Private Investment Funds and Reporting Requirements Under the Ethics Code Rule

As I wrote about yesterday on the code of ethics for an investment adviser, one of the requirements of registering with SEC as an investment adviser is implementing a code of ethics. The most involved part of the code is the extensive reporting requirement on securities activities to the chief compliance officer.

Rule 204A-1 under the Investment Advisers Act of 1940 takes the approach that extensive reporting of trading activities by employees of an investment adviser will been a strong deterrent from getting involved in insider trading.The rule breaks the reporting into two baskets: holdings report and transaction report.

Holding Report Under Rule 204A-1

Annually, each access person needs to submit a report of their securities holdings. The report needs to include the following:

  • title of the security;
  • type of security
  • as applicable, the exchange ticker symbol or CUSIP number
  • number of shares
  • principal amount of each reportable security
  • The name of any broker, dealer or bank
  • The date of the report

The rule does not require this to be a calendar year.

Transactions Report Under Rule 204A-1

Quarterly, each access person needs to submit a report of their securities trading activity. The report needs to include the following:

  • date of the transaction
  • title of the security
  • as applicable the exchange ticker symbol or CUSIP number
  • interest rate and maturity date for bonds and debt instruments
  • number of shares
  • principal amount
  • nature of the transaction (i.e., purchase, sale or any other type of acquisition or disposition)
  • price of the security
  • name of the broker, dealer or bank who effected the trade
  • submission date of the report

The report is due within 30 days after the end of the calendar quarter.

Access Person Under Rule 204A-1

The reporting obligations are limited to "access persons" at the investment adviser. These are every employee that

  1. has access to nonpublic information regarding any clients' purchase or sale of securities
  2. has access to nonpublic information regarding the portfolio holdings of any reportable fund
  3. is involved in making securities recommendations to clients
  4. has access to securities recommendations that are nonpublic

Those are some very broad categories. For most private funds, I would guess that most of their employees could be considered "access persons." It's probably easier and less likely to get you in trouble if you consider all employees to be access persons and require all employees to submit reports. Not easier on the compliance officers, but easier on employee understanding.

Exceptions From Reporting Requirements

Rule 204A-1 has some exceptions to personal securities reporting. No reports are required:

  • With respect to transactions effected pursuant to an automatic investment plan.
  • With respect to securities held in accounts over which the access person had no direct or indirect influence or control.

Plus there is also a group securities that are not reportable:

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

Preclearance for IPOs and Limited Offerings

Rule 204a-1 requires an access person to obtain approval before they any security in an initial public offering or in a limited offering. A "limited offering" is a private placement and would include the purchase of an interest in a private investment fund.

What About Alternative Investment Fund Advisers?

These rules make sense for an adviser focusing on tradable securities, but make much less sense for advisers to funds that focus on alternative investments. Venture capital is an obvious example, but it seems they have escaped from the registration requirement imposed on other private equity firms under the financial reform bills.

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For additional commentary on developments in compliance and ethics, visit Compliance Building, a blog hosted by Doug Cornelius.