A Costly Failure to Follow Written Policies and Procedures
A Costly Failure to Follow Written Policies and Procedures

On November 22, 2019, the Securities and Exchange Commission ("SEC") ordered Channing Capital Management, LLC ("Channing"), a registered investment adviser located in Illinois, to pay a $50,000 civil penalty for failure to enforce its own written policies and procedures. This specific case underscores the importance of following the safeguards you put in place to protect all clients at all times. (See: https://www.sec.gov/litigation/admin/2019/ia-5412.pdf).

Channing’s written trade aggregation and allocation policies and procedures required it to allocate the transaction costs associated with block trades on a pro rata basis among all clients participating in the same block trade. A separate written policy and procedure required Channing to follow the requirements and restrictions set forth in each client’s investment management agreement, including limitations placed on trading commissions.

Complicating Factors

Some of Channing’s institutional clients had placed limitations on the amount they were willing to pay in commission rates for execution of their brokerage transactions. Channing routinely conveyed those clients’ restrictions to executing brokers and requested that executing brokers apply lower commission rates for those clients while permitting them to participate in block trades with Channing’s other clients.

Channing’s trade aggregation policies stated that the “terms negotiated for the aggregated order will apply equally to each participating client,” and that the “price of the securities purchased or sold in an aggregated order will be at the average share price for all transactions of the clients in that security on a given day, with all transaction costs shared on a pro rata basis.”

Channing’s compliance manual separately required compliance with and observance of “all policies, prohibitions and restrictions mandated by a client” and adherence to clients’ investment and trading-brokerage guidelines and restrictions.

Four of Channing’s approximately 35-45 institutional clients during the relevant period included a provision in their investment management agreements or trading-brokerage restrictions that placed limitations on the amount they were willing to pay in commission rates for execution of their brokerage transactions. These clients restricted the commission rate for execution of their transactions to no more than $0.03 to $0.035 per share. The other clients did not specify or otherwise limit the commission rate they were willing to pay.

A Thin Margin of Error

Channing routinely aggregated the trades of clients who restricted commission rates with the trades of clients who did not impose similar commission rate restrictions. In those instances, Channing conveyed the commission rate restrictions to the executing broker and requested that the executing broker apply the lower commission rate for the clients who had placed restrictions. The executing brokers routinely agreed to Channing’s request to limit their commissions charged to those specific clients, while charging Channing’s other clients a higher commission rate.

This practice resulted in certain block trades in which most of Channing’s clients paid commission rates of $0.04 per share, while the Clients who had placed restrictions on their execution commission rates paid commission rates of only $0.03 or $0.035 per share.

While Channing disclosed to its institutional clients that it would observe their investment mandates and restrictions, Channing did not disclose to all affected clients that some clients in certain block trades paid a lower commission rate than other clients who participated in the same block trades. By engaging in the above practices, Channing failed to comply with its written trade aggregation policies and procedures as to pro rata allocation of trading costs as specified in its compliance manual.

In the Order relating to this matter, the SEC acknowledged Channing's remedial steps to voluntarily change its practices to avoid block trades being executed with differential commission rates. Channing further revised its policies and procedures to require that each client who placed a restriction on its execution commission rate provide Channing with standing authority either to (1) depart from its restriction in order to allow the client to participate in an aggregated trade at the same price and commission rate as all other clients or (2) remove the client’s trade from an aggregated trade and execute it at a possibly higher price while observing the client’s restriction.

Don’t Let it Happen to Your Firm

Regulatory problems at advisory firms arise from a lack of written policies and procedures and/or a failure to properly follow them. At Jacko Law Group, we leverage the collective knowledge and abilities of our attorneys and professional staff to fully achieve each client's particular goals and to deliver services with efficiency. For more information, contact our team of attorneys today.

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