After Henry Hill took his first pinch in Goodfellas, Jimmy Conway praised young Henry in the courtroom for learning and personifying the Mafia code: “Never rat on your friends and always keep your mouth shut.” While certainly one of the great bro-quotes in movie history, I don’t think I’m venturing too far out on a limb to suggest that the SEC would take issue with that code. In fact, the SEC imposes its own code on its registrants, and that code can be found in SEC Rule 204A-1.
The code I’m speaking of is the code of ethics, and each federally-registered advisor is required to have one. Contrary to the mafia’s code, the SEC’s version requires supervised persons to always rat on their friends (and themselves), and never keep their mouth shut. In regulatory-speak, all supervised persons are required to promptly report any violations of the firm’s code of ethics to the CCO. But what must a code of ethics include?
In principle, a code of ethics must hold all supervised persons to a fiduciary standard of business conduct and require compliance with applicable federal securities laws. “Access persons” (distinct from “supervised persons”) must report their personal securities transactions and holdings, and somebody must be tasked with reviewing those transactions and holdings. Lastly, the code must actually be provided to all supervised persons who in turn must acknowledge in writing they’ve received it.
Before going any further, it’s important to address the distinction between “supervised persons” and “access persons.” The former is a broader category of folks that includes:
“any partner, officer, director (or other person occupying a similar status or performing similar functions), or employee of an investment advisor, or other person who provides investment advice on behalf of the investment advisor and is subject to the supervision and control of the investment advisor.”
The latter includes anybody in the former category that also:
“has 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 has access to such recommendations that are nonpublic.”
All directors, officers and partners are presumed to be access persons if the firm’s primary business is providing investment advice.
All access persons are supervised persons, but not all supervised persons are necessarily access persons. The distinction is worth a tailored analysis, because certain provisions of Rule 204A-1 are applicable only to access persons.