The SEC fined a private equity firm $1 Million because its compliance department failed to stop open market purchases of a portfolio company’s securities while in possession of material nonpublic information (MNPI). A member of the firm’s deal team sat on the portfolio company’s board, thereby giving him access to MNPI about the firm. Although the compliance department placed the portfolio company on its restricted list, it approved significant and ongoing public market purchases. The SEC faults the compliance department for failing to conduct enough due diligence into whether the firm held MNPI. The SEC cites the compliance department’s failure to follow-up with internal parties about the extent of their information, a lack of follow-up, weak documentation, and policies that over-relied on individual discretion and knowledge.
How do you know if your compliance department is doing a good job (before the SEC makes a judgment)? In many firms, the compliance officer is the proverbial “one-eyed man in the kingdom of the blind,” left to his/her own judgment, experience, and knowledge without scrutiny. We recommend that senior management (not involving the CCO) engage a third party to conduct a periodic independent review. Alternatively, many firms have turned to the third party CCO model, whereby a legitimate compliance services firm has contractual, reputational, and regulatory accountability.