Category: Alerts

Do Not Neglect Your Compliance Health During the COVID-19 Pandemic

While the COVID19 Pandemic has seemingly ground our economy to a halt, compliance obligations still must be met. The COVID19 situation has led the SEC to close offices and to relax some obligations (i.e. relaxation of in person board meeting requirements, conditional relief from ADV filing deadlines, etc.), however, the SEC has made it clear that firms’ compliance obligations will be strictly monitored and enforced. In its March 23, 2020 statement, the SEC emphasized “the importance of maintaining market integrity and following corporate controls and procedures.”1 Moreover, the SEC “is committing substantial resources to ensuring that our Main Street investors are not victims of fraud or illegal practices in these unprecedented market and economic conditions.”2

The areas of SEC increased scrutiny, and as such compliance health areas that firms should focus upon, include: improper trading on material nonpublic information; disclosure and investor communications; valuations; and, business continuity plans (“BCPs”).

Material Nonpublic Information

Given the enormous amount of market volatility caused by the Covid19 Pandemic, corporate insiders have both an increased access to material nonpublic information (“MNPI”) and a tremendous incentive and opportunity to trade on MNPI. Covid19 has increased the SEC’s concerns regarding improper trading on MNPI.

“[I]n these dynamic circumstances, corporate insiders are regularly learning new material nonpublic information that may hold an even greater value than under normal circumstances. This may particularly be the case if earnings reports or required SEC disclosure filings are delayed due to Covid19. Given these unique circumstances, a greater number of people may have access to material nonpublic information than in less challenging times. Those with such access – including, for example, directors, officers, employees, and consultants and other outside professionals – should be mindful of their obligations to keep this information confidential and to comply with the prohibitions on illegal securities trading.”3

The C-19 pandemic presents some unique obstacles in the prevention of improper trading on MNPI such as: (i) employees, outside consultants, and not just directors, officers, and high-level insiders may have access to MNPI; and, (ii) it may be hard to monitor and control employees who are forced to work remotely.

Compliance procedures that firms can implement and follow to minimize risks from improper trading on MNPI include:

  • Policies that prohibit trading on C-19 MNPI that include and identify all employees who may have access to such information;
  • Provide the MNPI policy to all relevant employees and require the employees to acknowledge receipt as well as review and comprehension;
  • Reinforce the MNPI policy through frequent e-mails and training;
  • Consider implementing: (i) blackout periods; (ii) restricted securities lists that are updated daily; and, (iii) intensive pre-clearance procedures.
  • Institute valid 10b5-1 plans4 which allow employees to trade securities in a pre-planned manner, and thus creating an affirmative defense against insider trading allegations.
  • Insure that the firm’s technology is sufficient to monitor trading on MNPI while employees are working remotely.

Disclosure and Investor Communications

The stock market’s volatility in the wake of C-19 has motivated the SEC to weigh in on disclosure obligations. The SEC Division of Corporation Finance published new guidance to provide clarity regarding its view on disclosure obligations during the C-19 pandemic.

“The Commission has made clear that its disclosure requirements can apply to a broad range of evolving business risks even in the absence of a specific line item requirement that names the particular risk presented. In addition, a number of existing rules or regulations require disclosure about the known or reasonably likely effects of and the types of risks presented by COVID-19. As a result, disclosure of these risks and COVID-19-related effects may be necessary or appropriate in management’s discussion and analysis, the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over financial reporting, and the financial statements.”5

The Division of Corporation Finance’s guidance provides an illustrative list of questions which firms should focus upon, including: (i) C-19’s impact on a company’s financial condition and operations; (ii) U.S. GAAP considerations presented by the C-19 pandemic; and (iii) C-19’s impact on the demand for the company’s products and services.

To avoid Covid19 Disclosure and Investor Communications compliance issues, firms should:

  • Evaluate whether it has an affirmative disclosure obligation due to the risks and uncertainties associated with Covid19.
  • If a statement regarding Covid19 is to be made, ensure that such statement is neither materially misleading nor omits information that would make the statement material misleading.
  • Document steps taken to comply with the guidance provided by the Division of Corporation Finance as the Division.
  • Evaluate whether or not the Covid19 related disruptions to a company’s business and/or financial condition triggers reporting obligations under various 8-K items.
  • Scrutinize director and officer insurance policies in anticipation of possible litigation which may allege improper or misleading disclosures or communications.
  • Insure that all communications with investors are accurate and transparent especially with reporting of the financial condition and performance reporting of client funds and accounts.
  • Consider an early release of earnings information.

Valuation Issues

In light of the Covid19 fall out, the Division of Investment Management has, among other things, encouraged investment advisors and funds to evaluate their valuation procedures.6 Firms should:

  • Strictly adhere to their valuation policy.
  • Follow the valuation procedures outlined in their fund documents and/or compliance manual.
  • Insure that valuations are based upon realistic assumptions.
  • Consult with their valuation committee and/or advisory board.

Business Continuity Plans

In response to the C-19 crisis, the Division of Investment Management has also encouraged firms to “evaluate their business continuity plans.”7 Firms should carefully review and if needed update their BCPs with a focus on:

  • Business continuity plan and other firm compliance policies and procedures addressing the continuity of business operations.
  • Firm-issued policies, procedures guidance and other information tailored to address the continuity of the business operations specific to pandemics.
  • Unforeseen issues or weaknesses in the activation of the BCP plan during the COVID-19 pandemic.
  • How the BCP plan addresses the resiliency practices of third-party vendors, service providers and partners.
  • Cybersecurity and policies and procedures regarding employee remote access – for more information on this topic please see the Alaric Alert COVID-19: Protecting Employees Without Sacrificing Cyber Security.
  • Any difficulty or limitations in the ability to operate critical systems and maintain operations during the pandemic.
  • Management of vendors and outside consultants.

Social Distancing Will Not Slow the SEC

The Covid19 pandemic will undoubtedly have some impact on SEC operations. It would be unwise, however, to assume that this will translate into fewer SEC actions. As an initial matter, the SEC is proficient at running investigations and other enforcement actions across multiple field offices. As such, the Commission has developed considerable expertise in coordinating employees who are remote from one another. Moreover, the SEC has not missed a beat during previous interruptions and shutdowns. For example, even though there was a the four-week government shut down in 2018 and 2019, the commission brought 862 total enforcement actions in fiscal year 2019, the second highest total ever.8 In fact we can expect an increase in SEC actions relating to trading on MNPI, disclosure violations, valuation procedures, BCPs, and other cases in which the SEC staff believes are warranted do to the turmoil caused by the C-19 crisis.

With over 275 years of cumulative financial services compliance expertise, we have managed over 100 regulatory examinations while serving as chief compliance officers. Leveraging this experience, our team of former regulators, lawyers, and in-house chief compliance officers can help your firm keep your compliance program healthy.

Call Alaric today to learn more about our compliance services at 1-888-243-2448 or info@alariccompliance.com or visit our website, at www.alariccompliance.com.

1 Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC’s Division of Enforcement, Regarding Market Integrity, March 23, 2020, https://www.sec.gov/news/public-statement/statement-enforcement-co-directors-market-integrity
2 Id.
3 Id.
4 A 10b5-1 plan can protect an employee who trades in company securities even if the employee is aware of MNPI. In order to be valid, the plan must have the following attributes: (i) created in good faith; (ii) implemented at a time when the employee was unaware of MNPI; (iii) specific as to timing and pricing; (iv) implemented without any subsequent influence from the employee over how, when or if trades are made; and, (v) the purchase or sale of securities must be made pursuant to the terms of the plan.
5 Division of Corporation Finance, Securities and Exchange Commission, CF Disclosure Guidance: Topic No. 9, March 25, 2020, https://www.sec.gov/corpfin/coronavirus-covid-19
6 Division of Investment Management Staff Statement on Fund Board Meetings and Unforeseen or Emergency Circumstances Related to Coronavirus Disease 2019 (COVID-19), https://www.sec.gov/investment/staff-statement-im-covid-19
7 Id.
8 US Securities and Exchange Commission (SEC) Division of Enforcement 2019 Annual Report, https://www.sec.gov/files/enforcement-annual-report-2019.pdf

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