By Jacob Zamansky, Zamansky LLC
As an asset manager, you don’t expect to be on the hook for corporate misconduct. If you recommend investing in a company and it turns out that the company has published false financial guidance or its executives have engaged in insider trading, you might expect some angry emails, but you probably aren’t too concerned about getting sued.
Is this reasonable?
It depends. As a general rule, asset managers (like all professionals) are not liable for events that are beyond their control. Asset managers can’t predict the future, and they can’t evaluate information that is not available outside of a company’s walls. But, this does not necessarily mean that asset managers are off of the hook when corporate misdeeds lead to investor losses. Here’s why:
Asset managers owe various legal duties to their clients. Among these is the duty to provide sound investment advice. If an asset manager knows or should know information that is material to a client’s investment decision, then the asset manager must disclose this information to the client.
This obligation means that asset managers must do more than just review the information they are given. Oftentimes, information about corporate misdeeds won’t be available from the corporation itself, but it will be available from other sources. For example, if a company is under investigation for insider trading or securities fraud, the company might not disclose this, but it could still be public knowledge based on press releases issued by the U.S. Securities and Exchange Commission (SEC) or the U.S. Department of Justice (DOJ).
Asset managers must also be extremely careful about making investment recommendations when the documentation they receive about a company is missing information that they would normally expect to see. Rather than dismissing this as an oddity, asset managers must investigate the omission if they have any intention of recommending that their clients invest. This type of oversight is considered a form of investor fraud under federal securities laws and FINRA regulations, and it can entitle investors to compensation if they lose money based on their asset manager’s advice.
Of course, asset managers can also face liability if they have actual knowledge of corporate misdeeds. For example, consider a scenario in which an asset manager receives a tip from a corporate insider. Not only has the corporate insider potentially committed a federal crime as a “tipper,” but the asset manager could also face liability as a “tippee.” If the asset manager goes on to recommend investing in the company to his or her clients, these clients would likely have strong claims for damages based on the receipt of unsuitable or self-interested investment advice.
With all of this in mind, what can (and should) asset managers do to protect themselves? As a baseline, asset managers should be cautious about recommending a company’s securities if they identify (or are aware of) any of the following red flags:
- Missing corporate disclosures (i.e. missing 8-Ks, 10-Ks or 10-Qs)
- Corporate disclosures that omit material information
- Improper communications from corporate insiders
- Government investigations or enforcement proceedings targeting a company or its insiders
- Civil or criminal charges against a company or its insiders
Ultimately, it is up to asset managers to protect themselves and their clients. When in doubt, asset managers should exercise caution and avoid recommending investments based on incomplete or suspect information.
