Most in the industry do not consider being the perpetrator of insider trading as high risk, as most of those in the industry have no means of obtaining inside information. And in most cases, this is true.
With the former being said, it is important to truly understand what constitutes insider information. As an example, the SEC recently took action against an independent auditor for insider trading. The auditor subject to the SEC action obtained information from the company in which he was auditing regarding the company’s acquisition of one of their competitors. This auditor then took that information to execute a transaction in the market to take advantage of the knowledge.
Assume the above-mentioned individual was a client. This client goes to their registered investment adviser with a request to make these transactions on their behalf. The trade is outside of the scope of their investment objective so their investment adviser representative questions the client about the trade. The client informs the advisor that they are making the trade because of a pending acquisition. Seems harmless enough. However, the adviser thinks it sounds promising and makes the trade for the client, and invests some of their own money, and quite possibly other clients’ money as well, before conducting any due diligence on the companies participating in the merger. Now not only is the client being looked at for insider information, but the adviser that made the trade, and invested their own money, is being looked at as well. It will be hard to convince the regulators that there was no collusion because the advisor did not conduct any due diligence and there is nothing to prove they did not know the information was non-public.
This scenario is also an important reminder as to why it is important to know your customer. Take the same situation, except the client is an officer of the company that is in the process of acquiring their competitor. The advisor did not bother to collect adequate information about its client at the time the client engaged their services. The advisor may know that the client is the President of the company for whom they work, but did not obtain the name of the company. If the advisor executes the trade for the client and in their own account, they again could be accused of insider trading.
It is important to remember that although there are no formal Rules which require that registered investment advisers do or not do, there are certain things that all in the financial industry need to do in order to protect one’s self. At the top of the list is knowing your client, and conducting due diligence on all information obtained from clients, business associates, and “at the water cooler”.
About Red Oak Compliance Solutions
Red Oak Compliance Solutions is the global advertising review software of choice in the financial services industry. It is a comprehensive suite of SEC 17A-4 compliant features that are 100% books and records compliant and provides clients with 35% faster approvals and 70% fewer touches or better. We also offer Smart Review(SM), which solves for the storage and maintenance of disclosures, helping firms reduce risk, decrease review times, and increase the speed of distribution of marketing materials. Smart Registration(SM) automates the licensing and registration management process to help reduce regulatory risk and time spent on manual processes. Overall, Red Oak allows firms to minimize risk, reduce costs, and increase compliance review process effectiveness and efficiencies.