Investment Management
JULY 2004
Investment Adviser Codes of Ethics
Recently, the Securities and Exchange Commission
adopted new Rule 204A-1 under the Investment
Advisers Act of 1940, along with conforming
amendments to Rule 204-2, Form ADV and Rule 17j-1
under the Investment Company Act of 1940, to require
all SEC-registered investment advisers to adopt and
enforce codes of ethics.
As a result, SEC-registered advisers that previously were
not required to establish codes of ethics (all advisers that
do not advise or subadvise mutual funds) will need to
adopt and implement codes, and registered advisers to
mutual funds will be required to amend existing codes of
ethics adopted under Rule 17j-1. Part II of Form ADV
has been amended to require a description of the
adviser’s code of ethics, and an adviser must offer to
provide a copy of its code to its clients on request. New
Rule 204A-1 may be of even greater significance to
hedge fund managers going forward as the SEC
continues to consider whether certain hedge fund
managers should be required to register under the
Investment Advisers Act.
Although the effective date of Rule 204A-1 and the
related amendments is August 31, 2004, advisers must
comply with the new rule and related rule amendments
by January 7, 2005. Accordingly, advisers must adopt or
amend a code of ethics, and receive initial securities
holdings reports for access persons, by January 7, 2005.
OVERVIEW OF REQUIREMENTS
Rule 204A-1 represents an expansion on what
traditionally has been included in codes of ethics
adopted by registered investment advisers, usually
pursuant to Rule 17j-1, and requires internal reporting of
violations to the adviser’s chief compliance officer
(“CCO”) or other designated individuals. The key
requirements of Rule 204A-1 are highlighted below:
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General. Each SEC-registered investment adviser
must adopt and implement a code of ethics, regardless
of the number or types of clients serviced. This code
must be maintained and enforced by the adviser, and
enforcement must include the review of any access
persons’ personal securities reports generated
pursuant to the code.
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Standards of Conduct. Each adviser’s code of ethics
must include some statement of the firm’s “standards
of conduct” that applies to all of the adviser’s
supervised persons, reflect the adviser’s and its
supervised persons’ fiduciary duties, and clearly state
that compliance with the federal securities laws is
required.
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Reporting of Personal Trading. The code must
require that access persons (i.e., supervised persons
that have access to nonpublic information regarding
recommendations to clients on the purchase or sale of
securities, clients’ trading information or nonpublic
information regarding the portfolio holdings of an
affiliated mutual fund, or are involved in providing
investment advice to clients) report their personal
securities holdings within 10 days of becoming an
access person and annually thereafter. This
information must be current as of a date not more
than 45 days prior to the date the individual becomes
an access person or, for an annual report, the date the
report is submitted. Access persons also must report
their personal trading activities, if any, quarterly to the
adviser’s CCO or other designated persons within 30
days after the close of the quarter. Exceptions to
these reporting requirements are discussed below.
Kirkpatrick & Lockhart LLP
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IPOs and Private Placements. Each adviser’s code
of ethics must require pre-approval for the
participation of access persons in any initial public
offering (“IPO”) or private placement.
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Internal Reporting. The code must require that any
violations of the code be reported to either the CCO
or other designated personnel. If violations are not
reported to the CCO directly, other procedures must
be in place to ensure that all code violations are
ultimately reported to and periodically reviewed by
the CCO. The adopting release also stressed that
advisers must foster a firm culture that will
encourage internal reporting and protect supervised
persons who report violations from retaliation.
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Implementation and Ongoing Education. Advisers
must provide a copy of the code and all amendments
thereto to all supervised persons and obtain a written
acknowledgment of receipt from each such person.
Although the new rule does not require any
particular training programs or ongoing education
regarding the code of ethics for employees, the
adopting release emphasized the importance of such
programs.
Recognizing that each adviser is faced with different
concerns specific to its individual clientele and business
activities, the new rule does not prescribe the adoption
of trading pre-clearance (except with respect to IPOs
and private placements), blackout periods, or other
such measures typically used to restrict or monitor
personal trading activities of access persons. Rather,
the adopting release states that, when drafting codes of
ethics, advisers should consider whether the inclusion
of such procedures is necessary or appropriate. When
drafting codes of ethics, advisers should also consider
the inclusion of provisions governing, if appropriate,
procedures or restrictions on the acceptance of gifts, the
circumstances under which access persons may serve
on the board of a publicly traded company, and
procedures by which the firm and its compliance
department review the codes of ethics and any reports
generated pursuant to the code. Several organizations,
including the Investment Counsel Association of
America, the Financial Planning Association, the
Association for Investment Management and Research
and the Certified Financial Planner Board of Standards,
have developed or are in the process of developing
model codes for their members’ use.
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MATERIAL NON-PUBLIC INFORMATION
Although included in the proposed rule, the final rule
does not require a code of ethics to include provisions
that prevent access to material non-public information
regarding the adviser’s recommendations or clients’
securities transactions and holdings. The SEC instead
reminded advisers of their duty under Section 204A to
establish and enforce policies and procedures to
prevent the misuse of material nonpublic information.
An adviser individually may determine, however, that
inclusion of some provisions regarding access or use of
material nonpublic information in its code of ethics is
appropriate and helpful for the integration of its overall
compliance program.
PERSONAL TRADING OF ACCESS PERSONS
Generally, the new rule includes within the definition
of access person any of the adviser’s employees that
may be in a position to misuse or have access to
material nonpublic information. For example, the
adopting release states that even a client service
representative could be considered an access person
if that individual communicates investment advice,
and therefore has access to the firm’s
recommendations, to clients. Which adviser
employees are considered access persons also may
depend on how stringently the adviser limits access
to trading recommendations and client portfolio
information. Consequently, smaller advisory firms
may need to classify more of their staff as access
persons subject to the personal trading reporting
requirements if employees have multiple
responsibilities or if strict information barriers are
impracticable.
Additionally, the new rule does not require personal
securities reports for transactions pursuant to an
automatic investment plan or for transactions in
accounts over which the access person has no direct
or indirect influence or control. Also, holdings and
transaction reports need only cover “reportable
securities,” which include all securities except the
following:
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Transactions and holdings in direct obligations of
the US Government,
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Money market instruments (including bank
certificates of deposit, commercial paper and
repurchase agreements),
KIRKPATRICK & LOCKHART LLP INVESTMENT MANAGEMENT ALERT
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Shares of money market funds,
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Shares in mutual funds—unless the adviser or a
control affiliate of the adviser acts as the investment
adviser, subadviser or principal underwriter for the
fund, and
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Transactions in units of a unit investment trust if the
unit investment trust is invested exclusively in
unaffiliated mutual funds.
taken in response to violations of the code, and copies
of supervised persons’ written acknowledgment of
receipt of the code. Amended Rule 204-2(a)(13) will
require advisers to keep a record of the names of access
persons, personal securities reports by access persons,
and any records of decisions approving access persons’
participation in IPOs or private placements. Advisers
are required to comply with the current record-keeping
requirements under Rules 204-2(a)(12) and (13) until
they begin to comply with new Rule 204A-1.
RECORDKEEPING
Rules 204-2(a)(12) and (13) were also revised to reflect
the adoption of new Rule 204A-1. Amended Rule 2042(a)(12) will require advisers to maintain copies of
their codes of ethics, records of violations and actions
CARY J. MEER
202.778.9107
cmeer@kl.com
CAROLYN S. LEE
617.261.3193
clee@kl.com
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This bulletin is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
JULY 2004
© 2004 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.
Kirkpatrick & Lockhart LLP