Code of Ethics Requirements:

Q & A Regarding Rule 204A-1

IA Code of Ethics Requirements: Q&A Regarding Rule 204A-1

In July 2004, the Securities and Exchange Commission adopted a new regulation under the Investment Advisers Act of 1940 requiring all registered investment advisers to develop, implement, and enforce a written code of ethics. 

Rule 204A-1 requires advisers to do two primary things: (1) adopt, maintain, and enforce a code of ethics, and; (2) obtain and review securities holdings and transaction reports from representatives and other "access persons".   As it pertains to your firm’s code of ethics, you should be familiar with requirements contained in the rule relating to:

The following Q&A is meant to provide general information about the new rule and answer some of the most commonly asked questions.

Why was the rule adopted?

The rule was adopted to reinforce the fiduciary obligations that advisory firms and their representatives owe clients.  Recent investigations have uncovered several advisers that disclosed material nonpublic information about portfolio holdings to hedge funds and permitted those hedge funds, as well as in some cases employees of the adviser and other customers, to engage in market timing.  Based upon the outcome of these investigations, the SEC was concerned that some advisers were neglecting their fiduciary duty to always act in the best interest of customers.

Who does the rule apply to?

The rule applies to investment advisers registered with the SEC.  However, most states tend to follow the Adviser’s Act with respect to their regulation of State-registered advisers.  Therefore, in nearly all jurisdictions, the adoption of a code of ethics at the State level is required.     

What must my firm's code of ethics contain?

Your code of ethics must be in writing and must include:

The SEC expects adviser codes of ethics to effectively convey to employees the value the firm places on ethical conduct, and to challenge employees to live up not only to the letter of the law, but also the ideals of the organization.

Who must I deliver the code of ethics to?

Advisers must deliver the code of ethics to all supervised persons.

What information must be included in personal securities holdings reports?

Holdings reports must contain:

In most situations, a copy of the access person’s personal brokerage statements will be adequate to demonstrate compliance with this aspect of the Rule.

When must holdings reports be submitted?

Access persons must submit holdings reports no later than 10 days after the person becomes an access person and at least once each 12-month period thereafter.

What information must be included in personal securities transaction reports?

Transaction reports must contain the following information about each transaction in which the access person had beneficial ownership:

Again, a copy of the access person’s personal brokerage statements will typically suffice for Rule 204A-1 compliance.

When must transaction reports be submitted?

Each access person must submit a transaction report no later than 30 days after the end of the calendar quarter.

Must all securities in which the access person has any beneficial ownership be included in the holding and transaction reports?

No, only "reportable securities" need to be included in the holding and transaction reports.  Rule 204A-1 defines all securities as reportable securities except:

Does rule 204A-1 require advisers to train employees as to the code of ethics?

No, training is not required under rule 204A-1, but the SEC recommends training as a best practice.

What recordkeeping changes should I be aware of regarding Rule 204A-1?

The Rule 204-2 of The Investment Advisers Act has been amended to require advisers to keep copies of their code of ethics, records of violations of the code and actions taken as a result of the violations, and copies of written acknowledgements of receipt of the code from employees.  For example, dated copies of the firm’s code of ethics must be retained for 5 years after the last date they were in effect.  Records of violations must be retained for 5 years from the date employment of the individual ceases.  Copies of written acknowledgements must be retained for 5 years after the individual ceases to be a supervised person.  Copies of holdings and transaction reports should be kept for the length of employment of each employee plus 5 years after termination.

What changes to Part II of Form ADV should I be aware of?

Part II of Form ADV has been amended to require advisers to describe their codes of ethics and, upon request, to furnish clients with a copy of the code of ethics.  This requirement is typically satisfied via disclosure on the firm’s Schedule F.

For more information a copy of the final version of rule 204A-1 is available on the SEC's Web site at www.sec.gov/rules/final/ia-2256.htm.

The Investment Advisers Act of 1940 defines "supervised person" to mean any partner, officer, director, or employee of an investment adviser, or other person who provides investment advice on behalf of the investment adviser and is subject to the supervision and control of the investment adviser.

Rule 204A-1 defines "access person" to mean any supervised person who has access to nonpublic information regarding any client's purchase or sale of securities, or who is involved in making securities recommendations.

The term beneficial ownership means any person who, directly or indirectly, has a pecuniary interest (i.e., the ability to profit or share in any profit derived from a transaction) in the securities, including securities held by members of a person's immediate family sharing the same household.

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