RIA Compliance and Practice Management Blog

RIA Compliance Focus Area: Employee Trade Monitoring and Reporting

Posted by RIA in a Box

Aug 28, 2017 9:07:57 AM

RIA personal securities trading ruleRule 204A-1 ("Code of Ethics Rule") requires every registered investment adviser ("RIA") firm registered with the Securities and Exchange ("SEC") to "establish, maintain and enforce a written code of ethics." A key element of the Code of Ethics Rule relates to personal securities trading by requiring all access persons of an advisory firm to submit securities holdings and transaction reports to the firm's Chief Compliance Officer ("CCO") or other designated person(s). Earlier this year, the SEC released a National Exam Program Risk Alert which listed "access persons not identified" and "untimely submission of transactions and holdings" as two of the most common regulatory deficiencies discovered during regulatory examinations.


Download the SEC 2017 RIA Top 10 Exam Priorities Checklist

Who is considered an access person?

The Code of Ethics Rule defines an "access person" as follows:

  • (i) Any of your supervised persons:
    • (A) Who has access to nonpublic information regarding any clients' purchase or sale of securities, or nonpublic information regarding the portfolio holdings of any reportable fund, or
    • (B) Who is involved in making securities recommendations to clients, or who has access to such recommendations that are nonpublic.
  • (ii) If providing investment advice is your primary business, all of your directors, officers and partners are presumed to be access persons.

Additionally, the SEC staff provided this additional guidance in regards to identifying "access persons":

Access persons will include portfolio management personnel and, in some organizations, client service representatives who communicate investment advice to clients. These employees have information about investment recommendations whose effect may not yet be felt in the marketplace; as such, they may be in a position to take advantage of their inside knowledge. Administrative, technical, and clerical personnel may also be access persons if their functions or duties give them access to nonpublic information. Organizations in which employees have broad responsibilities, and where information barriers are few, may see a larger percentage of their staff subject to the reporting requirements. In contrast, organizations that keep strict controls on sensitive information may have fewer access persons.

Furthermore, the Code of Ethics Rule requires that holdings and transactions reports be filed for "each reportable security in which the access person has any direct or indirect beneficial ownership." Thus, access persons must also file applicable reports for "securities held by members of a person's (access person's) immediate family sharing the same household." 

Access Person Securities Trading Reporting Requirements

In regards to the content and timing of holdings report submissions, the Code of Ethics Rule states the following:

  • (i) Content of holdings reports. Each holdings report must contain, at a minimum:
    • (A) The title and type of security, and as applicable the exchange ticker symbol or CUSIP number, number of shares, and principal amount of each reportable security in which the access person has any direct or indirect beneficial ownership;
    • (B) The name of any broker, dealer or bank with which the access person maintains an account in which any securities are held for the access person's direct or indirect benefit; and
    • (C) The date the access person submits the report.
  • (ii)Timing of holdings reports. Your access persons must each submit a holdings report:
    • (A) No later than 10 days after the person becomes an access person, and the information must be current as of a date no more than 45 days prior to the date the person becomes an access person.
    • (B) At least once each 12-month period thereafter on a date you select, and the information must be current as of a date no more than 45 days prior to the date the report was submitted.

In relation to the content and timing of transaction report submissions, the Code of Ethics Rule states the following:

  • (i) Content of transaction reports. Each transaction report must contain, at a minimum, the following information about each transaction involving a reportable security in which the access person had, or as a result of the transaction acquired, any direct or indirect beneficial ownership:
    • (A) The date of the transaction, the title, and as applicable the exchange ticker symbol or CUSIP number, interest rate and maturity date, number of shares, and principal amount of each reportable security involved;
    • (B) The nature of the transaction (i.e., purchase, sale or any other type of acquisition or disposition);
    • (C) The price of the security at which the transaction was effected;
    • (D) The name of the broker, dealer or bank with or through which the transaction was effected; and
    • (E) The date the access person submits the report.
  • (ii) Timing of transaction reports. Each access person must submit a transaction report no later than 30 days after the end of each calendar quarter, which report must cover, at a minimum, all transactions during the quarter.

It's also important to note that there are a handful of exceptions to these reporting requirements including accounts for which the access person has no direct or indirect influence or control, transactions conducted as part of an automatic investment plan, or submitting a transaction report that "would duplicate information contained in broker trade confirmations or account statements that you hold in your records." Additionally, many firms many choose to require more frequent submissions of holdings and transactions reports above and beyond the rule's requirements depending on the firm's business model and risk profile.

Trade or Investment Pre-Approval

The Code of Ethics Rule requires that "your access persons to obtain your approval before they directly or indirectly acquire beneficial ownership in any security in an initial public offering or in a limited offering." However, many firms choose to implement a more robust pre-approval process not limited to initial public offerings and limited offerings for access persons' securities transactions. It's also important to note that many private fund investments such as a hedge fund or private equity investment fall under the definition of a "limited offering."

Reportable vs. Non-Reportable Securities

The Code of Ethics Rule defines the following securities as not reportable securities:

  • (i) Direct obligations of the Government of the United States;
  • (ii) Bankers' acceptances, bank certificates of deposit, commercial paper and high quality short-term debt instruments, including repurchase agreements;
  • (iii) Shares issued by money market funds;
  • (iv) Shares issued by open-end funds other than reportable funds; and
  • (v) Shares issued by unit investment trusts that are invested exclusively in one or more open-end funds, none of which are reportable funds.

In general, RIA firms should be careful to ensure that all potential "reportable securities" are properly disclosed, recorded, and reviewed. For example, SEC staff has previously provided guidance "that investment advisers consider treating open-end exchange-traded fund ("ETF") shares as Reportable Securities."

Required Books & Records to be Maintained

Rule 204-2, the "Books and Records Rule" requires the following in regards to personal securities recordkeeping for access persons:

  • (i) A record of each report made by an access person as required by § 275.204A-1(b), including any information provided under paragraph (b)(3)(iii) of that section in lieu of such reports;
  • (ii) A record of the names of persons who are currently, or within the past five years were, access persons of the investment adviser; and
  • (iii) A record of any decision, and the reasons supporting the decision, to approve the acquisition of securities by access persons under § 275.204A-1(c), for at least five years after the end of the fiscal year in which the approval is granted.

In regards to books and records requirements related to the Code of Ethics Rule, SEC staff has also provided this additional commentary:

The standard retention period required for books and records under rule 204-2 is five years, in an easily accessible place, the first two years in an appropriate office of the investment adviser. Advisers must maintain the records required under amended rule 204-2(a)(12) and (13) for this standard period, subject to special holding requirements for certain categories of records as specified in amended rule 204-2(a)(12) and (13). Codes of ethics must be kept for five years after the last date they were in effect. Supervised person acknowledgements of the code must be kept for five years after the individual ceases to be a supervised person. Similarly, the list of access persons must include every person who was an access person at any time within the past five years, even if some of them are no longer access persons of the adviser

Compliance Best Practices

As it relates to employee securities trading, monitoring, and reporting, the principals and CCO of RIA firms should consider this SEC staff guidance in relation to crafting personal securities trading policies and procedures:

  • Prior written approval before access persons can place a personal securities transaction ("pre-clearance").
  • Maintenance of lists of issuers of securities that the advisory firm is analyzing or recommending for client transactions, and prohibitions on personal trading in securities of those issuers.
  • Maintenance of "restricted lists" of issuers about which the advisory firm has inside information, and prohibitions on any trading (personal or for clients) in securities of those issuers.
  • "Blackout periods" when client securities trades are being placed or recommendations are being made and access persons are not permitted to place personal securities transactions.
  • Reminders that investment opportunities must be offered first to clients before the adviser or its employees may act on them, and procedures to implement this principle.
  • Prohibitions or restrictions on "short-swing" trading and market timing.
  • Requirements to trade only through certain brokers, or limitations on the number of brokerage accounts permitted.
  • Requirements to provide the adviser with duplicate trade confirmations and account statements.
  • Procedures for assigning new securities analyses to employees whose personal holdings do not present apparent conflicts of interest.

However, it's important to note that simply establishing tailored and robust policies and procedures is not enough. The CCO of RIA firms needs to not only establish such policies and procedures but also ensure that they are properly implemented. CCOs should ensure that not only all required reports are being submitted by all properly identified access persons, but also that all reports, pre-clearance approvals, and trading activity are being carefully reviewed and monitored. Firms may also want to explore an RIA compliance software platform to assist with supervision and review requirements

Download the Checklist on how to Comply with the DOL Fiduciary Rule

Lexington Compliance and RIA in a Box LLC are not law firms, investment advisory firms, or CPA firms. Lexington Compliance and RIA in a Box LLC do not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

Topics: RIA Operations, RIA Compliance

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