Trading Up: Considerations for Developing a 21st Century Trade Surveillance Program

The following article written by ACA's Michael Abbriano and Brett Ambrose appeared in the September 2018 National Society of Compliance Professional's Currents newsletter.

Regulatory Background

An effective trade surveillance program is an integral aspect of compliance oversight of an adviser’s trading activities. While there is no explicit requirement for an investment adviser to conduct trade surveillance, such a mandate is implied by various federal securities laws.1 Section 17(a) of the Securities Act, Sections 9 and 10 of the Exchange Act, and Rule 10b-5 under the Exchange Act broadly prohibit fraudulent or deceitful activity by any person in connection with securities transactions. All investment advisers are also subject to Section 206 of the Advisers Act, which imposes a fiduciary duty on the adviser to act in the best interest of clients at all times, and to Section 203(e)(6) of the Advisers Act, which requires the adviser to reasonably supervise “all persons acting on its behalf ” with a view toward preventing violations of the federal securities laws, including those noted above. Finally, investment advisers registered with the SEC are further subject to Section 204A of the Advisers Act, which requires the adviser to adopt policies and procedures to prevent the misuse of material nonpublic information, Rule 204A-1 under the Advisers Act, which, among other things, requires advisers to adopt certain pre-clearance and reporting requirements for employees’ personal securities transactions, and Rule 206(4)-7 under the Advisers Act, which includes a requirement for advisers to adopt written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder.

Advisers are also highly incentivized to adopt trade surveillance programs as a result of the SEC having greatly expanded its own trade surveillance capabilities in recent years. In 2014, the SEC announced its commitment to enhance the technological capability of its Office of Compliance Inspections and Examinations (“OCIE”) to detect insider trading, market manipulation, and other potential misconduct.2 In particular, the announcement highlighted OCIE’s National Exam Analytics Tool (“NEAT”), which represented a quantum leap forward in terms of OCIE’s ability to analyze large amounts of trading data and to identify potentially problematic trading activity.