[17015]
January 28, 2004
TO: CLOSED-END INVESTMENT COMPANY COMMITTEE No. 5-04
COMPLIANCE ADVISORY COMMITTEE No. 11-04
INVESTMENT ADVISERS COMMITTEE No. 2-04
SEC RULES COMMITTEE No. 11-04
SMALL FUNDS COMMITTEE No. 8-04
RE: SEC PROPOSES NEW INVESTMENT ADVISER CODE OF ETHICS REQUIREMENT
The Securities and Exchange Commission has proposed a new rule, Rule 204A-1, under
the Investment Advisers Act of 1940 that would require each registered investment adviser to
adopt a code of ethics.1 Advisers would be required to set forth in the code of ethics standards
of conduct for advisory personnel, provisions reasonably designed to prevent access to material
nonpublic information, and a requirement that access persons of the adviser report their
personal securities transactions and holdings, including transactions in any mutual fund
managed by the adviser. Each adviser would be permitted to develop its own code that takes
into consideration the nature of its business. The proposal is summarized below.
Comments on the proposal must be filed with the SEC by Monday, March 15th. The
Institute will hold a conference call on Tuesday, February 3rd at 2:00 p.m. EST to discuss the
proposal. The dial-in number for the call is 888-455-9648 and the pass code is 35520 . If you
plan to participate on the call, please send an e-mail to Monica Carter-Johnson at
mcarter@ici.org. If you are unable to participate in the call, please provide your comments
before the call, if possible, to Dorothy Donohue by phone (202-218-3563), fax (202-326-5827), or
e-mail (ddonohue@ici.org).
I. Standards of Conduct
Proposed Rule 204A-1(a)(1) would require each code of ethics to set forth a standard of
business conduct that the adviser requires of all its supervised persons. The standard would be
required to reflect the adviser’s fiduciary obligations and those of its supervised persons and to
require compliance with the federal securities laws.
1 See SEC Release Nos. IA-2209, IC-26337 (January 20, 2004) (the “Release”). A copy of the Release is available on the
SEC’s website at http://www.sec.gov/rules/proposed/ia-2209.htm.
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The SEC requests comment on, among other things, (1) whether it should specify a
particular standard of conduct that all codes of ethics must incorporate and, if so, what
standard should be adopted; and (2) whether the code should require supervised persons to
comply with all laws and regulations, rather than only the federal securities laws.
II. Protection of Material Nonpublic Information
Proposed Rule 204A-1(a)(3) would require that each code of ethics include provisions
reasonably designed to prevent access to material nonpublic information about the adviser’s
securities recommendations and client securities holdings and transactions. Individuals that
need to know this information to perform their duties would be permitted to have access to the
information. The Release notes that this requirement would not preclude the adviser from
providing necessary information to persons providing services to the adviser or account (i.e.,
brokers, accountants, custodians, and fund transfer agents).
The Release requests comment on, among other things: (1) whether computer files
containing nonpublic information should be required to be identified and segregated; and (2)
whether codes of ethics should be required to integrate a summary of law on insider trading
and procedures from the adviser’s Section 204A procedures.
III. Personal Securities Trading
Proposed Rule 204A-1(d) would require the code of ethics to call for the adviser’s
“access persons” 2 to periodically report their personal securities transactions and holdings to
the adviser’s chief compliance officer.3 In addition, the code of ethics would have to require
access persons to obtain the adviser’s approval before investing in an initial public offering or
private placement.
The Release requests comment on, among other things: (1) whether any advisers should
be exempted from any part of Rule 204A; (2) whether any of the proposed changes should be
extended to Rule 17j-1; (3) whether there is a significant need for Rule 204A-1 and Rule 17j-1 to
be as uniform as possible; and (4) whether Rule 204A-1 should prohibit access persons from
investing in IPOs and private placements for their own accounts.
A. Personal Trading Procedures
The SEC has not proposed any specific provisions regarding personal trading, other
than requiring pre-clearance of investments in an initial public offering or a private placement.
The Release requests comment on whether the rule should require any of several
enumerated “best practice” procedures to appear in an adviser’s code. The procedures identified
include: pre-clearance; maintenance of restricted lists; “blackout periods”; prohibitions or
restrictions on short swing trading and market timing; requirements to trade only through
2 Access persons generally are advisory personnel who have access to nonpublic information regarding client
securities recommendations, trading, and holdings.
3 An adviser with only one employee (i.e., the adviser himself) would be excepted from this requirement but would
be required to maintain records of his personal trades and provide them to SEC examiners upon request.
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certain brokers, or limitations on the number of brokerage accounts permitted; requirements to
provide the adviser with duplicate trade confirmations and account statements; and procedures
for assigning new securities analyses to employees whose personal holdings do not present
conflicts of interest. The Release also requests comment on whether there are other common
procedures that advisers should consider as best practices, and, if so, whether they should be
included in the adopting release.
In addition, the Release requests comment on whether codes should be required to
include certain provisions, such as, limitations on acceptance of gifts, and limitations on the
circumstances under which an access person may serve as a director of a publicly traded
company.
B. Persons Subject to the Reporting Requirement
Proposed Rule 204A-1 would require the adviser’s access persons to report their
personal securities holdings and transactions. Proposed Rule 204A-1(e)(1) would define “access
person” as a supervised person who has access to nonpublic information regarding clients’
securities transactions, is involved in making securities recommendations to clients, or who has
access to such recommendations that are nonpublic. Employees of affiliated organizations
would not be considered access persons.
The Release requests comment on whether the definition of access person should be
broadened or narrowed, and whether access persons should include employees of companies
that control, or are controlled by, the adviser.
Proposed Rule 204A-1 would create a legal presumption that, if the advisory firm’s
primary business is providing investment advice, then all of its directors, officers, and partners
are access persons. If the firm has another primary business, then whether such an individual is
an access person would depend on whether the individual has access to material nonpublic
client information.
The Release requests comment on whether the rule should specify a test for the adviser’s
primary business and, if so, whether the rule should use Rule 17j-1’s revenue-based test or some
other measure. The Release also asks if Rule 17j-1 should be amended to replace the current
revenue-based test with a legal presumption similar to that in proposed Rule 204A-1.
C. Reportable Securities and Beneficial Ownership
Several types of securities would be exempt from reporting requirements because they
appear to present little opportunity for abuse. Money market instruments, direct obligations of
the United States government, money market fund shares, and shares of other mutual funds
(unless the adviser or a control affiliate acts as the investment adviser or principal underwriter
for the fund) would be exempt from reporting requirements.
The Release requests comment on whether investments in index funds also should be
excluded from reporting requirements.
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D. Reporting of Investment Company Shares
Rule 204A-1 would require all advisers’ code of ethics to call for reporting of holdings
and transactions in affiliated mutual funds.
The Release requests comment on: (1) whether reporting of holdings and transactions in
all mutual fund shares should be required; (2) whether supervised persons who have
information about the holdings of non-fund clients should also be included as access persons;
and (3) whether Rule 17j-1 should be amended to include as an access person those individuals
who obtain information about the existing securities holdings in the adviser’s investment
companies.
E. Personal Securities Reporting
Proposed Rule 204A-1 would require access persons to report their securities holdings at
the time the person becomes an access person and at least annually thereafter. The proposed
rule also would require access persons to make quarterly reports of all personal securities
transactions.
The Release requests comment on: (1) the required frequency of the reports; (2) whether
reporting obligations under Rule 204A-1 and Rule 17j-1 should be consistent; and (3) whether
any transactions should be exempt from the quarterly reporting requirement.
IV. Reporting of Violations
Proposed Rule 204A-1(a)(5) would require prompt internal reporting of any violations of
the code to the adviser’s chief compliance officer or another person designated in the code.
The Release requests comment on whether advisers should be required to identify at
least two persons to whom reports of violations can be submitted and whether codes should be
required to call for reporting of apparent violations of the code.
V. Acknowledged Receipt of the Code
Proposed Rule 204A-1(a)(6) would require the adviser to provide each supervised
person with a copy of the code of ethics and any amendments thereto, and each supervised
person to acknowledge, in writing, receipt of those copies.
The Release requests comment on whether all codes should be required to contain
procedures for educating employees about the code and to inform employees about changes
made to the code.
VI. Adviser Review and Enforcement
Proposed Rule 204A-1(a) would require advisers to maintain and enforce their codes of
ethics by reviewing their access persons’ securities holdings and transactions. The Release
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states that the responsibility for enforcing the code is expected to lie substantially with the
adviser’s chief compliance officer.
VII. Recordkeeping
Rule 204-2(a)(13) under the Advisers Act would require advisers to keep copies of their
codes, their supervised persons’ written acknowledgement of receipt of the code, records of
violations of the code, and records of actions taken as a result of violations. In addition,
advisers would be required to keep a record of the names of their access persons, holdings and
transaction reports made by access persons, and records of decisions approving access persons’
acquisitions of securities in IPOs and limited offerings. Records of access persons personal
securities reports would be required to be kept electronically in an accessible computer
database.
The Release requests comment on whether advisers should be required to keep records of
waivers or exemptions granted from the code and whether there is a need to exempt smaller
advisory firms from the electronic recordkeeping requirement.
VIII. Amendments to Form ADV
Item 9 of Form ADV would be amended to require advisers to describe their codes and,
upon request, to furnish clients with a copy of the code.
Dorothy M. Donohue
Associate Counsel