SEC Division of Examinations Issues Risk Alert on Investment Adviser MNPI Compliance Deficiencies

May 4, 2022

On April 26, 2022, the staff of the SEC’s Division of Examinations (Staff) issued a Risk Alert (Alert) regarding deficiencies observed related to Section 204A of the Investment Advisers Act of 1940 (Advisers Act) and Rule 204A-1 (Code of Ethics Rule) thereunder.

Section 204A of the Advisers Act requires all investment advisers, whether registered or unregistered with the SEC, to maintain, establish, and enforce written policies and procedures designed to prevent the misuse of material non-public information (MNPI) by the adviser or persons associated with the adviser. The Code of Ethics Rule requires registered investment advisers to adopt a code of ethics that sets forth, among other things, the standards of business conduct expected from the adviser’s “supervised persons” (e.g., employees, officers, partners, directors, and other persons who provide advice on behalf of the adviser and are subject to the adviser’s supervision and control). The Code of Ethics Rule requires “access persons”1 to report their personal securities transactions and holdings to the adviser’s chief compliance officer or other designated persons.

Examples of Deficiencies Observed Related to Section 204A

  • Advisers that use alternative data2 but did not adopt or implement policies and procedures to address the potential risk of receipt and use of MNPI obtained through these sources.
  • Inadequate implementation of policies and procedures surrounding risks associated with investors who are more likely to possess MNPI, such as officers or directors at a public company, principals or portfolio managers at asset management firms, or investment bankers (often referred to as “value-add investors”).
  • Deficient policies and procedures regarding advisers’ discussions with expert network3 consultants who may be related to publicly traded companies or have access to MNPI.

Examples of Deficiencies Observed Related to the Code of Ethics Rule

  • Failure to define “access person” or accurately reflect which employees are considered access persons.
  • Failure of access persons to obtain required pre-approval before acquiring any interest in an initial public offering or limited offering.
  • Deficiencies relating to the required reporting of access persons’ personal securities transactions and holdings such as: (1) advisers that could not produce evidence of a supervisory review of holdings and transaction reports and (2) advisers’ codes of ethics that did not require access persons to include the specified content set out by the Code of Ethics Rule in their transactions and holdings reports, including situations where access persons did not include their investments in private placements.
  • Instances where supervised persons were not provided a copy of the code of ethics and did not provide written acknowledgement of their receipt of the code of ethics.

In the Alert, the Staff encouraged advisers to incorporate provisions into their code of ethics to include “restricted lists” of issuers about which the advisory firm has inside information and prohibit any trading in securities of those issuers while they remain on the restricted list. In addition, the Staff encouraged advisers to incorporate procedures to ensure investment opportunities are offered first to clients before the advisers or their employees may act on them.

The Alert can be found here.

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1 Access persons are 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 nonpublic, and, for most advisers, all officers, directors, and partners.
2 The Alert defines alternative data as information increasingly used in financial analysis, beyond traditional financial statements, company filings, and press releases. Examples include: analyses of aggregate credit card transactions, information gleaned from satellite and drone imagery, and social media and search data. For more information on alternative data, including the risks of using such data and ways to mitigate those risks, please see S&K article, “Use of Alternative Data by Investment Advisers” here.
3 As defined in the Alert, expert network refers to a group of professionals who are paid for their specialized information and research services.


Categories

Compliance, Investment Advisers, Regulatory