On August 26, 2024, the Securities and Exchange Commission (SEC) announced an order against a registered investment adviser, Sound Point Capital Management, LP, for its failure to “establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information (MNPI)” concerning its trading of collateralized loan obligations (CLOs). Interestingly, although the order describes instances of Sound Point trading CLOs that contained loans to a company about which Sound Point had MNPI, the order does not reach the question of whether that information was material to the CLOs. Instead, the order cites Sound Point only for policy and procedure violations.

Sound Point manages CLOs and trades interests in both proprietary CLOs (i.e., CLOs that it manages) and interests in CLOs that are managed by third parties. It also has a credit business for which it often participates in lenders’ groups or creditors’ committees. According to the order, Sound Point, in 2019 as a result of serving on the ad hoc lender group of a borrower company, came into possession of MNPI about the likely failure of a transaction by that company and the company’s resulting need for rescue financing. About a month later, Sound Point reduced its exposure to the equity tranche of two proprietary CLOs that contained loans to the company.  At the time, while Sound Point maintained a restricted list for securities trading, it did not have written policies or procedures requiring it to consider the impact of MNPI relating to a given corporate borrower on the value of a CLO (or any particular tranche of the CLO) containing a loan to that borrower. Following these events, Sound Point began to conduct pre-trade compliance reviews that considered the loan exposure of proprietary CLOs; it was not until several years later that the firm adopted policies and procedures governing these reviews. The order also highlights that the policies and procedures did not address loan exposure of third-party CLOs until after the SEC staff’s investigation.

Sound Point was found to have violated Sections 204A and 206(4) of the Investment Advisers Act of 1940, and Rule 206(4)-7 thereunder. These violations relate to the failure to “establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser’s business, to prevent the misuse of material, nonpublic information” and to have “policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder.” As a result, Sound Point was subject to SEC censure and ordered to pay a civil penalty of $1.8 million. In its order, the SEC notes that it took into account the firm’s prompt remediation and cooperation.

The SEC has previously brought cases alleging similar policy and procedure failures without allegations of MNPI misuse. See, e.g., In the Matter of Ares Management LLC, Advisers Act Release No. 5510 (May 26, 2020), https://www.sec.gov/files/litigation/admin/2020/ia-5510.pdf (finding that an adviser did not routinely establish information walls or conduct sufficient pre-trade reviews for potential MNPI with respect to publicly-listed companies in its portfolio on whose boards it had an employee-representative). The Sound Point action underscores the continued importance of having in place policies and procedures, such as information barriers and restricted lists, designed to prevent the misuse of MNPI, particularly where MNPI may be held by an adviser with multiple business lines.