In a significant enforcement action, the U.S. Securities and Exchange Commission (SEC) has sanctioned a private fund manager for failing to implement adequate policies and procedures to prevent the misuse of material nonpublic information (MNPI) while trading securities issued by collateralized loan obligation vehicles (CLOs). This case underscores the SEC’s focus on credit managers and emphasizes the importance of strong compliance frameworks for preventing MNPI violations in CLO trading.

Case Summary

The enforcement action involves a private fund and CLO manager accused of trading tranches of debt and equity securities issued by CLOs, both managed internally and by third parties. CLOs are typically structured with various tranches of risk, ranging from equity to senior debt, with the equity tranche holding the highest risk. These securities are collateralized by pools of corporate loans or loan participations.

The SEC found that the fund manager participated in an ad hoc lender group and became privy to negative developments concerning a borrower. While in possession of this confidential borrower information, the firm sold two CLO equity tranches that included loans tied to the borrower. Although the firm’s personnel were aware of the MNPI, they failed to evaluate its materiality before executing the trades. When the information became public shortly afterward, the borrower’s loan value dropped by more than 50%, leading to an 11% decrease in the value of the sold CLO tranches.

While the SEC did not allege insider trading, it penalized the fund manager for violating Section 204A of the Advisers Act and Rule 206(4)-7. The fund manager’s lack of appropriate MNPI policies and procedures led to a $1.8 million civil penalty.

SEC’s Focus on MNPI and CLO Policies

The SEC’s settlement focused on several key deficiencies in the fund manager’s compliance program:

1. No MNPI Prohibition in CLO Tranche Trading: The firm’s insider trading policies failed to include prohibitions on trading CLO tranches while in possession of MNPI concerning underlying loans.

2. Lack of Written Policies for Borrower Information: The firm did not maintain written policies addressing MNPI obtained through borrower loans or participation in ad hoc lender groups.

3. Delayed Pre-Clearance Reviews: The firm did not begin conducting pre-clearance reviews to assess the impact of borrower-related MNPI on CLO trades until 2019, formalizing the process only in 2022.

4. No Policies for Third-Party CLO Trading: The firm lacked specific policies for trading in third-party-managed CLOs until 2024.

These deficiencies highlight the SEC’s expectation that fund managers adopt robust policies tailored to the specific risks associated with their business models, particularly where MNPI is involved.

Borrower Information as MNPI

Although corporate loans themselves may not be considered securities under the Second Circuit’s recent Kirschner decision, borrower-related information can still constitute MNPI when related to other securities. In this case, the SEC’s findings were premised on the fund manager’s possession of loan-related MNPI, which was relevant to the CLO securities it was trading. This demonstrates that fund managers must carefully assess the materiality of any borrower information they possess before executing trades involving related securities.

Private Securities Trades Based on MNPI

This case is notable because the transactions in question were privately negotiated rather than executed in the public markets. Although insider trading enforcement typically focuses on public markets, this is not the first instance in which the SEC has applied MNPI standards to private securities trades. Past actions have targeted individuals and firms engaged in fixed-income securities trading, fraud involving securitized products, and private stock repurchases without disclosing inside information.

The application of MNPI-related antifraud provisions in private securities transactions underscores the importance of compliance programs that address all forms of trading—both public and private.

Key Takeaways for Fund Managers

The SEC’s enforcement action reinforces the need for fund managers to implement comprehensive MNPI policies tailored to their business activities. Several critical elements should be considered when designing such policies:

1. Analyzing MNPI Before Trading: When fund managers receive confidential borrower information, they should analyze its materiality before trading any securities linked to the borrower’s assets, whether publicly traded or privately issued.

2. Written Policies for MNPI: Even though written policies concerning borrower information or CLO tranches may not be common, the SEC’s order implies that such policies are necessary where advisers receive sensitive loan-related information.

3. Pre-Clearance and MNPI Reviews: Policies should establish a repeatable process for MNPI review and require pre-clearance before trades involving CLO securities are executed.

4. Information Barriers: Firms actively involved in CLO equity strategies should consider establishing information barriers between investment professionals to prevent the misuse of borrower-related MNPI.

5. Materiality Determinations: Determining the materiality of information can be challenging, particularly for equity tranches in middle-market CLOs. Fund managers should consult knowledgeable counsel to assess MNPI risks in these cases.

Conclusion

This enforcement action illustrates the SEC’s continued focus on ensuring that fund managers implement reasonable policies to prevent MNPI misuse in trading CLO tranches. The SEC’s emphasis on compliance—rather than direct insider trading allegations—serves as a reminder that firms must proactively address risks tied to confidential borrower information. Fund managers should review and update their compliance programs to ensure they meet the SEC’s expectations for MNPI policies and procedures.

By taking these steps, fund managers can mitigate the risk of enforcement actions and better navigate the complex landscape of CLO trading and MNPI regulations.

* * *

Attorney Advertising—Anderson P.C. is a U.S. law firm and provides this information as a service to clients, prospective clients, and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.

Anderson P.C. is a boutique law firm dedicated to defending clients in government investigations and securities enforcement actions initiated by the SEC, FINRA, DOJ, and other regulatory bodies. We provide focused, strategic counsel and regulatory guidance across the full spectrum of federal laws and regulations affecting broker-dealers, investment advisers, banks, asset managers, private funds, public companies, senior executives, and digital assets. Our deep expertise allows us to navigate complex legal challenges and deliver results-driven solutions tailored to our clients' unique needs.

If you have any questions or need legal assistance related to government investigations, securities enforcement actions, or regulatory compliance, please don't hesitate to contact us. Our team at Anderson P.C. is here to provide the expert guidance and support you need to navigate these complex challenges.