Views on improving the integrity of global capital markets
13 September 2013

SAC Capital Advisors and Exercising Supervisory Responsibility

In a high-profile action this summer, the U.S. Securities and Exchange Commission (SEC) deployed another weapon in its seemingly endless battle against insider trading.  Not only did the SEC charge two senior portfolio managers at SAC Capital Advisors with insider trading, but the agency also brought an administrative action against Steven A. Cohen, the founder and owner of SAC Capital Advisors and one of the most prominent figures of the hedge fund industry, alleging that he “failed reasonably to supervise two of his senior employees, who engaged in insider trading under his watch.”  According to the SEC, Cohen “received highly suspicious information” upon which he should have taken “prompt action” to determine whether his employees had engaged in “unlawful conduct.” “Faced with red flags,” Cohen should have taken action “to prevent violations of federal securities laws.”  Through this action, the SEC hopes to tie Cohen to the illegal behavior of two senior employees through their supervisory relationship. A spokesman for SAC Capital Advisers denied the allegations, stating that the fund has an “exceptional supervisory structure” and “extensive compliance policies and procedures” that enjoy “Cohen’s strong support.” Cohen potentially faces hefty fines, suspension, or even a lifetime ban from the industry.

While the “failure to supervise” charge is serious and seemingly very broad, the Investment Advisers Act of 1940 provides investment advisers and their supervisory personnel with an affirmative defense to a failure to such a charge. Cohen can avoid sanctions if he has (1) established procedures and a system for applying those procedures that reasonably would be expected to prevent and detect securities law violations and (2) reasonably discharged his obligations under those procedures and system without reasonable cause to believe that the procedures were not being complied with. Since (according to Bloomberg News’ tally) at least nine current or former SAC Capital Advisors employees have been linked to insider trading while working at the firm, including four who have pleaded guilty to crimes, it would still seem that Cohen has some work to do to take advantage of this defense.

While the Securities Exchange Act of 1934 and the Investment Advisers Act vests the SEC with the authority to impose sanctions on a person who has failed reasonably to supervise others to prevent violations of securities laws, rules, and regulations, supervisory responsibility is also a prominent part of the CFA Institute Code of Ethics and Standards of Professional Conduct. Charterholders, CFA Program candidates, and CFA Institute members must abide by Standard IV(C), Duties to Employers — Responsibilities of Supervisors. Currently this standard requires that “members and candidates make reasonable efforts to detect and prevent violations of applicable laws and regulations and the Code and Standards by anyone subject to their supervision or authority.”

The guidance for this standard, appearing in the 10th edition of the Standards of Practice Handbook, expands on what constitutes an “adequate” compliance system and “reasonable” supervision and reiterates that supervisors must take steps to see that appropriate procedures are established, documented, and communicated to all employees.

As part of the proposed revisions and updates to the Code and Standards (currently out for public comment), the CFA Institute Standards of Practice Council is proposing to significantly expand Standard IV(C). While the current version of Standard IV(C) focuses on the detection and prevention of violations, the updated version stresses broader compliance expectations. The new, more comprehensive language states that members and candidates “must use reasonable efforts to ensure that anyone subject to their supervision or authority complies with applicable laws, rules, regulations, and the Code and Standards.”

The proposed guidance for this new language, to be published in the 11th edition of the handbook, expands on the current discussion of establishing and enforcing adequate compliance procedures that prevent and detect violations to address such topics as implementation of compliance education and training and establishing appropriate incentive structure. The proposed new guidance states, in part:

“At minimum, this standard requires that supervisors make reasonable efforts to prevent and detect violations by ensuring the establishment of an effective compliance system. However, an effective compliance system goes beyond enacting a code of ethics, establishing policies and procedures to achieve compliance with the Code and applicable law, and reviewing employee actions to determine whether they are following the rules. An effective supervisor will implement education and training programs on a recurring or regular basis that will assist employees under their supervision meet their professional obligations to practice in and ethical manner within the applicable legal system. Further, establishing incentives, monetary or otherwise, for employees to not only meet business goals but to also reward ethical behavior, offers supervisors another way to assist employees comply with their legal and ethical obligations.”

The Standards of Practice Council —  a volunteer committee charged with updating and revising the Code and Standards to keep them current and reflective of industry best practices — believes the changes will facilitate supervision of employees, improve and promote ethical practice in the investment industry, and better protect client interests.

What do you think? Are these changes appropriate? Do they reflect best practice? Are the new requirements too onerous or do they not go far enough? Comment on these and other proposed changes to the Code and Standards and guidance in the Standards of Practice Handbook. Comments are due by 30 September 2013.

About the Author(s)
Jon Stokes

Jon Stokes is the director of Professional Standards at CFA Institute. His responsibilities include developing, maintaining, and providing interpretation on the organization’s Code of Ethics and Standards of Professional Conduct, Asset Manager Code of Professional Conduct, and other ethics codes and standards. He has designed and created on-line ethics education programs for CFA Institute, including the CFA Institute Ethical Decision-Making and Giving Voice to Values education programs. Stokes has led numerous in-person and online ethics trainings for members, societies, and investment professionals and contributes to the ethics curriculum at all three levels of the CFA Program. He holds a JD degree.

1 thought on “SAC Capital Advisors and Exercising Supervisory Responsibility”

  1. Rajeev Kumar Thakur says:

    I believe Standards should be much more rigourous and must be reflective of current industry practices.

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