & Compliance or senior management must authorize the disclosure. As a general matter, since legitimate information sharing may create appearance issues for an investment manager, Legal & Compliance or senior management will want the opportunity to consider and address these issues in the given situation. Particular risks to be considered when evaluating a proposal to share information with persons outside an asset manager might include that the act of sharing could trigger regulatory filing obligations (i.e., if the sharing would be deemed evidence of formation of a “group”), or could create the appearance of collusion with the counterpart firm or be deemed reflective of an intent to manipulate the market for a related issuer’s stock. Further, if the proposed information sharing would be with respect to a company as to which a tender offer is planned, the SEC’s tender offer rules, which prohibit divulging confidential information about a tender offer, would be implicated.
While we consider this authorization requirement generally advisable, we note that asset managers operating in the United States reasonably may determine, in the absence of facts indicating a proposed disclosure relates to a planned tender offer, that their client-investor interests are protected appropriately by substituting for this authorization requirement the condition that its analysts obtain the approval of the responsible portfolio manager before sharing an investment thesis with an analyst at another asset management firm.
In all cases, an approach to confidential information disclosure that is disciplined and deliberative will further the interests of asset managers’ clients.
Eva Marie Carney