Compliance Solutions for Investment Advisers

FAQs — Code of Ethics (General)

 

Are SEC-registered investment advisers required to adopt a code of ethics?

Yes. Rule 204A-1 under the Advisers Act (commonly referred to as the Code of Ethics Rule) requires all SEC-registered investment advisers to adopt a code of ethics.

Do state-registered investment advisers have to maintain a code of ethics?

Many states now require state-registered advisers to maintain a code of ethics. Some states have expressly adopted Rule 204A-1 under the Advisers Act while other have incorporated the requirement through other means. State-registered advisers should consult the rules and regulations of each particular state in which they are registered.

To whom is an investment adviser required to provide with a copy of the code of ethics?

Under Advisers Act Rule 204A-1, an investment adviser’s code of ethics must require the adviser to provide each supervised person with a copy of the code of ethics and any amendments. The code must also require each supervised person to acknowledge, in writing, their receipt of those copies.

What must be included in the code of ethics?

Rule 204A-1 requires each investment adviser’s code of ethics to set forth a standard of business conduct that the advisory firm requires of all its supervised persons.

Does the Code of Ethics Rule require an investment adviser to adopt a particular standard of business conduct?

The Code of Ethics Rule does not require an investment adviser to adopt a particular standard, but the standard chosen must reflect the advisory firm’s fiduciary obligations and those of its supervised persons, and must require compliance with the federal securities laws.

What are some examples of standards of business conduct that an investment adviser may incorporate into its code of ethics?

Some examples of business conduct standards include:

  • Acting with integrity, competence, diligence, respect, and in an ethical manner with the public, clients, and prospective clients;
  • Placing the interests of clients and the integrity of the investment profession interests above one’s own personal interests;
  • Adhering to the fundamental standard that you should not take inappropriate advantage of your position;
  • Avoiding any actual or potential material conflicts of interest;
  • Conducting all personal securities transactions in a manner consistent with the advisory firm’s policies and procedures;
  • Using reasonable care and exercising independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities;
  • Practicing and encouraging others to practice in a professional and ethical manner that will reflect favorably on you and the profession;
  • Promoting the integrity of, and upholding the rules governing, capital markets;
  • Maintaining and improving professional competence and striving to maintain and improve the competence of other investment professionals; and
  • Complying with applicable provisions of the Federal Securities Laws.

In addition to a standard of business conduct, what else must an investment adviser’s code of ethics address?

Codes of ethics must also address personal trading: they must require advisers’ personnel to report their personal securities holdings and transactions, including those in affiliated mutual funds, and must require personnel to obtain pre-approval of certain investments. The code of ethics must also require the adviser to review those reports.

Who is considered a “supervised person” of an SEC-registered investment adviser?

An SEC-registered investment adviser’s “supervised persons” are any of the firm’s officers, partners or directors (or other persons occupying a similar status or performing similar functions) or employees, or any other person who provides investment advice on the firm’s behalf.

Who is considered an “access person” of an SEC-registered investment adviser?

An SEC-registered investment adviser’s “access persons” are any of the firm’s supervised persons who have access to nonpublic information regarding any clients’ purchase or sale of securities, or nonpublic information regarding the portfolio holdings of any reportable fund or who is involved in making securities recommendations to clients, or who have access to such recommendations that are nonpublic. If providing investment advice is your firm’s primary business, all of your directors, officers and partners are presumed to be access persons.

What are the requirements for reporting violations of an adviser’s code of ethics?

Under Advisers Act Rule 204A-1, each adviser’s code of ethics must require prompt internal reporting of any violations of the code. An investment adviser can choose to have supervised persons report violations to either the chief compliance officer or to other persons designated in the code of ethics. But an advisory firm that designates someone other than the chief compliance officer to receive reports of code violations from supervised persons must have procedures requiring that the chief compliance officer also receives reports periodically of all violations.

How should an investment adviser address the fear of retaliation when a supervised person reports a code violation?

The SEC has said that it is incumbent on advisers to create an environment that encourages and protects supervised persons who report violations. Accordingly, advisers should consider how they can best prevent retaliation against someone who reports a violation; many advisers may choose to permit anonymous reporting, others may decide that retaliation constitutes a further violation of the code, and still others may find other methods to ensure that concerned employees feel safe to speak freely.

Does the Code of Ethics Rule require that an investment adviser implement training?

No. However, even though the SEC does not believe it is necessary to require employee education as an element of codes of ethics, the SEC does expect most advisory firms to ensure that their employees have received adequate training on the principles and procedures of their codes.

What are the recordkeeping requirements related to the code of ethics?

Advisers are required to keep copies of their code of ethics, records of violations of the code and actions taken as a result of the violations, and copies of their supervised persons’ written acknowledgment of receipt of the code. Advisers are also required to keep a record of the names of their access persons, the holdings and transaction reports made by access persons, and records of decisions approving access persons’ acquisition of securities in IPOs and limited offerings.

What are some common code of ethics deficiencies cited by the SEC during regulatory exams?

Deficiencies frequently cited by SEC examiners include:

  • Adviser’s code of ethics was incomplete. The adviser’s code of ethics did not appear to address all regulatory requirements. For example, examiners have commented when firms’ codes of ethics do not require access persons to obtain pre-approval before investing in certain limited investment opportunities (e.g., private placements, hedge funds, or initial public offerings).
  • Adviser’s code of ethics was not followed. The adviser and/or its employees engaged in practices that deviated from the adviser’s written code of ethics (e.g., trades were not pre-cleared, pre-clearance forms did not contain information required to be provided by the employees, the adviser did not receive duplicate confirmations, and trades were placed in securities that are on the adviser’s “do not trade” list).
  • Weak procedures regarding oversight. Examiners also commented when they believe an adviser had weak control procedures regarding oversight of supervised investment personnel (i.e., portfolio managers, traders, and analysts), such as when these personnel disclosed sensitive portfolio and trading information to advisory personnel at other advisory firms, which were managing the supervised personnel’s money in hedge funds or separate accounts.
  • Reporting requirements were not followed and/or monitoring was not performed. Access persons did not submit, or did not submit in a timely manner, reports of their personal securities transactions or holdings consistent with applicable regulations or the adviser’s policies and procedures. Also, some advisers did not review reports of access persons’ personal trading for indications that trades were inconsistent with applicable regulations or the adviser’s policies and procedures.
  • Disclosure was inaccurate. The adviser’s brochure appeared to contain inaccuracies with respect to its controls over personal trading.

 

Important Information

The information contained in this Frequently Asked Questions is only a summary and is not intended to be a comprehensive analysis of the rules and regulations applicable to registered investment advisers. It is not intended to constitute legal or compliance consulting advice or apply to any one investment adviser’s particular situation. For more information, please see our Terms of Use.

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