With the upcoming requirement that advisers to many private investment funds must register with the SEC, I figured it was time to look at some of the requirements that registration will impose.
Section 204A of the Investment Advisers Act requires registered investment advisers to
“establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser’s business, to prevent the misuse … of material, nonpublic information by such investment adviser or any person associated with such investment adviser.”
It also requires the SEC to adopt “adopt rules or regulations to require specific policies or procedures reasonably designed to prevent misuse.” That leads to the issuance of Rule 204A-1 under the Investment Advisers Act of 1940
Rule 204A-1 has three key elements: Adoption, Reporting, IPOs.
The adoption element lays out what needs to be in the advisers code of ethics:
- A standard of business conduct that you require which reflect the fiduciary obligations;
- Provisions requiring your supervised persons to comply with applicable federal securities laws;
- Provisions that require all of your access persons to report, and you to review, their personal securities transactions and holdings periodically;
- Provisions requiring supervised persons to report any violations of your code of ethics promptly; and
- Provisions requiring you to provide each of your supervised persons with a copy of your code of ethics and any amendments, and requiring your supervised persons to provide you with a written acknowledgment of their receipt of the code and any amendments.
Number five requires the standard delivery of the code and signature that they received the code. The prompt reporting is also standard for a code of conduct, as is the compliance with laws.
The fiduciary obligations may be a surprise for the advisers to private investment funds. Fund managers typically structure the funds as limited partnerships. The enabling statute impose a fiduciary duty on the general partner of a limited partnership, which for a private fund will be the investment adviser affiliate. Delaware limited partnership law allows a general partner to reduce its fiduciary obligations, but still must retain the implied contractual covenant of good faith and fair dealing. (see 17 Del Code §17-1101)
On the other hand, Section 206 of the Investment Advisers Act imposes fiduciary duties on investment advisers, regardless of whether or not they are registered with the SEC. This is a different body of law defining the obligations of an investment adviser as opposed to the general partner of a limited partnership.
The fiduciary obligation in 206 make its a violation to
- employ any device, scheme, or artifice to defraud any client or prospective client;
- engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client;
- engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative;
Those are your conventional anti-fraud provisions. There is one more violation and it gets the most attention:
“Acting as principal for his own account, knowingly to sell any security to or purchase any security from a client, or acting as broker for a person other than such client, knowingly to effect any sale or purchase of any security for the account of such client, without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction.”
The key here is that is a violation to if you don’t disclose the conflict prior to completion of the transaction.
Fora private fund, you will need to take a look at Rule 206(4)-8 because it lays out some additional fraud prohibitions for investment advisers to private investment funds.
If you run a private fund and don’t have written code of ethics, it’s time to start thinking about putting one in place. Here are some examples of investment adviser code of ethics:
If you don’t have a code of conduct and are looking for a starting point. Those three are worth taking a look at. There are plenty of others out there and findable with an internet search.
Also keep in mind that you will have to revisit your code next year. Rule 206(4)-7 requires an annual review of your code of ethics.
Sources:
- Section 204A of the Investment Adviser Act
- Rule 204A-1 – Investment Adviser Code of Ethics
- Investment Adviser Code of Ethics Rule by Shearman and Sterling
- Section 206 of the Investment Advisers Act
- Rule 206(4)-7
- Rule 206(4)-8