The SEC filed a civil injunctive action with a federal district court charging the primary equity trader (the “Trader”) employed by an SEC-registered investment adviser (the “Adviser”) with (1) trading ahead of client trades (“front-running”), (2) insider trading, and (3) failing to report trades and brokerage accounts to the Adviser. The SEC also filed a claim to recover proceeds of the alleged trading activity from the Trader’s wife (the “Relief Defendant”) in whose account the improper trades were alleged to have been made. The federal district court granted the SEC’s request to issue an emergency court order freezing the assets of the Trader and the Relief Defendant. This article summarizes the SEC’s allegations against the Trader and the Relief Defendant, as to which no final determinations have been made.
Background. The Adviser provides advisory and portfolio management services to a variety of clients, including registered investment companies (“Funds”). The SEC noted that the Adviser specializes in, and is considered by many investors to be an authority on, master limited partnership (“MLP”) issuers, MLP-related securities, and other energy-income securities (collectively referred to as “MLP/Energy securities”) and publishes four MLP Indices that are the basis for products offered by Credit Suisse and Morgan Stanley has a similar product based on one of the Adviser’s Indices.
The Adviser’s Code of Ethics. The Adviser has a Code of Ethics and Personal Trading Policy (“Code of Ethics”) that prohibited the Trader from using material, nonpublic or “inside” information for personal profit, and included in its definition of inside information “knowledge of pending orders or research recommendations, . . . and other material non-public information that could affect the price of a security.” The Code of Ethics also prohibited the Trader from: (1) buying or selling, for his own direct or indirect benefit, any “covered security” (as defined in the Code of Ethics and the federal securities laws) which he knew at the time the Adviser was buying or selling, or “actively considered” buying or selling, on behalf of a client; (2) using knowledge of portfolio transactions made or contemplated by the Adviser for personal profit, or otherwise engage in fraudulent conduct in connection with the Adviser’s trading; or (3) abusing his position of trust.
Under the Code of Ethics, the Trader was required to electronically execute questionnaires each quarter regarding his personal trading activity, which included disclosing his covered securities transactions for the quarter. The Adviser’s Code of Ethics also required the Trader to disclose all personal brokerage accounts in which he has a direct or indirect interest, and to report and pre-clear certain personal securities transactions and holdings.
Alleged Selective Disclosure of Trading Accounts. The SEC alleged that the Trader failed to report to the Adviser a trading account with Broker A in his own name, 3 accounts with Broker A in the Relief Defendant’s name, and 3 accounts with Broker B in the Relief Defendant’s name, although required to do so, in quarterly questionnaires submitted to the Adviser. In November 2011, Broker A, whose affiliate was the clearing firm for one of the Adviser’s executing brokers, terminated the Trader’s and the Relief Defendant’s accounts after surveillance personnel reviewed the trading activity in the Relief Defendant’s accounts and the corresponding trades made on behalf of the Adviser’s clients. In February 2013, when SEC inspection staff interviewed the Trader during an on-site examination of the Adviser, he failed to disclose the Relief Defendant’s accounts when asked to disclose all personal accounts.
Alleged Unlawful Trading Activity. The SEC alleged that the Trader used the Adviser’s confidential trading information to trade on and ahead of hundreds of the Adviser’s client trades. The Trader accessed the Relief Defendant’s accounts from his office computer during the work day at least 1,123 times. On over 400 occasions, without seeking pre-clearance, the Trader executed same day trades in the same securities that the Adviser traded in on behalf of its clients, realizing at least $1.7 million in profits. The Trader made at least 132 of those trades, representing over $520,000 of the $1.7 million total profits alleged, ahead of the Adviser’s client trades in MLP/Energy securities.
The SEC’s allegations note (a) the movement from July 2013 through February 2013 of approximately $1.85 million from the Relief Defendant’s account with Broker B to a bank account, (b) the movement of approximately $1.1 million from his account at the same bank to one of the Trader’s brokerage accounts, and (c) a number of instances in which large deposits to the Trader’s brokerage account were made on the same day or within a few days of transfers between the Relief Defendant’s Broker B and bank accounts. The SEC’s complaint also includes allegations that the Trader and the Relief Trader had significant personal expenditures, including monthly credit card bills that exceeded $10,000 and the purchase of a $94,000 automobile.
Alleged Violations. The SEC alleged that the Trader violated and unless enjoined, would continue to violate (1) the anti-fraud prohibitions of (A) Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(a) and (c) thereunder and (B) Section 17(j) of the Investment Company Act of 1940 (“Investment Company Act”) and Rules 17j-1(b)(1), (3) and (4) thereunder and (2) the requirements of Section 17(j) of the Investment Company Act and Rule 17j-1(d) thereunder with respect to reporting by specified personnel of a Fund adviser regarding certain securities transactions and brokerage accounts in which those personnel have a direct or indirect beneficial ownership interest.
The SEC also claimed that having received, directly or indirectly, from the Trader the proceeds of alleged unlawful activities, the Relief Defendant has been unjustly enriched, and under such circumstances, it is not equitable for her to retain those amounts.
Relief Sought. The SEC has asked the Court to (a) grant permanent injunctions with respect to the above-referenced securities law violations, (b) order disgorgement by the Trader plus prejudgment interest, (c) levy civil penalties against the Trader, and (d) order disgorgement by the Relief Defendant plus prejudgment interest.