Distress Signal: SEC Takes Action Against Distressed Credit Adviser
Executive Summary
On September 30, the SEC announced an enforcement action against an adviser (the “Respondent”) alleging deficient policies and procedures related to material nonpublic information (MNPI) received in connection with the adviser’s participation on ad hoc creditors’ committees. The adviser agreed to pay a penalty of $1.5 million to settle the case. This comes on the heels of another enforcement action announced in August related to an adviser’s participation in an ad hoc lender group, suggesting that the SEC is keenly focused on how credit advisers are handling MNPI. Equity advisers would also do well to take note of this case, as it hearkens back to a 2020 enforcement action against an adviser alleging deficient compliance controls related to the adviser’s participation on a company’s board of directors.
The Facts of the Case
According to the SEC’s order, a key part of the Respondent’s business was investing in distressed debt instruments, which led to the Respondent regularly being involved in creditors’ committees. The purpose of a creditors’ committee is for large debtholders of an issuer to evaluate opportunities to restructure the issuer’s debt in a manner that provides a favorable return to the lenders and allows the issuer to avoid having to take more drastic measures, such as filing for bankruptcy. To the extent the borrower is an issuer of publicly-traded securities, participation on a creditors’ committee will often entail the execution of a non-disclosure agreement (NDA) and receipt of MNPI.
The order states that the Respondent came to believe the financial condition of “Issuer 1” was becoming impaired to the point that Issuer 1 could default on its debt payments. This led to the Respondent deciding to participate in a creditors’ committee. The SEC alleges that contemporaneously with these efforts to join a creditors' committee, the Respondent began building a significant position in Issuer 1’s bonds, which continued up until it entered an NDA with Issuer 1. In the interim, the creditors’ committee engaged “Adviser A” to act as its financial advisor and liaison to Issuer 1. In this capacity, Adviser A entered into an NDA with Issuer 1, pursuant to which it received MNPI about Issuer 1. The timeline described in the order indicates that the Respondent did not enter into its own NDA with Issuer 1 until the following month.
According to the SEC, the Respondent’s analysts on the creditors’ committee participated in numerous meetings and communications with Adviser A before the Respondent entered into an NDA with Issuer 1, but did not obtain any written representations from Adviser A or conduct any due diligence of Adviser A with respect to their practices for handling MNPI. This led the SEC to conclude that the Respondent failed to adopt policies and procedures reasonably designed to address the potential receipt of MNPI in connection with participation on a creditors’ committee and interactions with advisers and other consultants acting on behalf of the committee.
Notably, while the order appears to suggest the SEC had concerns regarding the timing of the Respondent’s purchases of Issuer 1’s bonds, it does not allege that the Respondent misused MNPI in connection with those trades. Further, the order acknowledges several points that would seem to be mitigating factors, including that the Respondent had written policies and procedures to address the handling of MNPI more broadly; that the Respondent informed Adviser A and the other members of the committee that it did not want to be restricted from trading Issuer 1’s securities until it entered into its own NDA; and that written materials provided by Adviser A to the committee included a disclaimer to the effect that the content of the materials was derived from publicly available information. Obviously, the SEC did not find these steps to be sufficient.
Key Takeaways
Advisers that are likely to participate on creditor committees or in other lender groups may consider making the following enhancements to their compliance program:
Policies and Procedures – Update written policies and procedures to specifically address the risks associated with such participation and to provide for appropriate diligence of third-party advisors and other consultants engaged by the committee concerning their practices for handling MNPI.
Notification to Compliance – Require the compliance department to be notified promptly of efforts to form or join a creditor committee as well as any material developments after the adviser’s personnel join the committee (e.g., if the committee is seeking to engage a third-party advisor).
Compliance Oversight – Consider whether additional monitoring, testing, or other oversight should be put into place related to participation on creditors’ committees. For example, it may be prudent for the compliance department to monitor communications between advisors and consultants to a creditor committee and the adviser’s personnel that sit on the committee and/or communications between the adviser’s personnel that sit on the committee and other investment or trading personnel that may be involved in trading securities of the issuer.
How Apogee Can Help
Apogee’s consultants have extensive experience working with advisers who invest in public and private credit and a deep understanding of the unique risks that can arise in this space. We can help with reviewing and updating your written policies and procedures, disclosure documents, and compliance monitoring and testing based on our observations of regulatory expectations and industry best practices. For more information, please contact us as info@apogeecomply.com.