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News July 26, 2004 Issue

An IM Insight Special Report: The New Code of Ethics Rule (Part 3 of 3)

Step 9: Amend your ADV.

Advisers must describe their code of ethics on Schedule F in response to Form ADV Part II, Item 9. They also must state that they will provide a copy of their code "to any client or prospective client" upon request.

The SEC noted that an adviser that has disclosed its policies and procedures but then materially deviated from them may be subject to action under Section 206 of the Advisers Act (translation: charged with fraud). Consequently, achieving the right balance of detail in your Form ADV disclosures is critical. It may be worth noting that in certain circumstances, waivers and exceptions may be granted from the codeís requirements by the firmís compliance officer (or other official(s), if applicable).

Step 10: Consider the ICAAís Best Practices.

Who said thereís no such thing as a free lunch?

On July 20, the ICAA issued its Best Practices for Investment Adviser Codes of Ethics. The Practices are freely available to all advisers and are similar in function to the Investment Company Instituteís 1994 recommendations on personal trading for funds.

The ICAA Best Practices contain a number of practical suggestions. A few highlights:

  • When circulating a copy of the code to firm personnel, the head of the firm, such as the firmís president or CEO, could write a cover letter emphasizing his views about the importance of ethical conduct.
  • Draft the code in plain English. "The more readable a code is, the more likely it is that employees will be able to understand and comply with its precepts," said the ICAA.
  • Because supervised persons must receive any amendment to the code, save up technical amendments and make them annually, or with other material amendments distributed throughout the year. This, said the ICAA, will help "avoid inundating employees." Using titles or positions instead of specific names will help minimize amendments during the year, as well.
  • Donít just distribute the amended code, "bring important changes to the attention of employees," said the group. One way to do this: attach a cover memorandum highlighting the changes.
  • Firms could consider requiring employees to certify annually that they are not subject to any of the disciplinary events list in Item 11 of Form ADV.
  • Consider maintaining records of any decisions that grant employees or access persons a waiver from or exception to the code (remember: waivers canít be granted for things that are required by Rule 204A-1, such as preclearance of IPOs and limited offerings).

In a few areas, the ICAAís recommendations go beyond what Rule 204A-1 requires. For example, the group recommended that advisers prohibit access persons from trading the same security on the same day as a client, and suggested that advisers consider a longer black-out period. It recommended that advisers prohibit "investment personnel" (a narrower sub-class of access persons comprised of portfolio managers, portfolio assistants, securities analysts, and traders) from acquiring IPOs and engaging in short-term trading (the group didnít suggest a time period, but noted that many firms define "short-term" as within 30 or 60 days). It also recommended that access persons disclose their securities accounts to the CCO or other designated person (thatís required by ICA Rule 17j-1 but was not picked up in the Advisers Act rule).

In addition to personal trading, the ICAAís Best Practices provide helpful detail on drafting procedures on the following topics:

  • Insider trading;
  • Gifts and entertainment;
  • Political and charitable contributions;
  • Confidentiality;
  • Service on a board of directors;
  • Other outside activities; and
  • Marketing and promotional activities.

One last tip: one industry attorney suggested that advisers treat the compliance date of the code of ethics rule as October 5, rather than January 7, 2005, to coordinate with the implementation of the compliance program rule. "If you want to be efficient, youíve got an October 5th deadline for both of these things," she said. Implementing the compliance program and the code of ethics rule separately will be "complicated and confusing," she predicted. In contrast, if you "do everything at once," you can make one distribution of documents to employees and can integrate the code of ethics into the larger compliance program. "I certainly wouldnít wait until January," she added. "Why do double the work?"