April 1, 2008
The Securities and Exchange Commission (“SEC”) recently issued a Report of
Investigation under the Securities Exchange Act of 1934 (“Exchange Act”) to warn
public pension funds of the dangers of operating without appropriate policies,
procedures and training concerning the federal securities laws. The report is an
important reminder that public pension funds and their employees are subject to
the insider trading restrictions imposed under federal securities laws, even
though they are generally exempt from certain other provisions of federal
The SEC report stemmed from its investigation of the Retirement Systems of
Alabama (“RSA”). RSA is a state agency that administers twenty retirement funds.
RSA’s in-house investment staff and CEO manage all of RSA’s investments. The two
largest retirement funds have Boards of Control, or an Investment Committee
consisting of board members, that must approve RSA’s investment decisions. In
practice, however, that authority was largely delegated to the CEO. Thus,
according to the SEC, there was little oversight of the investment activities of
RSA’s investment staff and CEO.
Receipt of Inside Information
In 1996, RSA founded Raycom Media Inc. (“Raycom”) and became its primary
funding source. In June 2005, a business adviser firm (the “Adviser”), with whom
RSA and Raycom had a preexisting relationship, suggested that RSA consider
financing Raycom’s purchase of The Liberty Corporation (“Liberty”). When the
Adviser initially approached Liberty, the company’s CEO required assurance that
RSA would, in fact, finance the prospective transactions. RSA’s CEO provided
this assurance in a telephone conversation on June 24, 2005.
A few days later, the Adviser entered into a written nondisclosure agreement
with Liberty. The agreement required that, prior to disclosing Liberty’s
confidential information, the Adviser must require the recipient to be bound by
the terms of the nondisclosure agreement. The agreement also contained an
acknowledgment that the Adviser was aware of the securities laws prohibiting the
misuse of inside information.
On July 1, 2005, the Adviser acquired confidential information. Shortly
thereafter, on July 12th, the Adviser made a written presentation about the
proposed acquisition to Raycom’s CEO, RSA’s CEO and some of RSA’s investment
staff. The presentation contained indicia that the Adviser was communicating
During the presentation, the Adviser believed RSA was losing interest in the
transaction. The Adviser stated that, no matter what the company decided to do,
RSA should buy some Liberty stock, but limit its purchases to five percent of
the outstanding Liberty shares. The Adviser was not in an attorney-client
relationship with RSA, and RSA did not have any reason to believe that the
Adviser had federal securities law experience or expertise.
At the conclusion of the July 12th meeting, RSA and Raycom authorized the
Adviser to inform Liberty the acquisition could proceed. On July 19th, Raycom
entered into a confidentiality agreement with Liberty.
On August 8, 2005, RSA’s CEO received notice that a special meeting of
Raycom’s board of directors would be convened to discuss the Liberty purchase.
The notice specifically cautioned against insider trading and confidentiality
violations. The CEO circulated the notice to members of RSA’s investment staff,
including the Chief Investment Officer.
During the special meeting that occurred on August 15th, Raycom’s board
reacted positively to the Liberty acquisition. The Adviser reported the result
to RSA’s CEO the following day.
Trading on Inside Information
After receiving notice of Raycom’s special meeting, RSA’s CEO instructed the
Chief Investment Office to make purchases of Liberty stock. During the two-week
period leading up to the public announcement of the acquisition, RSA purchased
73,700 shares. RSA stopped buying stock on the day it learned the announcement
was likely to be made. The day after the agreement was announced, the value of
RSA’s Liberty shares rose by nearly $700,000.
Lack of Adequate Procedures to Prevent Insider Trading
As highlighted in the SEC report, state pension funds remain subject to the
anti-fraud provisions of the federal securities laws and SEC rules thereunder,
even though the funds are exempt from the requirements of the Investment Company
Act of 1940 and the Investment Advisers Act. Section 10(b) of the Exchange Act
and Rule 10b-5 prohibit the purchase or sale of securities on the basis of
material, nonpublic information in breach of a duty of trust or confidence. That
prohibition covers both "insiders," those who acquire the information in the
context of a relationship of trust or confidence, and “tippees" of "insiders" or
persons who have misappropriated the information. In addition, controlling
persons who fail to prevent insider trading may be subject to civil penalties
under Section 21A of the Exchange Act.
The SEC report observed that RSA had “no policies, procedures, training or
compliance officer to ensure its compliance with the federal securities laws in
general or insider trading laws in particular.” In addition, RSA’s in-house
counsel had no responsibility for compliance with the securities laws, and was
not consulted before the Liberty purchases were made. Finally, RSA did not have
a practice or procedure in place to consult outside counsel with securities law
Observations on Compliance Programs
As noted above, the report highlights the need for public pension plans and
their obligation to comply with insider trading restrictions under the federal
securities laws. To help ensure compliance with those laws, plans and their
investment managers should establish, maintain and enforce a compliance program
reasonably designed to prevent misuse of material nonpublic information.
Essential components of such a program would include:
Written Policies and Procedures: Written
policies and procedures concerning the handling and use of material
nonpublic information. Such procedures may also include a review of personal
securities transactions by those employees who have regular access to
Appointment of Compliance Officer: One or
more persons should be designated as responsible for ensuring compliance
with the policies and procedures. The compliance officer(s) should have a
clearly defined set of procedures to follow upon learning of a potential
Employee Training: A copy of the policies
and procedures, as well as training, should be provided to all employees, as
any employee may inadvertently (or intentionally) gain access to
In addition, the persons responsible for the selection and oversight of
investment managers of both public and private pension plans should consider
whether the investment managers that they retain for the plan have in place
adequate internal controls to prevent insider trading from occurring.
Fiduciaries of private pension plans subject to the Employee Retirement Income
Security Act of 1974 (“ERISA”) should also be aware that their failure to
adequately consider such controls in selecting and monitoring their investment
managers may cause them to be subject to potential liabilities under ERISA for
losses or other liabilities incurred by the plan as a result of an investment
manager’s violation of insider trading laws.
McGuireWoods LLP regularly advises companies, including pension funds,
investment advisers, investment companies and broker-dealers, on securities
regulatory issues. Please contact the authors if you have any
questions concerning the SEC report or the issues discussed above.