Compliance Failures Result in $1Million Penalty
Compliance procedures have long been a key matter when it comes to material non-public information or inside information. This is particularly true for regulated entities that are required to have such systems. And, the systems can effectively constitute the first line of defense for the firm if there is a violation.
Even a good system may not save the company for a violation. Indeed, in some instances the system may in fact become the predicate for an enforcement action. This is precisely what happened in the Commission’s most recent case involving the handling of potential material non-public information – the firm failed to follow its own procedures. While apparently that did not result in insider trading it did end with the payment of a large fine and a cease and desist order. In the Matter of Ares Management LLC, Adm. Proc. File No. 3-19812 (May 26, 2020).
Ares is a global alternative asset manager whose clients are pooled investment vehicles. In some instances, the clients are public firms; in others they are not. Ares had over $149 million in total assets under management at the end of 2019.
In 2016 Ares had in place a comprehensive set of procedures governing the handling of material non-public information. In that year the firm invested several hundred million dollars in Portfolio Company. The investment gave the adviser the right to appoint two directors to the board of Portfolio Company creating the risk that Ares would obtain material non-public information. During the period the firm did receive inside information with respect to a Portfolio Company loan.
Over time, Areas also received a variety of information that was potentially material inside information such as changes to senior management, mid-quarter hedging adjustments, efforts to sell a passive interest in a specific assets and similar matters. All of the information was later disclosed. All of the purchases were approved by the investment committee. As a result of the purchases Ares acquired over 1 million shares representing about 17% of the float.
Although Ares placed the Portfolio Company stock on its restricted list, the compliance team failed to properly follow the firm procedures which governed the situation –that is, where the firm held shares in an entity where its employees had board seats. In those instances the procedures required that the staff make prepare written entries for entry into the mangement system sufficiently documenting if prior to approving the trade inquiry was made to determine if the deal team had inside information.
Here in numerous instances, the compliance staff failed to make entries in the order management system sufficiently documenting if prior to the approval of the trade it had inquired if the deal team had obtained inside information. And, to the extent such entries were made, they lacked consistency and detail. Accordingly, despite the increased risk resulting from the relationships between Ares and Portfolio Company, the compliance staff failed to properly adhere to and apply the firm’s systems.
After the Commission’s investigation began in 2019 however, the firm retained a consultant and reviewed and evaluated its policies and procedures. The Order alleges violations of Advisers Act Sections 204A and 206(4).
To resolve the matter the firm consented to the entry of a cease and desist order based on the sections cited and to a censure. Ares also agreed to pay a penalty of $1 million.