SEC Warns Public Pension Funds of Dangers of Operating with Inadequate Compliance Programs

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 securities laws.


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 confidential information.

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 expertise.

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 confidential information.
  • 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 violation.
  • 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 confidential information.

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.