A recent Risk Alert (the “Alert”) issued by the Division of Examinations (“EXAMS”) addressed Staff findings and several areas of concern that the SEC has regarding misuse of Material Non-Public Information (“MNPI”) by registered investment advisers. The Alert came shortly after the SEC’s 2022 Examination Priorities (“Priorities Letter”). While MNPI concerns were not explicitly mentioned within the Priorities Letter, it appears the Staff felt the topic should be addressed separately.
The Alert speaks to the types of deficiencies commonly found during examinations of registered investment advisers since Code of Ethics infractions or Rule 204A-1 violations are a top finding during examinations. The Division divided its findings into two categories: (1) Issues under Section 204A, and (2) Issues related to the Code of Ethics Rule (Rule 204A-1).
At first glance the EXAMS findings are typical and do not seem to warrant an Alert. However, once reading the details of the Alert, it becomes clear that the Staff believes it’s important to show registered investment advisers how to improve processes and systems. Described below are the ways the SEC would expect investment advisers to improve their Code of Ethics policies and practices. If not already in place, we suggest you undertake the following 6 Actions now:
1. Track and monitor alternative data use. Ensure that your firm has written policies in place to govern how alternative data is used and distributed both internally and externally. A strict due diligence process is needed to monitor alt data vendors both at initial onboarding as well as thereafter.
2. Scrutinize value-add investors. These are typically key person individuals at corporations that the adviser invests or other portfolio managers or investment bankers that may have access to MNPI of corporations in which the firm invests.
3. Monitor use of expert networks routinely. Meetings and calls with these MNPI elevated risk vendors should be tracked, logged, and reviewed on an ongoing basis. Trading activity in a security around the same time as contact with an expert network consultant on the security should be evaluated at both the firm level and the supervised person level.
4. Do not forget risks posed by private investments. Employees must be reminded that private placements in which they wish to invest must be pre-approved and reported on annual holdings and quarterly transaction reports. Employee training is an effective way to enforce this message.
5. Use technology wisely. There are many personal trading surveillance systems available that provide excellent support for a Code of Ethics program. However, they are only as good as the information they collect and produce. Ensure that your system is working as intended by having it tested regularly. Restricted lists should be loaded into the system for automated monitoring against employee and firm trading.
6. Put firm fiduciary duty into practice. As a registered investment adviser your firm has a fiduciary duty to its clients. This can be put into practice by utilizing some commonsense techniques such as requiring every employee to sign the Code of Ethics policy annually (also a Rule requirement) and enforcing a “client first” approach to trading so that no employee account trades ahead of a client.
Finally, routine testing of your compliance program that encompasses all the above will keep your Code of Ethics compliance program on track.