Compliance errors aren’t any Chief Compliance Officer’s (CCO) idea of a great pastime – but by recognizing where many firms are getting compliance wrong, your RIA can be better equipped to take proactive measures and prevent costly damage.
That penchant for proactiveness brings us to part two in our RIA top deficiencies blog series: the Securities and Exchange Commission’s (SEC) Code of Ethics rule, which promotes fiduciary responsibility and standardized rules of conduct for RIA employees.
Today, we’re covering what the SEC Code of Ethics rule entails for RIAs, which areas firms are often getting wrong and three steps you can take to better comply with the rule.
What is the SEC Code of Ethics Rule?
The Code of Ethics rule was implemented in 2004 with the intent to encourage more transparency and reduce potential conflicts of interest via a written, firm-specific standard of conduct. Along with those standards, Rule 204A-1 of the Investment Advisors Act requires advisory staff to disclose personal trading information on a regular basis.
To comply with the rule, all RIAs must create and maintain a Code of Ethics document that covers:
- Fiduciary duty
- Insider trading laws
- A procedure for reporting personal securities transactions
- Reporting for access persons (those who have access to nonpublic information about clients’ securities holdings)
- How the CCO will enforce and maintain the Code of Ethics
- Training and education practices for new and existing employees
- Documentation of compliance to the rule dating back at least five years
*Note that the above list isn’t exhaustive, but gives a high-level look at the rule’s requirements.
Furthermore, firms must provide a copy of their Code of Ethics to clients upon request, and notify clients of any real or potential violations of the rule.
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Defining “Access Persons” To fully comply with the Code of Ethics rule, it’s crucial that your CCO and staff understand the role of an “access person.” FinancialPlanning.com writes: “An access person is a supervised individual who meets at least one of the following two conditions:
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Where Do Advisers Get the SEC Code of Ethics Rule Wrong?
In 2017, the SEC published a press release covering their most frequently cited compliance deficiencies, including the Code of Ethics rule.
One of the top concerns is that firms were lax in “identifying all of their access persons (e.g., certain employees, partners or directors) for purposes of reviewing personal securities transactions.” Furthermore, the SEC notes that access persons are not submitting transactions and holding information as often as required.
The regulatory organization also reminds RIAs that the SEC Code of Ethics rule needs to be referenced while creating and updating key documents. For example, firms must inform clients and prospects that their Code of Ethics is available upon request in Part 2A of their Form ADV.
Lastly, the SEC briefing notes that all Code of Ethics documents should specify “reviews of the holdings and transactions reports, and specific timeframes for submissions.”
How to Comply with the SEC Code of Ethics Rule
1. Identify key access persons
If you’re reviewing your firm’s Code of Ethics, identifying your access personnel is a great way to start. These individuals have direct access to nonpublic information about client transactions, holdings and strategies and – without proper diligence – could easily create damaging conflicts of interest via insider trading.
As your CCO creates your access persons list, it’s also a good idea to schedule a training session on proper reporting procedures for these individuals’ personal transactions. The SEC requires a “complete report of each access person’s securities holdings, at the time the person becomes an access person and at least once a year thereafter.” In addition, firms need to compile quarterly transactions reports within 30 days of the end of each quarter, with some exceptions.
2. Know your deadlines
Meeting deadlines is a non-negotiable aspect of compliance. From reporting personal securities transactions to providing timely disclosures, adherence to deadlines ensures transparency and accountability. To that end, your CCO will need to remain up-to-date on the deadline requirements for the Code of Ethics rule.
For example, your holdings reports for access persons must be accurate within 45 days prior to submission, while annual reports must be accurate within 30 days prior to the submission date. While crafting your firm’s code of conduct, the CCO should be sure to include these timeframes.
3. Check your Form ADV
The rule requires each firm to include a provision in Part 2A of their Form ADVs to clients noting that the Code of Ethics documentation is available upon request. The SEC states that this disclosure “will help clients understand the adviser’s ethical culture and standards, how the adviser controls sensitive information and what steps it has taken to prevent employees from misusing their inside positions at clients’ expense.”
As you review your Code of Ethics compliance practices, procedures and training, it’s important that you double-check your Form ADV to ensure it complies.
Adhering to the SEC Code of Ethics rule is not only a regulatory requirement but also a testament to an RIA’s commitment to ethical conduct and client protection. By identifying key access persons, staying on top of deadlines and regularly reviewing Form ADVs, RIAs can better build a culture of trust and compliance within their firms.
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