A recent U.S. Securities and Exchange Commission (the “SEC”) order has put private credit funds in the US on alert. On August 26, 2024 the SEC ordered private fund adviser Sound Point Capital Management LP (“Sound Point”) to pay $1.8 million to settle charges that it failed to prevent the misuse of nonpublic information received in connection with certain collateralized loan obligations (the “Order”). Although Sound Point did not admit or deny any wrongdoing, the size of the settlement and the mere fact that such an investigation by the SEC occurred has similarly situated funds reviewing their internal trading policies and procedures.

Background

According to the Order, in 2019 Sound Point was exploring the possibility of reducing their exposure to certain CLO equity tranches, which included loans made to a media services company (“Company A”). Sound Point was allegedly in possession of material non-public information (“MNPI”) about Company A, which it obtained in connection with its participation in an ad hoc lender group for Company A. On July 30, 2019, Sound Point sold two CLO equity tranches to two counterparties. When the MNPI was publicly disclosed the next day on July 31, 2019, the value of the Company A loans in the traded CLO tranches dropped by over 50% and materially decreased the value of the CLO tranches Sound Point had sold the previous day by approximately $685,000. Although certain Sound Point personnel recognized that the firm was in possession of MNPI about Company A at the time of the trades of the CLO equity tranches, Sound Point failed to consider whether such information was material with respect to the CLO tranches before it sold them.

Charges

The SEC charged Sound Point with violating Sections 204A and 206(4) of the Investment Advisers Act of 1940 (the “Advisers Act”) and Rule 206(4)-7 promulgated thereunder as a result of its sale of the two equity tranches. These sections of the Advisers Act require investment advisers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by such investment adviser and to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder by the investment adviser or its supervised persons. Notably, the SEC did not charge Sound Point with violating SEC Rule 10b-5, which is the insider trading rule promulgated by the SEC pursuant to the Securities Exchange Act of 1934. Such a charge is more typical of an allegation of trading securities based on MNPI.

Finding

Citing subsequently enhanced controls implemented by Sound Point, the SEC accepted an offer by Sound Point to settle the SEC charges in exchange for certain remedial actions, including payment of $1,800,000 civil penalty as well a censure and order for Sound Point to cease and desist any such further activities.

Take-Aways

Although the SEC may have taken a somewhat reserved approach in this case, the fine imposed and the investigation itself should be a warning to other private funds who invest in loans and therefore could have exposure to MNPI. In particular:

• Fund advisers should evaluate how their roles as lenders could expose them to MNPI that may relate to their collateral loan obligation trading positions or other securities in the capital structure.
• Funds advisers must adopt and implement reasonable policies and procedures around the possession and use of MNPI generally.
• When possessing or having access to MNPI it is essential to evaluate the assets being traded by the fund or investment manager to determine whether securities trading could be taking place while possessing MNPI (even if inadvertently).
• Prior to adopting a new trading strategy or investing in a new product, a thorough regulatory review is essential.
• If an alleged regulatory violation has occurred, immediate remedial action could be helpful in mitigating punitive charges.

We are here to help. Our attorneys have extensive experience advising clients on matters relating to MNPI in the loan market. We can assist in the review of your current trading policies, develop and amend existing policies or advise in the event of an enforcement action. Please reach out to the below contacts should you have any questions or wish to discuss.