RIA Compliance Blog
At this time of year, it is important for registered investment advisers to assure that they are in compliance with federal and/or state rules requiring them to monitor their supervised persons’ security holdings and transactions for compliance with the firm’s code of ethics. Even seasoned compliance professionals will encounter questions regarding application of the rule from time to time. While this article is no substitute for a detailed analysis of the rule and its application to a specific firm and its supervised persons, an overview of the rule may be helpful.
As background, all SEC-registered investment advisers are required to adopt a Code of Ethics, which must describe the standards of conduct expected for representatives of the firm and address conflicts that arise from personal trading by advisory personnel. This federal requirement, which governs SEC-registered advisers only, derives from SEC Rule 204A-1, which took effect in 2005. Since then, many state securities administrators have adopted identical or similar requirements, either by adopting SEC Rule 204A-1 “by reference”—i.e., verbatim—into state law, or by crafting similar “me too” provisions. Accordingly, if your firm is SEC-registered, it will be bound by Rule 204A-1; but, if your firm is currently a state-registered adviser, it may be bound by the same or similar requirements.
This guide will focus specifically on the personal trading aspects of an SEC-registered adviser’s Code of Ethics compliance responsibilities. Although state law requirements may be similar, it is important to evaluate the specific state law to assure compliance.
SEC Rule 204A-1 (the “Rule”) generally requires all of an adviser’s “access persons” to periodically provide reports to the firm detailing their holdings and transactions in “reportable securities.” An “access person” is defined as any supervised person who has access to nonpublic information regarding any clients’ purchase or sale of securities, is involved in making securities recommendations to clients, or who has access to such recommendations that are nonpublic. A supervised person who has access to nonpublic information regarding the portfolio holdings of affiliated mutual funds is also an access person. “Supervised persons” of an adviser, in turn, encompass all of “its partners, officers, directors (or other persons occupying a similar status or performing similar functions) and employees, as well as any other persons who provide advice on behalf of the adviser and are subject to the adviser’s supervision and control.” Notably, the Rule’s personal trading reporting requirement only applies to “reportable securities,” which specifically exclude direct US government obligations, money market instruments, shares of money market funds, shares of unaffiliated mutual funds and unit investment trusts.
Practically speaking, in many cases, the Rule’s construction and definitions may sweep most of an adviser’s staff under its reporting requirement. Care should be taken to identify what staff may have “access to nonpublic information regarding clients’ purchase or sale of securities” will fall under the Rule.
Two types of reporting are required under this regulatory scheme: (i) initial and annual holdings reports; and (ii) quarterly transaction reports. Initial and annual holdings reports entail the provision of a complete detailed listing of each access person’s securities holdings, at the time the person becomes an access person and at least once a year thereafter. The holdings reports must be current as of a date not more than 45 days prior to the individual becoming an access person (for an initial report) or the date the report is submitted (for an annual report). Quarterly transaction reports, in turn, consist of a full reporting of all securities transactions conducted by an access person, and are due no later than 30 days after the close of the calendar quarter.
The Rule articulates several exceptions to the personal securities reporting requirement. For example, transaction reporting is excused if such reporting would contain information that is a duplication of information contained in any statement of account, or confirmation of trades, that the broker already has in its records. These exceptions should be closely examined to determine whether any particular adviser may be relieved of receiving reports from any particular supervised persons.
Beyond establishing a reporting requirement, the Rule also dictates that access persons first obtain the advisory firm’s approval prior to investing in any initial public offering (“IPO”) or private placement (such as a Reg D offering). The firm should craft its written supervisory procedures or its Code of Ethics to conform to this requirement and should explain the requirement to its supervised persons in regular compliance training sessions.
That said, advisers are reminded of the need to craft compliance programs reasonably designed to prevent violation of the Advisers Act and the SEC’s rules thereunder. It is well understood that this means custom-tailoring a firm’s compliance program in such a way as to address that adviser’s particular business model and particular risk profile. Accordingly, advisers should take this into account as they draft and refine their personal trading procedures.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.