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News July 13, 2015 Issue

New Guidance Clarifies Personal Securities Transactions Reporting

Better go back and check the arrangements your employees have with the managers of their trusts and third-party discretionary accounts. If access persons in your firm aren’t reporting their personal securities holdings and transactions for these accounts, they may need to start.

The SEC’s Division of Investment Management last month issued a new Guidance Update (No. 2015-3) that addresses a question many advisers have had: When are personal securities transactions reports required for trusts and third-party discretionary accounts (i.e., accounts over which an employee claims to have no direct or indirect benefit or control)? The answer, according to the SEC staff, is that it depends. But advisers can now be assured that such accounts are eligible for the reporting exemption if they put some additional controls in place – and the guidance provides examples of such controls.

"This latest guidance from the Division will require many advisers to reexamine how they evaluate whether their access persons need to file personal trading reports," said Willkie Farr partner James Burns. "Although it is useful to have clarification as to practices the Division finds acceptable, many firms will need to reevaluate their current approaches and revise their certification processes in order to substantiate that these persons are not exerting influence or control over their personal accounts."

"There was a gray area here before, and now it has become more black and white," said Mayer Brown attorney Adam Kanter. "CCOs may have previously told their employees that if they had third-party discretionary accounts, they didn’t need to submit personal securities transactions reports. Now they will need to look at each one and make sure the arrangements qualify for the exemption."

Code of Ethics

The root of the reporting requirement is Rule 204A-1, the Code of Ethics Rule, under Section 204A of the Advisers Act. The rule helps prevent insider trading and conflicts of interest, such as an employee’s misuse of information about client securities holdings and transactions.

The rule mandates that an adviser’s code of ethics requires that certain advisory "access persons" – directors, officers, partners, employees and others who have access to material nonpublic information regarding securities transactions – report their personal
securities trading. These reports provide a way for the adviser and examiners to identify if any improper trades or patterns of trading occurred.

There is, however, an exception to the reporting requirement. Subsection (b)(3)(i) of the rule exempts an access person from having to report when his or her securities are held in accounts over which he or she has "no direct or indirect influence or control." The classic example of such an account would be a blind trust, the staff noted in the Guidance Update. Such trusts typically involve an arrangement under which a trustee manages funds for the benefit of another person, such as, in this case, an access person, who would have "no knowledge of the specific management actions taken by the trustee and no right to intervene in the trustee’s management."

Trusts and third-party accounts

But what of other accounts where access persons have limited or no control, such as personal trusts managed by a third-party trustee and for which the access person is a grantor or beneficiary and has limited involvement in trust affairs? Or third-party discretionary accounts, under which a third-party manager has discretionary investment authority over access persons’ personal accounts? "These advisers assert that these types of trusts and discretionary accounts are akin to a blind trust in terms of an access person’s influence or control," the SEC staff said in its guidance.

The existence of such accounts, in and of themselves, does not qualify for the exemption, the guidance states. Arrangements involving a trust managed by a trustee for an access person who is a grantee or beneficiary, or a third-party discretionary account, are, by themselves, "insufficient for an adviser to reasonably believe that the access person had no direct or indirect influence or control over the trust or account for purposes of relying on the reporting exception," the guidance states.

Why? Because even with such arrangements, an access person might still have direct or indirect influence or control, the staff said. For instance, the guidance notes, having a trustee with management authority or a third-party manager with discretionary investment authority would still permit an access person to:

  • Suggest purchases or sales of investments to the trustee or third-party manager,
  • Direct purchases or sales of investments, or
  • Consult with the trustee or third-party manager in regard to investment allocations in the accounts.

The safety hatch

But advisers will be glad to know that the guidance update does provide a way for such vehicles to meet the exemption – through the imposition of additional controls.

"The staff … believes that the adviser may be able to implement additional controls to establish a reasonable belief that an access person had no direct or indirect influence or control over the trust or account and could accordingly rely on the exception," the guidance says. It goes on to state that such policies and procedures "should be reasonably designed to determine whether the access person actually had direct or indirect influence or control over the trust or account, rather than whether the third-party manager had discretionary or non-discretionary investment authority."

The staff provided four examples of actions that advisers could take to meet this new threshold:

  • Obtain information about a trustee or third-party manager’s relationship to the access person. For instance, is the trustee or third-party manager an independent professional or a friend or relative of the access person? Is the trustee or third-party manager affiliated or unaffiliated with the advisory firm?
  • Obtain periodic certifications by access persons and their trustees or discretionary third-party managers. These certifications should state the access persons’ influence or control over trusts or accounts.
  • Provide access persons with the exact wording of the reporting exception. They should also provide "a clear definition" of what "no direct or indirect influence or control" means and ensure that the adviser applies it consistently to all access persons.
  • Request reports, on a sample basis, of holdings and/or transactions made in the trusts or discretionary accounts. These reports should identify transactions that "would have been prohibited pursuant to the adviser’s code of ethics, absent reliance on the reporting exception," the guidance states.

Specific certifications

Make sure that any certifications you provide are not general, as the staff said that general certifications "would likely be insufficient" in establishing that an access person did not exercise direct or indirect influence or control. Such certifications "may not be reasonably designed" to do so. Instead, the guidance suggests that advisers consider "more specific certifications" from each access person by asking questions such as:

  • Did you suggest that the trustee or third-party discretionary manager make any particular purchases or sales of securities for account X during time period Y?
  • Did you direct the trustee or third-party discretionary manager to make any particular purchases or sales of securities for account X during time period Y?
  • Did you consult with the trustee or third-party discretionary manager as to the particular allocation of investments to be made in account X during time period Y?