Revocation of Investment Adviser License & Disgorgement of Profits
Managers are becoming more aware of the various securities laws and compliance issues involved with the use of expert networks. While the SEC has recently been active in this area (both in the RR insider trading complaint and the recent expert network action), the states are also becoming more aware of the potential issues involved with expert networks. Recently the Massachusetts Securities Division instituted an administrative complaint against a Massachusetts state registered fund manager who utilized expert networks to gain inside information. This post will provide an overview of that compliant.
James Silverman was registered as an investment adviser representative for a Massachusetts registered IA firm which was managing the RRC Bio Fund, LP (“Fund”). The IA firm was subject to a routine announced examination by the Massachusetts Securities Division (“Division”). During that routine examination, the examiners found a number of violations of the various state securities laws including the fact that Silverman was trading on inside information obtained from an expert network firm.
The examiners found that Silverman started using the expert network firm after the Fund suffered a long period of losses. After utilizing the expert network firm, the Fund posted consecutive years of gains in excess of 50%. During the course of the relationship with the expert network firm, the Fund paid $80,000 a year to the firm so that Silverman could have access to certain consultants in the biotechnology industry. Many of these consultants were either insiders or otherwise bound to confidentiality agreements with respect to their activities in the industry. The expert network firm did not monitor their consultants in any way but, pursuant to the firm’s policies, the consultants’ had a duty to identify and avoid any disclosure that would violate a confidentiality agreement. The agreement that Silverman signed with the expert network fir
m provided that Silverman agreed not to elicit or otherwise obtain any “material nonpublic or otherwise confidential information” from the expert consultants.
In addition to the insider trading, Silverman and the IA firm engaged in either blatantly illegal or egregiously sloppy business practices, especially once the examination began. For example, the complaint states that Silverman did the following:
- deleted notes containing study results prior to producing the notes to the Division in response to its subpoena
- deleted certain documents and correspondence
- failed to maintain required records
- made false filings with the Division
- violated minimum financial requirements
- violated document retention requirements
- improperly assessed performance fees
- left client data vulnerable
The consequences for breaking the securities laws, whether at the state or federal level, are severe. The Enforcement Section of the Massachusetts Securities Division sought the following items in its action against Silverman:
- accounting and disgorgement of all ill-gotten gains as a result of insider trading
- disgorgement of direct and indirect remuneration from the insider trading
- revocation of the IA registration for the firm and Silverman
- enjoining Silverman from performing any investment advisory services for compensation on behalf of any person or entity within the Commonwealth of Massachusetts
- imposition of a fine
Protecting Your Firm – Developing Compliance Programs
This case and the earlier SEC actions do not mean that fund managers can no longer use expert network firms. However, managers need to be careful and the best practice is for managers to develop compliance policies for all interaction with expert network firms. These policies and procedures need to be tailored to the business practices of each manager and need to be followed consistently.
Cole-Frieman & Mallon LLP is a boutique hedge fund law firm. We provide hedge fund compliance and registration services to SEC and state registered hedge fund managers. Bart Mallon can be reached directly at 415-868-5345.