On 26 August 2024, the SEC settled charges against an SEC-registered adviser for policies and procedures failures related to the misuse of material nonpublic information (MNPI) concerning its trading of collateralized loan obligations (CLOs). The adviser paid a US$1.8 million penalty.

According to the SEC’s order, the adviser managed CLOs and traded the tranches of CLOs it managed as well as tranches of third-party CLOs. In connection with managing CLOs, the adviser also often participated in ad hoc lender groups or creditors’ committees. Through the adviser’s participation in these ad hoc groups, it received confidential information about issuers. On one occasion, the adviser sold tranches of a CLO while in possession of confidential information concerning the borrowers whose loans were included in the CLO.

The Order notes that although, after the above incident, the adviser began conducting pre-clearance reviews to assess the impact of potential MNPI on the trading of CLOs that it sponsored, the adviser did not adopt written policies or procedures to address those risks for three years. In addition, the adviser never adopted any procedures regarding the trading of third-party CLOs. In particular, the SEC noted that the adviser failed to maintain any information barriers between the personnel responsible for credit investment decisions (including those potentially exposed to MNPI from participation in ad hoc lender groups) and the personnel responsible for its CLO trading.

Key Takeaways

This settlement highlights that: (i) participation in ad hoc lender groups or creditor’s committees is a potential source of MNPI; and (ii) information about underlying loans in the CLO can be material to the decision to buy or sell tranches in that CLO. This action also shows that the SEC continues to focus on preventing the misuse of MNPI and expects investment advisers to adopt written policies and procedures concerning the possession of MNPI with respect to CLOs. Investment advisers (especially those who both manage and invest in CLOs) should assess how they may come into possession of MNPI and then implement (and document) processes to mitigate risks of trading on MNPI, either through information barriers, firmwide trading restrictions or otherwise.