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Regulation and Compliance > Federal Regulation > SEC

How to Avoid Trouble With Ethics Codes, Nonpublic Information

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In April, the Securities and Exchange Commission’s Division of Examinations issued a risk alert to provide further information on common investment advisor examination deficiencies relating to Section 204A of the Investment Adviser Act and Rule 204A-1 under the Investment Adviser Act of 1940. My partner Jeff Lang outlined some key points on the division’s alert.

Jeff explained that the alert included a set of reminders of what must be included in any investment advisory Code of Ethics (CoE) document, including standards of business conduct that govern how the advisor will operate its business and requirements for all supervised and access persons.

A key CoE component is the requirement that access persons report and the advisor review their personal securities transactions and holdings. Required provisions must also address supervised person compliance with federal securities laws and the duty to report CoE violations to the chief compliance officer or their designee.

Also highlighted were a number of weaknesses in compliance programs. For example, many firms did not correctly identify or supervise their access persons. In addition, firms did not accurately define access person terminology in their CoE document (which may erroneously omit certain employees from the access person list).

Firms also failed to furnish their employees with a copy of the CoE. Further, many firms did not obtain written acknowledgments from employees regarding receipt of the CoE.

Other Deficiencies

The agency also noted that firms were deficient in the areas of personal securities trading, preapproval and disclosure requirements, Jeff said. Many deficiencies related to personal securities transactions and holdings, including:

• Review of holdings and transaction reports. Some firms were not able to provide evidence of its supervisory review of holdings and transactions reports (including separate review of the CCO’s own activity and holdings). • Submission of holdings and transaction reports. Such reports were not submitted to the compliance department by access persons in a timely manner, or at all (or existing procedures did not require such reporting). • Content of holdings and transaction reports. Some codes were inadequate with respect to requesting appropriate information to meet CoE requirements. The division offered considerations on how to craft an effective CoE: • Develop an updatable restricted list of trading investments that is incorporated into CoE material. These would include securities in which the firm has inside information, and they should prohibit trading of these securities. • Firms must implement procedures to ensure that investment opportunities are offered to clients before the advisor or its employees may act on them.

The alert also cautioned advisors to establish and enforce written policies and procedures designed to prevent the misuse of material nonpublic information (MNPI) by the advisory firm. According to the division, many advisors used data from nontraditional sources without implementing policies and procedures to address the receipt and use of MNPI through alternative data sources.

Alternative data is defined as information used in financial analysis beyond traditional financial statements, company filings and press releases. Although alternative data may not contain MNPI, such information might include data, such as geolocation data from consumers’ mobile phones, that may contain MNPI.

Advisors must develop procedures and safeguards to determine when staff members may be in possession of MNPI, particularly in relation to pending trades. As the alert suggests, any compliance issues stemming from inappropriate use of MNPI will be judged in hindsight (i.e., whether the firm adopted adequate procedures to detect or prevent improper use of MNPI). Employees should be trained on misuse and sharing of MNPI.

Thomas D. Giachetti is chairman of the Investment Management and Securities Practice Group of Stark & Stark. He can be reached at [email protected].


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