As a financial investment adviser, you’re entrusted by clients to manage and invest their money — often millions of dollars at a time. But money is incredibly personal to many people, and it’s not always easy for clients to open up to a professional about their financial lives.
They want to know they can trust their adviser to do right by them and work in their best interest. In short, clients can develop a greater level of trust and confidence when they know their advisor is adhering to a strict code of ethics.
Establishing a Code of Ethics isn’t something that’s just nice to do, it’s required by federal and state regulators. In fact, the SEC continues to crack down on firms that forego their fiduciary duty to clients, and the penalties can be severe.
If your firm hasn’t nailed down the requirements to comply with the SEC Code of Ethics mandates, here’s an overview of how to get started.
Why is a Code of Ethics important for financial investment advisers?
Not only does following a financial adviser ethics code keep your advisory firm and individual advisers compliant, but it helps your team avoid a common scenario called the “fraud triangle” as well.
The fraud triangle is a model commonly used to explain how three individual components often come together and cause someone to commit fraud. The three components are pressure, opportunity and rationalization.
Pressure
Certain factors, both within a firm and outside of it, may make an individual feel like they can’t solve a problem in a compliant manner. For example, they may experience a reduction in income following a merger or acquisition, a drop in the stock market impacts their assets under management (AUM), or a rise in unemployment reduces their book of business.
The individual feels pressure from these outside forces to take action and preserve their own financial well-being, even if it means taking on riskier investment practices or other unethical strategies.
Opportunity
Individuals within your advisory firm may identify certain internal control weaknesses which result in a lack of oversight. As a result, they find that they can take advantage of the situation for their own gain.
Common examples of opportunities for unethical behavior include working remotely, flexible hours of operation and roles that offer more autonomy with little direct supervision.
Rationalization
Someone on your team may find a way to justify unethical behavior by determining that the potential outcome of their actions is more important than the possibility of getting caught. They may approach the situation assuming that either no one will know what’s happening or others are probably already doing it. They are attempting to rationalize their decision to conduct unethical behavior.
Understanding the SEC Code of Ethics rule
Adopted on July 2, 2004, the SEC Final Rule 204A-1 established an investment adviser Code of Ethics. All SEC-registered advisors are required to adopt their own Code of Ethics to remain compliant with this ruling. By following these minimum guidelines for implementing an ethics code in your advisory firm, your chief compliance officer (CCO) can better steer your firm on the right path toward maintaining ethical and compliant practices.
The SEC Final Rule 204A-1 was developed in response to an increasing number of SEC enforcement actions regarding fiduciary duty violations. It’s designed to prevent fraud by reinforcing the fiduciary principles that govern advisor conduct.
Establishing an Ethics Code for your firm based on the SEC Code of Ethics requirements
First, you should determine if your financial investment advisory firm is regulated by the SEC or state regulators. A general rule of thumb is if your firm has less than $100 million in AUM, you’re required to register with your state(s). If your firm has over $100 million in AUM, you’ll likely be registered with the SEC. Keep in mind, there are some exceptions to this rule.
If you’re registered with the SEC, there are certain requirements each Code of Ethics needs to meet in order to comply with the SEC Final Rule 204A-1.
These include:
- Standards of conduct regarding advisor’s fiduciary obligations.
- Supervised persons are required to comply with securities laws.
- Access persons must report personal trading.
- Access persons must have pre-clearance of initial public offerings (IPOS) and private placements.
- Provisions relating to how violations are enforced and reported.
- All supervised persons must provide a certification of compliance.
It’s worth noting that the SEC has kept its codes of ethics ruling intentionally broad. Firms are encouraged to create their own financial adviser ethics codes which best reflect their business models and operations. While the above-listed items are minimum requirements, it’s possible your firm may need additional guidelines to maintain compliance with SEC regulators.
Many state-registered investment advisers are required to adopt codes of ethics or requirements for the collecting and reviewing of personal transactions for inside information. The states that implement these requirements include Alaska, California (proposed), Colorado, Delaware, Washington D.C., Georgia, Hawaii, Idaho, Iowa, Kansas, Louisiana, Maine, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, New Mexico, New York, North Carolina, Ohio, Pennsylvania, South Dakota, Tennessee, Texas, Utah, Washington, Wisconsin and West Virginia.
Remember, if your firm starts out as a state-regulated entity but eventually transitions to SEC registration, it must adopt a code which meets the SEC Code of Ethics requirements.
Implementing your financial investment adviser firm’s Code of Ethics
As you work to implement a Code of Ethics, it may be helpful to identify whether people associated with your firm are considered supervised persons or access persons. How you categorize team members and contractors will impact the ethical standards they’re held to.
A “supervised persons” could be a director, officer, partner of the adviser, employee or any other person who provides advice on the advisor’s behalf and is subject to their supervision and control (such as contractors).
“Access persons” are supervised persons who are required to comply with specific personal trading and holdings reporting requirements. A supervised person is considered an access person if they have access to any of the following:
- Nonpublic information regarding any clients’ purchase or sale of securities.
- Nonpublic information regarding the portfolio holdings of any reportable fund.
- Is involved in making securities recommendations to clients.
- Recommendations that are nonpublic.
If your RIA firm’s primary function is to provide investment advice, all of your directors, officers and partners are presumed to be access persons.
All supervised persons in your firm should receive a copy of your Code of Ethics and amendments. Once they have time to review, they need to provide written acknowledgment of receipt. They must certify in writing that they have read and understand all code provisions, agreeing to comply with its terms and requirements. A review and certification of the Code of Ethics should be done annually.
Need help developing and implementing your firm’s Code of Ethics?
NRS offers financial professionals the robust resources and ongoing support needed to address compliance concerns and develop an effective Code of Ethics. If you’re looking for the next step in creating a compliance ethics code, check out our upcoming webinars or watch our presentations on ethics in our on-demand Continuing Education center.
