The staff of the SEC’s Division of Investment Management (the Staff) recently issued guidance regarding an exception to the reporting requirements for personal securities transactions of certain investment advisory employees.1 Section 204A of the Investment Advisers Act of 1940 (the Advisers Act) requires registered investment advisers to have written policies and procedures reasonably designed to prevent the adviser and its employees from misusing material nonpublic information. Rule 204A-1 thereunder provides that an adviser’s Code of Ethics must include requirements that certain advisory personnel with access to nonpublic information regarding clients’ securities transactions or holdings or who are involved in making securities recommendations to clients (Access Persons) report personal securities accounts and trading information to the adviser so that the firm and the SEC can identify potential improper activity. However, the rule grants an exception to these reporting requirements when an Access Person’s securities are held in an account over which he or she has “no direct or indirect influence or control” (the Reporting Exception).
In the guidance, the Staff stated that a “blind trust” in which a trustee manages assets for the benefit of an Access Person who has no knowledge of the specific management actions taken by the trustee and no right to intervene in the trustee’s management would qualify for the Reporting Exception. However, the Staff cautioned that other arrangements, such as when an Access Person establishes other types of trusts, or grants investment discretion over an account to a third-party investment manager, may or may not qualify. The Staff stated its belief that the fact that an Access Person provides a trustee with management authority over a trust for which the Access Person is grantor or beneficiary, or provides a third-party manager discretionary investment authority over a personal account, by itself, is insufficient for an adviser to reasonably believe that the Access Person has no direct or indirect influence or control over the trust or account. In those circumstances, the Access Person could still discuss securities transactions with the trustee or third-party manager, and could potentially direct the trustee or third-party manager to engage in a transaction. The Staff believes that an Access Person’s discussions with the trustee or third-party manager concerning account holdings may, in certain circumstances, reflect direct or indirect influence or control. However, the Staff did state that discussions in which a trustee or third-party manager simply summarizes, describes or explains account activity to an Access Person, without receiving directions or suggestions from the Access Person, would not implicate influence or control by the Access Person over that trust or account.
The guidance notes that an adviser can implement additional controls to establish a reasonable belief that an Access Person has no direct or indirect influence or control over a trust or account. Such policies and procedures should be reasonably designed to determine whether the Access Person actually has direct or indirect influence or control over the trust or account, rather than whether the trustee or third-party manager had discretionary or non-discretionary investment authority. Advisers may want to consider: (i) obtaining information about a trustee’s or third-party manager’s relationship to the Access Person (i.e., independent professional versus friend or relative; unaffiliated versus affiliated firm); (ii) obtaining periodic certifications by Access Persons and their trustees or third-party managers regarding the Access Persons’ influence or control over trusts or accounts2 ; (iii) providing Access Persons with the exact wording of the Reporting Exception and a clear definition of “no direct or indirect influence or control” that the adviser consistently applies to all Access Persons; and (iv) on a sample basis, requesting reports on holdings and/or transactions made in the trust or account to identify transactions that would have been prohibited pursuant to the adviser’s Code of Ethics, absent reliance on the Reporting Exception.
In light of this new guidance, advisers should review the circumstances surrounding any accounts of their Access Persons which are currently relying on the Reporting Exception to ensure such reliance is appropriate.