Client Alert: SEC Charges Adviser for Inadequate MNPI and Restricted List Policies and Procedures

February 25, 2020

On February 4, 2020, the Securities and Exchange Commission (“Commission”) entered a settled order against private fund adviser Cannell Capital, LLC (“Cannell”) for failure to establish, implement, and enforce policies and procedures reasonably designed to prevent the misuse of material nonpublic information (“MNPI”) in violation of § 204A of the Investment Advisers Act of 1940 (“Order”).1 Under the terms of the settlement, Cannell was censured and required to pay a $150,000 penalty. Remarkably, there is no indication in the Order that Commission staff suspected (but felt, perhaps, they could not prove) Cannell was engage in insider trading or other fraudulent conduct. Rather, it appears, the enforcement action was premised solely on Cannell’s failure to establish reasonably designed MNPI and restricted list policies and procedures.

Cannell, a Commission-registered investment adviser headquartered in Alta, Wyoming, employed a strategy focused on trading the equity of small market capitalization public companies for which there may have been minimal trading and little or no sell side analyst coverage. According to the Order, this strategy entailed communicating frequently with issuer insiders; entering into nondisclosure agreements with issuers to gain access to financial information and engage in strategic communications about the issuer; communicating with investment bankers; participating in confidentially offered secondary offerings and PIPE transactions; and publishing its own research articles on the internet. The strategy, in the Commission’s view, put Cannell and its covered persons at heightened risk of coming into possession of MNPI.

Cannell had a generic MNPI policy (as described in the Order) which, the Commission found, failed to address the firm’s business-specific risk factors or to establish specific procedures for handling the potential sources of MNPI that were part and parcel of its strategy. The policy prohibited covered persons (and their family members) from engaging in insider trading; however, it relied on covered persons who thought they may have come into possession of MNPI to self-report that fact to Cannell’s chief compliance officer (“CCO”). Then, under the policy, the CCO would determine whether to add the security at issue to the firm’s restricted list. The fact that the managing member controlled all aspects of the firm, including all trading decisions, in the Commission’s view, increased the importance of reasonably designed MNPI policies and procedures.

The Commission also found Cannell failed to maintain a reasonably designed restricted list. According to the Order, Cannell had a “patchwork” system that relied on a combination of restrictions within an electronic order management system, documents saved to a sharedrive, emails, and/or verbal conversations to communicate restrictions to covered persons. The order management system could be used to block trading in restricted securities, but Cannell did not use this feature of the system consistently or effectively. Only the CCO could enter a security in the system to prevent trading. When the CCO was out of the office, the system would not be updated. Often, securities were not restricted in the system for days after the CCO had determined they should be restricted. Additionally, though Cannell used its sharedrive to store documents related to restricted securities, in many instances, the Order found, the documents were not added until months or years after the restriction occurred. Finally, the CCO communicated restrictions, at times, by email, phone, or in person; however, these ad hoc communications, in the Commission’s view, were not sufficient and, in any event, did not provide notice to covered persons not privy to them.

The Order notes that, in July, 2017, in response to a deficiency letter from the Commission’s Office of Compliance, Inspections, and Examinations (“OCIE”), Cannell revised its MNPI policy, among other things, to require that the restricted list be updated and circulated to all covered persons each time a security was added to it or every seven days, whichever happened first. However, the CCO failed to follow the new policy, circulating the list only on Mondays, not each time it was updated.

S&K Observations

The adequacy of advisers’ MNPI policies and procedures, as well as their implementation, are perennial priorities for OCIE staff during examinations. This is especially true for private fund advisers and their restricted list controls. We recommend you take this opportunity to review your MNPI policies and procedures, and restricted list controls, to ensure they are reasonably designed to address your firm’s business-specific risk factors, including all potential sources of MNPI intrinsic to your investment strategy.

Please contact your primary attorney at Seward & Kissel if you have any questions or want any assistance with a review of your firm’s MNPI policies and procedures.


1 In the Matter of Cannell Capital, LLC, File No. 3-19689 (Feb. 4, 2020).