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News January 24, 2005 Issue

Access Persons, Reportable Securities, and Other Ethical Dilemmas

Whether you are merely amending your long-standing 17j-1 code of ethics or are building a new code from scratch, youíll need to have the job done by February 1, the compliance date for new Advisers Act Rule 204A-1.

If you still have questions, youíre not alone. Based on conversations with investment management lawyers and consultants, there are a number of perplexing issues out there:

Whoís an access person?

The ruleís definition of access person is broad and may pick up a range of people that you might not immediately think of as an "access person." For example, as ICAA general counsel Karen Barr points out, "What about people in the IT department who have access to securities information while fixing a computer?" Depending on the size of your firm, one approach that might make sense is to treat all employees who walk in the door in the morning as an access person. National Regulatory Services consultant Richard Cortese said that advisers are grappling with the question of whether to broaden the definition of access person. "I think it is fairly clear that if you have a small firm, especially in terms of personnel, and you donít have information barriers between administrative people and portfolio managers, it is probably wise to bring everyone within the purview of being an access person," Cortese said. "Information barriers, or lack thereof, are a key component here," he added. But "at the end of the day, itís probably a lot easier to treat everyone as an access person." An adviser that treats everyone as an access person, he added, doesnít have to maintain a list of access persons and determine "whoís on or whoís off" that list.


Access persons are presumed to beneficially own any securities owned by immediate family members that reside under the same roof (although that presumption can be rebutted). As a result, access persons have to consider spousal investments when completing their holdings and transaction reports.

What if an access personís spouse balks at the notion of providing a list of investments? Hereís one approach: The access person could tell the uncooperative spouse that if he (or she) doesnít cooperate, he (or she) could be the familyís sole breadwinner. Or, as Barr put it: "Compliance with the code is a condition of employment. Your spouse needs to understand that if he or she does not cooperate, you could be terminated."

And just wait until the spouse wants to invest in a hedge fund. Under the ruleís preclearance requirement, in combination with the definition of "beneficial ownership," access persons have to obtain approval from their firmís CCO (or other designee) before their spouse can invest in a hedge fund, IPO, or other limited offering.

Imagine this scenario: Say your spouse is a portfolio manager at another firm, perhaps running a fund of hedge funds. He (or she) has some of his personal money invested alongside the fundís investors. After February 1, what happens when the portfolio manager spouse wants to cause the fund to buy interests in a hedge fund? Does he have to wait until the CCO at his spouseís firm grants approval of the purchase? And wouldnít that make the CCO an access person of the spouseís firm?

A New York-based investment management lawyer swears heís run across the situation more than once. The solution: rebut that presumption of beneficial interest. "As a practical matter, you canít have a competitor preclear," he noted.

Of course, thereís the question of who, exactly, is a "spouse." Are domestic partners picked up? Significant others? The New York lawyer said that his firm is generally advising that such individuals be treated like spouses.

List of accounts in holdings reports.

There are two parts to your access personsí initial and annual holdings reports: first, a list of "reportable securities" held, and second, a list of banks, brokers, and dealers at which "any securities" are held for the access personís direct or indirect benefit. In other words, when preparing their list of holdings, your access persons can ignore the non-reportable stuff, such as money market funds and unaffiliated mutual funds. But when they prepare their list of accounts, they need to list brokers, dealers, and banks where any security is held, regardless of whether the security is a "reportable security" that has to be included on the list of holdings.

Letís say your access person buys shares of an open-end mutual fund not affiliated in any way with your firm. Itís a non-reportable security, so it doesnít need to be listed on the access personís holdings reports. But what about the list of accounts? If the share was purchased through a brokerage account, the account needs to be listed. If the shares were purchased directly from the fund company and no brokerage account was opened (instead, there was just a bookkeeping entry on the fundís transfer agentís books), the "account" doesnít need to be listed.

Also: While bank accounts containing securities have to be included on the list of accounts, keep in mind that some bank instruments, such as CDs, are not securities.

We are family . . . Iíve got all my sister affiliates with me . . .

If your firm has been acquired by a parent company that owns other advisers, things can get really interesting. Although mutual funds are generally excluded from the ruleís definition of "reportable security," the definition does pick up open-end funds advised or subadvised by an adviser or its control affiliate (namely, a parent, subsidiary, or sister firm). So, under the rule, your firmís access persons will be required to report their holdings and transactions in any mutual fund advised or subadvised by your sister firms, even if your firm has nothing to do with the activities of those firms.

There seem to be two ways to deal with this issue: one option is to ask your parent company to prepare a master list of all funds advised or subadvised by firms under their umbrella to help your access persons (and the access persons at your sister firms) identify which mutual funds might be subject to the reporting requirements. Alternatively, you can require your access persons to report holdings and transactions in all open-end mutual funds, regardless of whether they are affiliated or not, under the theory that by casting a wide net, you will sweep in the required funds. Of course, the latter approach will result in unnecessary work by whoever is in charge of reviewing the holdings and transaction reports, as they will have to review holdings and transactions in mutual funds that would not otherwise be reportable under the rule.

Are ETFs reportable securities?

Hereís what IM Insightís been told by an expert attorney: If the ETF is organized as a closed-end fund, it is a "reportable security" that has to be listed in your access persons holdings and transaction reports.

If the ETF is organized as an open-end fund, whether it needs to be reported or not hinges on whether the open-end fund is affiliated with your firm (i.e., is the open-end fund advised or subadvised by your corporate parent, a sister company, or a subsidiary, or one of those firms acts as the fundís principal underwriter?)

What about ETFs organized as UITs? The general rule is that all UITs are reportable whether they are affiliated or unaffiliated. Rule 204A-1 contains a special exception for UITs that are invested exclusively in open-end funds that are not reportable funds. ETFs that are UITs, however, generally do not meet this requirement. (Weíre told that the exception in the rule was designed for variable insurance products, not ETFs.) [Ed. note: thatís a bit different than IM Insight reported back in the summer. The electronic versions of the August 2, 2004 article have been revised accordingly.]

Other reportable securities.

Are private placements and interests in limited partnerships reportable securities? "The answer is clearly yes," said Cortese. Remind your access persons to report reportable securities that might not appear on any brokerage statement.

Reviewing reports.

While Rule 204A-1 says that advisers must "review" the reports submitted, it does not specify what, exactly, that review must encompass. The adopting release, however, does suggest a number of steps that an adviser should take in the review process. Cortese noted that an adviser could seemingly tailor the scope of its review to the types of conflicts presented by its firm. He gave the example of a firm that primarily places clients into mutual fund asset allocation programs. "The potential there for conflict is so negligible that I think the review would certainly wouldnít be as expansive," he said.

And lastly . . .

If you havenít already, take a look at the ICAAís Best Practices for Investment Adviser Code of Ethics. Itís a valuable resource and is freely available on the groupís website. Barr reports that her group is working on a list of frequently asked questions and answers on the code of ethics rule.