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It is by now commonplace that issuers, broker-dealers and investment advisers must adopt written policies and procedures designed to prevent the misuse of material, nonpublic information. But recently the Securities and Exchange Commission issued a broadly-worded reminder of the critical need to tailor such procedures closely to a company’s own business realities. In In the Matter of Guy P. Wyser-Pratte, Wyser-Pratte Management Co., and Wyser-Pratte and Co., Admin. Proc. No. 3-10479 (May 9, 2001), the SEC found that the jointly-owned Wyser-Pratte broker-dealer and investment-adviser firms had failed to adopt adequate policies and procedures, in violation of, respectively, Section 15(f) of the Securities Exchange Act of 1934 and Section 204A of the Investment Advisers Act. Because the Wyser-Pratte firms engaged in merger arbitrage and initiated and urged approval of shareholder proposals designed to cause changes in a company’s governance, while also taking substantial long positions in the stock of such a company, there was a heightened risk in the SEC’s view that Wyser-Pratte would direct trading relating to an issuer “after exposure through the firms’ investment initiatives to persons in possession of material nonpublic information relating to that issuer.” The SEC found the firms’ written procedures did not guard adequately against that risk, and thus ordered the imposition of censures, fines totaling $450,000 and the retention of an independent consultant to conduct a comprehensive review of the firms’ procedures and prepare a report recommending modifications of such procedures. The SEC decision does not mean that activist investors will need to decide between engaging in corporate governance activities or trading in the stock of the companies targeted; however, when material nonpublic information is received there must be adequate controls in place to prevent the information received from influencing trading decisions. According to the SEC’s assistant enforcement director: “The message is that if you are engaged in two perfectly legitimate businesses, and one of them appropriately gives you the opportunity to see nonpublic information, then you have to have sufficient safeguards to assure that market integrity is maintained and the nonpublic information does not affect your perfectly legitimate trading business.” The learning from this decision is simple: it is not enough simply to adopt written policies and procedures; instead, a careful assessment must be made of a firm’s particular businesses and the risks those businesses create for the misuse of inside information, followed by the adoption of special procedures comprehensively designed to police those risks. The SEC also noted that preplanned trading permitted under new Rule 10b5-1 could also be used to avoid the misuse of material nonpublic information. John F. Savarese and David A. Katz are partners at Wachtell, Lipton, Rosen & Katz.

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