In response to recent insider trading allegations against investment advisers, the Massachusetts Securities Division (MSD) has adopted regulations that will require investment advisers to obtain a written certifi cation from any paid consultant or expert network service fi rm providing “investment consulting services.”18 19 The regulation becomes effective December 1, 2011.
Both the MSD and the SEC recently have brought enforcement actions as a result of the use by hedge funds and investment advisers of consultants, either directly or indirectly through the use of so-called expert network service fi rms, to provide specialized information about prospective investments. In the federal cases, the SEC alleges that the persons providing the information were moonlighting as consultants or experts without the knowledge of their employers and were providing non-public information about publicly traded companies (including Apple and Dell) with which their employers were doing business.
The new MSD regulations will require Massachusetts registered investment advisers (and possibly other investment advisers, as discussed below) to obtain a written certifi cation when retaining investment consulting services. The certifi cation must:
- describe all confi dentiality restrictions relevant to the potential consultation which the consultant has, or reasonably expects to have;
- affi rmatively state that the consultant will not provide any “confi dential information”20 to the investment adviser; and
- be signed and dated by the consultant (which may be in electronic form), and be accurate as of the date of the initial, and any subsequent, consultation(s).
Failure to obtain the certifi cation will be deemed a dishonest or unethical practice in the securities business under Massachusetts law, subject to fi ne, censure and/or denial, suspension or revocation of registration.
The new MSD regulations make it clear that regardless of whether an investment adviser obtains the certifi cation, an investment adviser may not trade on non-public information obtained from a consultant or expert network services fi rm.
The new regulation will apply to Massachusetts registered investment advisers; however the MSD also has made it clear that the new requirement will not apply to federally registered investment advisers given the limitations placed on states pursuant to the National Securities Market Improvement Act of 1996.21 What is not clear is the extent to which the new regulation will apply to investment advisers that are not registered with either Massachusetts or the SEC, but which provide advisory services to Massa chusetts clients; however, the language in the new regulations is broad enough to support an effort by the MSD to subject such investment advisers to the new regulations if it so chooses.
All Massachusetts registered investment advisers should comply with the regulation and obtain the certifi cation when engaging consultants or expert networks. In light of increased Federal and state focus on insider trading in this area, all investment advisers (including those exempt from the Massachusetts regulation as noted above) that use such consultants or expert networks should consider, as a best practice, the use of a similar certifi cation. Other best practices to be considered include:
- discussing with the consultant or expert network the source of their information and ensuring that all information obtained does not breach any confi dentiality obligations of the consultants or any other person;
- inserting provisions in engagement agreements with consultants and expert networks to prohibit the conveyance of non-public information; and
- reviewing and revising the investment adviser’s insider trading policies to address the issues raised by the use of consultants and expert networks.