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Sound Point Capital Management has agreed to pay a $1.8m civil penalty as it settled charges with the US Securities & Exchange Commission, over “failing to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material non-public information,” while trading CLOs.

Sound Point, like many in the CLO industry, both manages and invests in CLOs. According to 9fin’s Q2 2024 CLO manager rankings, the firm is the seventh largest issuer globally with $33.42bn (56 US CLOs and 17 European CLOs).

As part of its CLO management business, Sound Point comes into possession of material non-public information (MNPI) about companies whose loans also happen to be held in third-party CLOs that Sound Point invests in.

According the SEC’s order, published yesterday, after an incident in July 2019, Sound Point “began conducting pre-trade compliance reviews of the potential impact of MNPI about loans in Sound Point-managed CLOs, though it did not adopt a written policy for these reviews until July 2022”.

In addition, Sound Point did not establish, maintain, or enforce any written policies or procedures concerning the potential impact of MNPI about the loans in third party-managed CLOs until June 2024, the SEC said.

“Fund managers — including those with multiple business lines or strategies — must consider how they may come into possession of material non-public information and then adopt and implement reasonable policies and procedures around those risks,” said Andrew Dean, co-chief of the SEC’s asset management unit in the news release.

“Among other things, advisers must evaluate how their roles as lenders could expose them to MNPI that may relate to their CLO trading positions.”

In addition to the $1.8m penalty, Sound Point agreed to a cease-and-desist order and censure. The fine is equal to nearly three times the economic advance the SEC claims Sound Point sold by allegedly using MNPI. The SEC did not use the word disgorgement which can now only be used in fraud case, according to a former SEC enforcement lawyer who spoke with 9fin.

“Sound Point being censored is on the light end of the penalties that could have been lobbed. The SEC could have banned Sound Point from being an investment advisor,” Nick Morgan a former SEC enforcement lawyer told 9fin in an interview today. Morgan also points out this reads like the SEC is rule-making by enforcement.

“The Sound Point settlement represents a further extension of the SEC's actions against investment advisers for failure to have or implement policies "reasonably designed" to prevent the misuse of MNPI,” added attorney Morgan, who was a former SEC defense lawyer at Paul Hastings.

Morgan noted that in prior similar cases, such Ares in 2020 ($1m penalty) and OEP in 2023 ($4m penalty), the SEC similarly alleged a failure to have, or implement, MNPI policies. The difference here is that the SEC alleges specifically that the settling party sold securities while in possession of MNPI.

In response to questions from 9fin, a representative for Sound Point said: “We are pleased to enter into the settlement with the SEC on a ‘no admit or deny’ basis. We cooperated with the SEC in this matter, which relates to certain compliance policies and procedures, the majority of which were modified in 2019. We have enhanced our controls since then. This matter does not include any findings of insider trading or misuse of material nonpublic information by Sound Point or its employees.”

The representative went on to say that the company remains committed to operating with the highest standards of governance and compliance.

Another twist on lender-on-lender violence? Essentially, Sound Point, part of an ad hoc group of lenders, obtained MNPI about a borrower, some of whose loans were in Sound Point-managed CLOs and eventually sold to another CLO investor.

In early 2019, as part of its CLO management business, Sound Point became a member of an ad hoc lender group to a media services company (company A), according to the SEC’s report.

Sources indicate this loan was Deluxe Entertainment. 9fin data reveals Sound Point had $81m loans of Deluxe across its US CLOs.

In June that year, some personnel became aware of the likely failure of an expected major asset sale by the firm and its need for rescue financing, given Sound Point’s role as a member of the ad hoc group, the SEC said.

In July, after exploring the possibility of reducing Sound Point’s exposure to Sound Point CLO equity tranches, which by nature have leveraged exposure to single name credits, a “Sound Point co-portfolio manager for its CLO investments emailed Sound Point’s compliance department to request approval to sell portions of two equity tranches of Sound Point CLOs that contained loans by Company A”, the SEC added.

Sound Point had an insider trading policy in place that prevented Sound Point from trading in the securities of a company while Sound Point was in possession of MNPI about that company. The policy, however, did not prohibit trading a CLO tranche while in possession of MNPI about the underlying loans in that CLO.

As such, Sound Point’s compliance department approved the proposed sales of the tranches.

Sound Point sold portions of these two CLO equity tranches to two counterparties on 30 July, although it continued to hold other CLO and hedge fund positions with exposure to the company’s loans.

“When this MNPI was publicly released on 31 July 2019, the value of the Company A loans in these 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,” the SEC said.

Following that, one counterparty, which Sound Point sold these CLO equity tranches to contacted Sound Point and “demanded either rescission of the sale or a reduction in the purchase price equal to the decline in the value of the CLO tranches in response to the Company A MNPI becoming public (around $350,000) and threatened litigation,” the SEC said.

Sound Point paid the amount requested by the counterparty in full.

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