One of the more difficult aspects of a private equity fund when it registers as an investment adviser is dealing with the Rule 204A-1 requirement of monitoring employee trading. The SEC recently issued guidance on the applicability to managed accounts when there is no direct or indirect influence or control.
The Guidance focuses on the code of ethics rule: Advisers Act rule 204A-1. The rule requires supervised persons to report their personal securities holdings and transactions. Subsection (b)(3)(i) offers an exception to the personal trading review requirement provided the supervised person has “no direct or indirect influence or control.”
Typically, CCOs have taken a hard line on this and the SEC has as well. For example, the hard line standard had typically been a blind trust, where the access person has no influence or control, and may not even know the holdings in the accounts. Some CCOs have take a more liberal approach. Clearly, the SEC has seem some CCOs incorrectly determine that some access persons’ trusts and third-party discretionary accounts qualify for the exception when they don’t.
Under the Guidance, the SEC is demanding more diligence.
Having “a third-party manager with discretionary authorities isn’t enough to qualify for the exception.” That does not eliminate actual or possible influence on what securities the third-party manager sells or purchases. The Guidance recommends CCOs probe deeper with managed accounts.
The Guidance states that obtaining a general certification alone is insufficient to determine if the access person exercised direct or indirect influence or control. The Guidance recommends that the CCO issues some probing questions:
“Did you suggest that the trustee or third-party discretionary manager make any particular purchases or sales of securities for account X during time period Y?”
“Did you direct the trustee or third-party discretionary manager to make any particular purchases or sales of securities for account X during time period Y?”
“Did you consult with the trustee or third-party discretionary manager as to the particular allocation of investments to be made in account X during time period Y?”
The Guidance may offer some relief for CCOs that took the hard line on the definition of managed accounts. On the other hand, it may he a tougher standard for those CCOs who took a more liberal view. In either case, there is clear guidance.
Sources:
- Code of Ethics Guidance for Investment Advisers (June 26, 2015)