Consulting Firm Settles Allegations That It Had Inadequate Procedures For Handling Of MNPI Between Units
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  • Consulting Firm Settles Allegations That It Had Inadequate Procedures For Handling Of MNPI Between Units

    On November 19, 2021, the Securities and Exchange Commission (“SEC”) announced that an affiliate of McKinsey & Company (“McKinsey”), McKinsey Investment Office Partners, Inc. (“MIO”), had agreed to pay an $18 million penalty for alleged compliance failures in its handling of material nonpublic investment information (“MNPI”).  While the SEC did not allege that MIO had ever improperly used material nonpublic investment information in executing trades, it alleged that MIO’s procedures were inadequate to account for the risk that certain members of its investment committee had access to such information due to other roles they had with McKinsey.  MIO neither admitted nor denied the allegations in resolving the matter through an administrative proceeding.

    According to the SEC’s order (the “Order”), MIO’s team of portfolio managers, led by its Chief Investment Officer, maintained day-to-day responsibility for MIO’s investments.  MIO invested approximately 90% of MIO client assets indirectly, via a “fund of funds” strategy, and the remaining 10% directly, by buying and selling securities.  MIO’s CIO reported to the Board’s Investments Committee, which oversaw and monitored investments made by each fund.  The Investment Committee also had the power to formally ratify MIO’s investment decisions.

    The SEC alleged that active McKinsey partners who were also members of the Investments Committee of MIO’s Board of Directors had access to MNPI about issuers because of their consulting work.  This information included financial results, planned bankruptcy filings, material changes in senior management, and M&A activity.  Through their participation on the MIO Investments Committee, however, the SEC claimed that these same partners also had access to MNPI about investments made by MIO funds, including MIO’s investment strategies, risk limits, and MIO’s holdings.  Indeed, MIO policies and procedures specifically considered such people to be “above the wall” such that it was not prohibited for them to receive both categories of information.

    The SEC found that MIO invested hundreds of millions of dollars in companies that McKinsey was advising between 2015 and 2020.

    Although the SEC did not allege any specific instance of insider trading or improper use of MNPI, the SEC alleged that permitting active McKinsey partners to supervise and monitor MIO’s investment decisions presented an ongoing risk, which MIO did not have adequate policies and procedures to mitigate.  While the SEC did not articulate precisely what MIO’s policies were required to include, it did cite certain alleged shortcomings.  For instance, the SEC alleged that MIO’s written policies and procedures did not (1) outline how to identify Investments Committee members that may have MNPI that was relevant to their involvement in MIO’s investment decisions, or (2) set out a recusal procedure reasonably designed to prevent misuse of McKinsey client and MIO material nonpublic information.

    The SEC concluded that, by having inadequate policies and procedures, MIO violated Sections 204A and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7, which require registered investment advisers like MIO to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of MNPI.  Without admitting or denying the findings, MIO consented to the entry of a cease-and-desist order and censure and agreed to pay an $18 million penalty.

    The Order highlights the risks and conflicts of interest inherent in investment committees that include individuals with broader business mandates.  Although the SEC does not contend that it is improper for a company to structure an investment committee as MIO had (by including individuals on its investment committee who would otherwise have ongoing access to MNPI), it makes clear that consistent recusal policies are expected.  Compliance officials at companies with such investment committees should thus take the opportunity to ensure that their written policies outline how the company identifies potential conflicts of interest and the procedure for eliminating or mitigating the risks associated with the conflict.