Investment Management

Archive for August 2017

Posted on Thursday, August 31 2017 at 5:45 pm by

DOL’s Proposed Rule Would Extend the Transition Period for Certain Fiduciary Rule Exemptions to July 2019

 By Paul Foley and John I. Sanders

Today, the text of a Department of Labor (the “DOL”) Proposed Rule we have been anticipating for several weeks was made available to the public.[i] The Proposed Rule would “extend the special transition period” for certain components of the Best Interest Contract Exemption (the “BIC Exemption”) and certain other exemptions to the Fiduciary Rule.[ii] Perhaps the most important aspect of the Proposed Rule is that it would maintain the current version of the BIC Exemption, which requires fiduciaries relying on it to merely “give prudent advice that is in retirement investors’ best interest, charge no more than reasonable compensation, and avoid misleading statements.”[iii] In making the proposal, the DOL stated that its purpose was to give the DOL “time to consider possible changes and alternatives” to the exemptions.[iv] If finalized, the Proposed Rule would extend the transition period of the effected exemptions to July 1, 2019.[v]

Please contact us if you have any questions about this article or the DOL Fiduciary Rule generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] DOL, Notice of proposed amendments to PTE 2016-01, PTE 2016-02, and PTE 84-24, 82 Fed. Reg. 41365, available at https://www.federalregister.gov/documents/2017/08/31/2017-18520/extension-of-transition-period-and-delay-of-applicability-dates-best-interest-contract-exemption-pte.

[ii] Id.

[iii] Id. at 41367.

[iv] Id. at 41365.

[v] Id.

Posted on Friday, August 25 2017 at 9:51 am by

Second Circuit Clarifies its Post-Salman Position, Affirms Insider Trading Conviction

By Paul Foley and John I. Sanders

On August 23rd, the Second Circuit issued its much-anticipated opinion in U.S. v. Martoma, affirming the 2014 insider trading conviction of S.A.C. Capital Advisors portfolio manager Matthew Martoma.[1]  In doing so, it clarified an important point regarding what is required to convict a person who trades on a tip received from an insider.  We believe this decision will have an immediate impact on how hedge fund portfolio managers and other investment advisers interact with third party resources.

Section 10(b) of the Securities Exchange Act of 1934[2] and Rule 10b-5[3] promulgated thereunder prohibit insider trading.  The basic elements of insider trading are:  (i) engaging in a securities transaction, (ii) while in possession of material, non-public information, (iii) in violation of a duty to refrain from doing so.

Under the classic theory of insider trading, a corporate insider trades in shares of his employer while in possession of material, non-public information (e.g., advance notice of a merger).  In addition to the classic theory of insider trading, case law has extended the liability to persons who receive tips from insiders (i.e., individuals whose duty to refrain from trading is derived or inherited from the corporate insider’s duty).  Thus, not only may insiders be liable for insider trading, but those to whom they pass tips, either directly (tippees) or through others (remote tippees) may be liable if they trade on such tips.

The seminal case involving tippee liability is Dirks v. SEC.[4]  In Dirks, the U.S. Supreme Court held the following:

In determining whether a tippee is under an obligation to disclose or abstain, it is necessary to determine whether the insider’s “tip” constituted a breach of the insider’s fiduciary duty.  Whether disclosure is a breach of duty depends in large part on the personal benefit the insider receives as a result of the disclosure.  Absent an improper purpose, there is no breach of duty to stockholders.  And absent a breach by the insider, there is no derivative breach.[5]

The question of what constituted a “personal benefit” was left ill-defined until the Second Circuit gave it shape in U.S. v. Newman.[6]  Newman held that a tipper and tippee must have a “meaningfully close personal relationship” and that the insider information be divulged in exchange for “a potential gain of a pecuniary or similarly valuable nature” for the court to find the tipper had breached his fiduciary duty to the source.[7]  For a period of time after the Second Circuit issued its opinion in Newman, it seemed that Martoma’s conviction was likely to be overturned.

Unfortunately for Martoma, the U.S. Supreme Court issued its opinion in U.S. v. Salman while Martoma’s appeal was pending.[8]  In Salman, the U.S. Supreme Court flatly rejected certain aspects of the Newman holding and called others into question.[9]  Accordingly, the Second Circuit held in Martoma that “Salman fundamentally altered the analysis underlying Newman’s ‘meaningfully close relationship’ requirement such that the ‘meaningfully close personal relationship’ requirement is no longer good law.”[10]

In Martoma, the court held that rather than looking at objective elements of the relationship between tipper and tippee, the proper inquiry is now whether the corporate insider divulged the relevant information with the expectation that the tippee would trade on it.[11]  This is “because such a disclosure is the functional equivalent of trading on the information himself and giving the cash gift to the recipient.”[12]

Please contact us if you have any questions about the Second Circuit’s opinion in Martoma or the law concerning insider trading generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[1] U.S. v. Martoma, available at http://www.ca2.uscourts.gov/decisions/isysquery/71a89161-eec1-457e-b79b-a0d9503765c1/2/doc/14-3599_complete_opn.pdf#xml=http://www.ca2.uscourts.gov/decisions/isysquery/71a89161-eec1-457e-b79b-a0d9503765c1/2/hilite/.

[2] 15 U.S.C. 78j (2016).

[3] 17 CFR 270.10b-5 (2016).

[4] Dirks v. SEC, 463 U.S. 646 (1983).

[5] Id. at 647.

[6] U.S. v. Newman, 773 F.3d 438 (2d Cir. 2014).

[7] Id. at 452.

[8] Salman v. U.S., available at https://supreme.justia.com/cases/federal/us/580/15-628/opinion3.html.

[9] Id. at 10.

[10] U.S. v. Martoma, supra note 1, at 24.

[11] Id. at 25.

[12] Id.

Posted on Tuesday, August 22 2017 at 2:05 pm by

Adviser Settles with SEC over Insider Trading Controls for Political Intelligence Firms

By Paul Foley and John I. Sanders

Yesterday, the SEC announced a settlement under which Deerfield Management Company L.P. (“Deerfield”), a hedge fund adviser, agreed to pay more than $4.6 million.[i]  The SEC charged Deerfield with failing to “establish, maintain and enforce policies and procedures reasonably designed to prevent the illegal use of inside information”[ii] as required by Section 204A of the Investment Advisers Act of 1940 (the “Advisers Act”).[iii]

The SEC cited Deerfield for failing to tailor its policies and procedures “to address the specific risks presented by its business.”[iv]  In particular, Deerfield’s reliance on third-party political intelligence firms to provide insight into upcoming legislative and regulatory action created the risk that Deerfield would receive and illegally trade on inside information (e.g., a regulator’s unannounced decision to finalize a rule that would materially affect certain industries and publicly traded companies).[v]

The SEC’s settlement with Deerfield serves as a warning for advisers utilizing investment strategies dependent on obtaining or correctly predicting non-public information (e.g., unannounced mergers and acquisitions or the governmental approval of a pharmaceutical product), particularly those advisers partnering with third party consultants and analysts.  Such advisers should consider whether their current policies and procedures address the specific risks likely to arise under such strategies and partnerships.

Please contact us if you have any questions about the SEC’s recent settlement with Deerfield or an adviser’s obligations under the Advisers Act generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] SEC, Hedge Fund Adviser Charged for Inadequate Controls to Prevent Insider Trading (Aug. 21, 2017), available at https://www.sec.gov/news/press-release/2017-146 (hereinafter SEC Release).

[ii] Id.

[iii] 15 USC 80b-4a (2017).

[iv] SEC Release, supra note 1.

[v] Id.

Posted on Thursday, August 17 2017 at 8:39 am by

DOL Proposes an Extension of the Fiduciary Rule Transition Period

By Paul Foley and John I. Sanders

When the DOL Fiduciary Rule became effective on June 9th, it marked the start of a transition period that was scheduled to end on January 1, 2018 (the “Transition Period”).[i]  During the Transition Period, compliance burdens under the Fiduciary Rule are relaxed.  For example, those seeking to rely on the Best Interest Contract Exemption (the “BIC Exemption”) will face less stringent requirements.[ii]  Also, the DOL stated that it would not bring enforcement actions during the Transition Period against “fiduciaries who are working diligently and in good faith to comply with the new rule and exemptions.”[iii]

Last week, the DOL submitted proposed amendments to the BIC Exemption and certain other exemptions to the Fiduciary Rule.[iv]  We learned of this development through a 2-page filing the DOL made in relation to ongoing litigation.[v]  Unfortunately, the filing provided little detail, and the full text of the proposed amendments will not be available to the public until the conclusion of an interagency review.[vi]  However, what seems apparent, based upon the title of the proposed amendments in the filing, is that the proposed amendments include an extension of the Transition Period from January 1, 2018 to July 1, 2019.[vii]

In the long term, we believe that the DOL’s proposed amendments foreshadow either significant modifications to or a full repeal of the Fiduciary Rule and its exemptions.  In the near term, we believe the extension of the Transition Period, coupled with the temporary non-enforcement policy, provides fiduciaries with a reason to breathe easier.

Please contact us if you have any questions about this article or the DOL Fiduciary Rule generally.

Paul Foley is a partner with Kilpatrick Townsend & Stockton’s Winston-Salem and New York offices.  John I. Sanders is an associate based in the firm’s Winston-Salem office.

[i] Department of Labor, Conflict of Interest FAQs (Transition Period) (May 2017), available at https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/faqs/coi-transition-period-1.pdf.

[ii] Id.

[iii] Id.

[iv] Thrivent Financial for Lutherans v. Acosta, et al., No. 0:16-cv-03289 (D. Minn. Sept. 29, 2016), available at http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwjTqJP_utzVAhWI7CYKHdKTDrcQFggrMAE&url=http%3A%2F%2Fmedia.thinkadvisor.com%2Fthinkadvisor%2Farticle%2F2017%2F08%2F09%2Fthriventvdolnotice8-9-2017.pdf&usg=AFQjCNFWeSsTSR6C69Z17yHF1q1a7bkDpg.

[v] Id.

[vi] Id.

[vii] Id.