The U.S. Securities and Exchange Commission’s (SEC) Division of Examinations (EXAMS) issued a Risk Alert last month focusing on notable deficiencies examiners have found related to investment advisers’ compliance with material non-public information (MNPI) and Investment Advisers Act Rule 204A-1 – the “Code of Ethics Rule.”
Rule 204A-1 requires firms to adopt policies and procedures that are reasonably designed, taking into consideration the nature of the adviser’s business, to prevent the use of (MNPI) by the adviser and any person associated with the adviser.
In recent months, regulators have been isolating advisers access persons who purchase beneficial ownership in initial public offerings and limited offerings without requisite pre-approval.
The Risk Alert cited several deficiencies and weaknesses in MNPI policies and procedures, including the following:
- The use of data from non-traditional sources (“alternative data”) that did not appear to adopt or implement reasonably designed written policies and procedures to address the potential risk of receipt and use of MNPI through alternative data sources.
- Heightened vulnerability due to the lack of, and inadequacy to implement, policies and procedures regarding investors (or in the case of institutional investors, key persons) who are more likely to possess MNPI, including officers or directors at a public company, principals or portfolio managers at asset management firms, and investment bankers.
- Insufficient policies and procedures regarding their discussions with expert network consultants who may be related to publicly traded companies or have access to MNPI.
Code of Ethics Compliance
EXAMS staff observed that advisers often did not identify and supervise certain employees as access persons in accordance with the Code of Ethics Rule, as well as adviser codes that did not define “access person” or accurately reflect which employees are considered access persons.
Among other Code of Ethics deficiencies:
- Advisers could not produce evidence of supervisory review of holdings and transaction reports.
- Advisers that did not have policies and procedures in place to assign the CCO’s reporting to another member of the adviser – effectively permitting the CCO to self-review his/her own holding and transaction reports.
- Situations in which the holdings and/or transaction reports were not submitted by access persons, the adviser’s code of ethics did not include provisions requiring access persons to submit reports, or the reports were not submitted within the timeframes reflected in the Code of Ethics Rule.
- Codes that did not require access persons to include the specified content set out by the Code of Ethics Rule in their transaction and holdings reports, including instances in which access persons did not include their investments in private placements.
- Instances where employees traded investments that were on the adviser’s restricted list.
- Situations where the adviser or its employees purchased securities at a better price, ahead of the adviser’s clients in contravention of the adviser’s code.
Proactive Steps for Advisers
The SEC encourages firms to review their practices, policies, and procedures as they relate to MNPI and the Code of Ethics. Advisers often don’t know if their written policies and procedures are sufficient to avoid a deficiency letter from the SEC for an issue that could have been easily avoided.
Advisers frequently ask us to review their compliance manuals to detect potential shortcomings. Outside consultants can provide an objective viewpoint and prevent your firm from being the quintessential poster child to a subsequent enforcement action involving prior SEC Risk Alerts. Contact us at 619.278.0020 to schedule a consultation.
 code-ethics-risk-alert.pdf (sec.gov)