Warning: Political Intelligence May Be Material Non-Public Information
Advisers receiving information from political intelligence firms – or advisers that themselves act as political intelligence firms – need to ensure that any intelligence received or forwarded does not constitute material non-public information, and that they have the proper policies and procedures in place if it does. Firms that fail to do so may find themselves in the SEC’s cross-hairs.
Marwood Group Research, a dually registered advisory firm/broker-dealer that provides legislative and regulatory research analysis to hedge funds, mutual funds and other investment advisers, on November 24 settled with the SEC. The settlement involved two instances in which the advisory firm received information that presented a substantial risk of MNPI, given Marwood employee internal comments about the nature of the information, the agency said. Marwood then allegedly failed to have the information reviewed by its chief compliance officer.
As part of the settlement, the adviser had to pay a $375,000 fine and admit to compliance violations. The order also found that Marwood voluntarily and pro-actively enhanced its policies and procedures for controlling possible MNPI in 2013 and 2014.
The SEC charged that although Marwood had a general policy prohibiting the acquisition and misuse of MNPI and required employees to bring confidential information to the firm’s compliance department before using it, it wasn’t enough.
"Marwood had no written policy or procedure that reasonably ensured that the chief compliance officer was provided with sufficient information to assess whether a research note may have been influenced by improperly obtained MNPI or to evaluate independently other Marwood employees’ assessments that any information they had received from a government employee was not MNPI," the agency said. Those policies and procedures, it said, did not "expressly require the compliance department to be advised as to the source of the information included in the research note or about communications with government sources. … Instead, Marwood’s policy principally relied on line employees and managers to make the assessment, with limited
review by the CCO."
"Government employees routinely possess and generate confidential market-moving information," said SEC Division of Enforcement director Andrew Ceresney. "When political intelligence firms like Marwood Group obtain information from government employees, they must take the necessary steps to prevent the dissemination of potentially material non-public information obtained in the course of their research." An attorney representing the firm declined an opportunity to comment.
"This case is somewhat unusual," said Baker Hostetler partner Marc Powers. "In cases of this kind, it is usual for the SEC to bring charges against a firm for trading on or passing along MNPI. This case is unusual in that the agency is not charging insider trading, but is instead bringing the case under a theory of inadequate policies and procedures and their enforcement." In addition, he noted, Marwood did not appear to be doing anything different than what a lobbying firm does, and the political intelligence it provided was not obtained from a specific company, but was instead from the government and alleged to affect the market in companies’ securities.
The SEC’s settlement with Marwood found two instances where information raised a risk of being potential MNPI. Both involved information on policy issues or pending regulatory approvals, one from the Centers for Medicare & Medicaid Services (CMS), and the other from the Food and Drug Administration (FDA).
While few advisers are themselves political intelligence firms, it would not be uncommon for them to retain such firms as part of their investment process, said Faegre Baker Daniels partner Jeffrey Blumberg. He likened political intelligence firms to the expert networks that drew the SEC’s attention a few years back. Political intelligence firms are "expert networks that are political in nature rather than industry or sector in nature," he said.
In either case – whether through an expert network or a political intelligence firm – there is the potential for the consultant to relay MNPI to the adviser’s personnel. Advisers that retain such firms would therefore be wise to first perform due diligence on these external information sources, making sure that they have policies and procedures in place to prevent misuse of MNPI, and also to "get some representations and warranties from the firm stating that they have these policies and procedures in place and will ensure that such policies and procedures are enforced," Blumberg said.
Secondly, he said, any adviser retaining a political intelligence firm or an expert network needs to make sure that its own policies and procedures address the issues around MNPI and insider trading with particular attention to the additional risks that arise from using outside consultants, and put in place appropriate internal procedures.
One such possibility to consider, Blumberg said, is "chaperoning," under which the firm’s compliance staff monitors calls between the political intelligence firm and the adviser. In such situations, the political intelligence firm or expert network, as well as the adviser’s own personnel, would, at a minimum, need to be told that any calls "may be monitored," he said. The advisory firm should also be prepared, depending on the relevant laws of its state, to take any additional steps the state may require.
Powers suggested that the case demonstrates that a general policy involving MNPI is "no longer sufficient," and that policies and procedures need to include specific and clear internal information barriers that match the business of the firm and an independent supervisory review by a designated person, such as a CCO, before any such information is acted upon or disseminated outside the firm to clients.
Analysts and research notes
Since its founding in 2003, Marwood has conducted research, written reports and updates, and communicated other information about regulatory and legislative issues, which it sells to clients, predominantly mutual funds, investment advisers and hedge funds, according to the SEC’s administrative order instituting the settlement.
Research notes were one of the firm’s principal methods of providing this information, according to the administrative order. They "often included previews of anticipated legislative or regulatory developments and post-views of government actions already undertaken. Preview notes often included a predictive opinion of the likely outcome of government activity. Post-view notes summarized government activity that had already
occurred and reiterated prior opinions or offered new opinions about the implications of government action."
In order to facilitate analysts’ ability to write such intelligence, "Marwood encouraged its analysts to maintain contacts and seek information from personnel within the federal government," the SEC said.
The firm also allegedly arranged meetings and phone calls with government employees that sometimes included client representatives. "During these meetings and calls, Marwood employees sought and obtained information from the government employees, which Marwood then, at times, used to inform its research," the agency said.
Medical coverage and drug approval
The two specific instances of violations cited by the SEC were:
CMS drug coverage. CMS determines which medical items and services it will cover and what it will pay for those services through what is known as a national coverage determination (NCD), which is created after conducting a national coverage analysis (NCA). The announcement of an NCD can therefore be a material event that reduces or enhances the market value of a company’s publicly offered securities. In this instance, CMS conducted a NCA of a metastatic prostate cancer immunotherapy drug known as Provenge. Marwood, during the summer of 2010, employed as its CMS analyst a former CMS employee who had previously worked in the CMS group responsible for NCAs, and who maintained CMS contacts, the SEC said. It quoted an email from the analyst in which the analyst made clear that his CMS contact was providing certain information only to him. After the Provenge NCA was complete, Marwood allegedly wrote a research note, "Provenge NCA Likely to Support On-Label Coverage," which it shared with its clients.
FDA drug application. The FDA was considering a revised application for a new drug called Bydureon in 2010, and some of Marwood’s clients sought the firm’s view of what the FDA’s decision would likely be. Marwood retained as a consultant a former high-ranking FDA official "to assist with its analysis of FDA issues, which included the Bydureon new drug application," the SEC said. During a 73-minute telephone conversation between this consultant and certain Marwood employees, the consultant allegedly said that his contacts at the FDA indicated there was still concern about approval of the drug and that there was an internal debate going on. "No Marwood staff or managers took any steps to quarantine the information received from the consultant or to alert the CCO," the SEC said. Marwood then allegedly communicated the consultant’s information to its clients.
Violations and penalties
The SEC charged Marwood with violating Section 204A of the Advisers Act, which requires advisers to establish, maintain and enforce written policies and procedures to prevent the misuse of MNPI. It also charged the firm with violating Section 15(g) of the Exchange Act, which requires registered broker-dealers to do much the same thing.
In addition to the civil money penalty and having to admit wrongdoing – something the SEC requires only in cases where it views the violations as particularly significant or when it wants to send a message to the industry – it required Marwood to retain an independent compliance consultant, and that the firm adopt all recommendations from the consultant. Marwood will also have to certify in writing its compliance with the consultant’s remedies.