New York, NY – In recent weeks a few asset managers have decided that, given the ongoing insider trading investigation, it might make more sense if they stopped using independent research providers like expert networks, channel check providers, or other unregistered research firms. Instead, they have decided to rely on research from registered broker-dealers, based on the conclusion that they would be safer. However, last month the SEC proved this was not the case by sanctioning registered broker-dealer and institutional research provider Buckingham Research Group; registered investment adviser Buckingham Capital Management; and Lloyd Karp, the chief compliance officer of both entities for altering compliance records prior to their production for an examination and inadequate procedures to control the flow of nonpublic information.
According to the SEC, Buckingham Research Group (BRG), and affiliated Buckingham Capital Group (BCG), failed to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information. The SEC complaint against BRG, BCG, and compliance officer Lloyd Karp can be read in its entirety by clicking on the following link http://www.sec.gov/litigation/admin/2010/34-63323.pdf.
The SEC acknowledged that BRG had created a policy regarding how it would treat the receipt of material research information. This policy was designed to document compliance with the firm’s confidentiality policy, and to make sure that the firm’s analysts were aware of their responsibility to restrict the disclosure of such information. The SEC claims that BRG’s policy was not followed.
In contrast, BCG did not have a written policy to address the potential misuse of BRG’s material research information prior to February 2007. While BCG eventually adopted practices designed to prevent the misuse of this type of information, they were not consistently followed. BCG did have rules regarding the use of material nonpublic information, however they were not followed. BCG also had a written Insider Trading Prohibitions policy which required that persons with access to inside information report all relationships that may result in access to such information. It was not followed.
In 2005, Lloyd Karp, the Chief Compliance Officer of both BRG and BCG, created a compliance review log form to ensure that compliance reviews were conducted by Buckingham Capital. The purpose of this log was to prevent violations of anti-fraud provisions. There were no written procedures that explained how the log was to be used.
Also, as BCG prepared for its 2006 SEC examination, staff learned that it was missing pre-approval forms for more than 100 employee trades that took place during 2005. The firm also discovered that its compliance review logs were incomplete. Rather than producing the incomplete records, BCG staff recreated the missing documents and furnished them to the SEC examination staff without disclosing what they had done.
SEC Findings and Penalties
In its Order, the SEC concluded that BRG willfully violated Exchange Act Section 15(f), while BCG willfully violated Advisers Act Section 204A. These sections require that broker-dealers and investment advisers establish and maintain written policies and procedures to prevent the misuse of material nonpublic information.
The SEC also ruled that BCG violated the Advisers Act Section 206(4), which prohibits fraud and deceptive acts, and Rule 206(4)-7, which requires the adoption of written procedures to implement the provision by failing to adopt adequate procedures with respect to the use of the compliance log. BCG was also found to have violated Rule 206(4)-7(b) which requires that an annual compliance review be conducted, and Advisers Act Section 204(a), which requires that all records be subject to examination by the SEC.
To resolve the action, BRG, BCG, and Lloyd Karp consented to cease and desist from any future violations, or causing any violations of Section 15(f) of the Exchange Act; Advisers Act Sections 204(a), 204A and 206(4) along with all pertinent rules. BRG and BCG were also ordered to retain a consultant and adopt the recommendations provided by the consultant to improve their compliance policies and procedures. Each Respondent also agreed to pay the following civil penalties: $50,000 for BRG; $75,000 for BCG; and $35,000 for Lloyd Karp. Lastly, Buckingham Research Group, Buckingham Capital Group, and Mr. Lloyd Karp were all censured for their actions in this case.
Consequences of This Case
The Buckingham Research and Buckingham Capital case is notable on two fronts. First, the two entities at issue are both registered (broker-dealer and investment adviser) entities that had policies and procedures in place, yet the SEC found that the policies were inadequate and ineffective. Also, the chief compliance officer was individually named and had to pay a civil penalty.
The team at Integrity Research Associates thinks it is extremely ironic that more than seven years ago, US federal authorities discovered that the equity research provided by registered broker-dealers was overtly conflicted as a result of the influence of trying to win investment banking mandates. This directly led to the Global Research Analyst Settlement. However, the current US federal investigation into insider trading has led some asset managers to question the safety and reliability of using independent research providers as a part of their research process.
Ultimately, we believe asset managers should view these developments as evidence that investment research provided by independent research providers like expert networks, channel check providers, or other nonregistered entities are no safer or more compliant than research provided by registered broker-dealers. What should matter for all money managers is 1) what policies do their research providers have in place, 2) the commitment of each providers’ management towards compliance, and 3) whether the research providers consistently work at abiding by their policies and procedures. We believe this means that asset managers need to proactively review both their registered and independent research providers to determine how they rank on these three scales.
If you would like to discuss how Integrity Research Associates might be able to help your firm conduct these type of research compliance audits on your third-party research providers, please call Michael Mayhew at 646-786-6859 or e-mail me at Michael.Mayhew@integrity-research.com.