On April 26, 2022, the Securities and Exchange Commission (SEC) Division of Examinations (EXAMS) released a new risk alert highlighting the recently observed deficiencies related to Section 204A of the Investment Advisers Act of 1940, (the “Advisers Act”) and Rule 204A-1 (the “Code of Ethics Rule”).
Investment advisers must establish, maintain, and implement policies and procedures to prevent the misuse of potential material non-public information (MNPI) by the adviser or any relevant persons identified as “access persons”.
Below we discuss both the compliance deficiencies and best practices highlighted in this investment adviser risk alert.
As mentioned above, the Advisers Act requires all investment advisers to develop and enforce written policies and procedures, specifically designed for the nature of the adviser’s business, to prevent the misuse of MNPI by the adviser or any person associated with the adviser.
The Code of Ethics Rule requires investment advisers registered under the Advisers Act to establish a code of ethics, including standards of business conduct, and the requirement for access persons of an investment adviser to report, and the adviser to periodically review their personal securities transactions and holdings, and obtain pre-approval of certain investments.
The SEC defines “access persons” as “any supervised persons who have access to non-public information regarding client transactions or reportable fund holdings, make securities recommendations to clients, or have access to such recommendations that are non-public, and, for most advisers, all officers, directors and partners.”
The staff of EXAMS previously notified investment advisers, investors, and other market participants of deficiencies related to the Code of Ethics Rule in the risk alert: The Five Most Frequent Compliance Topics Identified in OCIE Examinations of Investment Advisers. We’d like to stress the importance of the Chief Compliance Officer (CCO) of all RIA firms to review both risk alerts.
The risk alert details the following failures to act consistently, with Section 204A, the “Advisers Act”:
- Failure to adopt or implement reasonably designed policies and procedures to address the following: 1) the risks associated with obtaining or using MPNI from alternative data sources, 2) risks related to the access of MPNI by “value add investors”, such as directors or officers at a public company, and 3) communications with expert network consultants who may obtain MNPI or be related to publicly traded companies.
The risk alert details the following failures to act consistently, with the Code of Ethics Rule:
- Failure to correctly identify and supervise certain access persons.
- Access persons made certain investments without required pre-approval.
- Failure to provide adequate proof of submission, supervisory review, and required content in access persons personal securities transactions and holdings reports.
- Supervised persons did not receive a copy of the Code or have written acknowledgement of their receipt of the Code.
In addition, the EXAMS staff indicated the following best practices that advisers should incorporate into their Code of Ethics:
- Develop and implement “restricted lists” for proper employee trade monitoring.
- Ensure the clients are presented with the investment opportunities first, before the adviser or other employees can act on them.
Again, we highly recommend that the CCO and all advisory firm principals carefully review this latest SEC RIA compliance risk alert.