MNPI compliance failures trip up PE firm

An SEC settlement resulted in $1m penalty for Ares Management.

The compliance department for a Los Angeles-based private equity firm is facing unwanted attention after the global alternative investment manager was charged on 26 May by the Securities and Exchange Commission with failing to implement and enforce P&Ps “reasonably designed” to prevent the misuse of material nonpublic information (MNPI). That failure has resulted in a $1 million penalty for Ares Management.

Chief among the compliance failures was the Commission’s finding that Ares and its compliance department didn’t take into account the “special circumstances” presented by one of its senior representative’s dual role as both a member of a portfolio company’s board and an employee who continued to participate in the firm’s trading decisions concerning the company. The settlement doesn’t name any of the compliance staff; only the firm was charged.

Key provisions

Without admitting or denying the SEC’s findings, Ares entered into a settlement agreement with the Commission. The settlement states that in 2016, Ares invested several hundred million dollars in a public company through a loan and equity investment. There were confidentiality provisions in the loan agreement between Ares and the portfolio company. Additionally, the equity investment allowed Ares to appoint two directors to the portfolio company’s board.

As one of its allotted two reps on the board, Ares appointed a senior member of the Ares “deal team” who was involved in the debt and equity investment. That rep, along with other members of the deal team, would receive information from the portfolio company that posed a risk it could be MNPI, the SEC noted.

MNPI examples

Ares ultimately obtained potential MNPI about the portfolio company, including through Ares’ rep on the company’s board. Examples of such MNPI consisted of changes in senior management, adjustments to the company’s hedging strategy and decisions with respect to the company’s assets, debt and interest payments.

After receiving the information while the rep was on the board, Ares moved on purchasing more than 1 million of the portfolio company’s common shares – 17 percent of the company’s publicly-available shares. The stock purchase orders were approved by Ares’ compliance department.

Flawed compliance approvals

Those approvals were flawed. The SEC found that Ares didn’t require its compliance staff, prior to approving the trades, to sufficiently inquire and document whether the board rep and members of his deal team possessed MNPI relating to the portfolio company.

The portfolio company’s insider trading policy did provide that its trading window would typically be closed from the 16th day of each quarter/year until three full trading days after the filing of its financial results for that quarter. For its part, Ares’ MNPI procedures were detailed in portions of the Ares Global Ethics and Compliance Manual, as well as the Ares Compliance Department Confidential Information and Trading Procedures.

Trading restrictions

The SEC noted that Ares’ MNPI P&Ps detailed circumstances under which securities should be subject to trading restrictions and tracked on a “restricted list.” Where Ares had an employee-rep sitting on the board of a publicly-listed company in its investment portfolio, the firm’s P&Ps required that company’s stock to be placed on Ares’ restricted list and mandated that any trades in the stock be pre-approved by compliance staff.

The case offers a number of lessons learned. Compliance staffers were required to confirm with the portfolio company that any restrictive trading window applicable to directors was open. They were also to “check with Ares director for MNPI.” The P&Ps further provided for the discretionary establishment of information walls, irrespective of whether a company’s stock was on the restricted list. However, Ares didn’t “routinely establish information walls with respect to publicly-listed companies in its investment portfolio on whose boards it had a rep, and did not do so here,” the SEC stated.

Documentation failures

The Commission faulted Ares’ compliance staff for further failing, in numerous instances, to document sufficiently that it had inquired with the board rep and the members of the deal team as to whether any of them had received potential MNPI from the portfolio company. A consistent practice wasn’t applied. This resulted in ambiguity as to whether, or if, inquiries were made in certain instances, the SEC stated.

“Investment advisors and private equity firms that place employees on the boards of public companies bear heightened risks that they will obtain nonpublic material information through their representative occupying dual roles,” said Anita Bandy, associate director in the SEC’s Division of Enforcement. “It is critical for firms like Ares to have proper policies and procedures in place to address these risks and prevent the misuse of information obtained under these special circumstances,” she added.

Troutman Sanders Associate Kurt Wolfe sees the enforcement action as a “signal” case to remind market participants to be ever vigilant.

Steps taken

Ares has taken steps to shore up its MNPI compliance. Last year, after the SEC investigation commenced, the firm voluntarily engaged an outside consultant to review and evaluate the design and implementation of its MNPI P&Ps. Ares also expanded the size and authority of its compliance teams and enhanced training programs on MNPI issues.