On April 26, 2022, the Securities and Exchange Commission’s Division of Examinations (EXAMS) issued a risk alert to warn investment advisors, investors and other market participants of the most common deficiencies that EXAMS staff members observed in connection with Section 204A of the Investment Advisers Act of 1940 and Rule 204A-1 (the Code of Ethics Rule) thereunder, that specifically relate to the misuse of material nonpublic information (MNPI), usually associated with insider trading.
Section 204A requires investment advisors to follower certain policies and procedures designed to prevent the misuse of MNPI, while the Code of Ethics Rule requires registered investment advisor to adopt a “code of ethics” to set a standard of conduct that advisors and certain “supervised persons” (persons who provide advice on behalf of the advisor) must follow, including heightened rules that require certain supervised persons, called “access persons,” to report personal securities transactions to the chief compliance officer (CCO) or a designated person within the company.
The most common deficiencies associated with Section 204A involved a failure of investment firms to adequately memorialize diligence processes for the handing MNPI internally or, if adequate rules were in place, a failure to follow the rules consistently. EXAMS staff also found a lack of policies and procedures that specifically apply to “value-add investors” or key persons who are more like to possess and handle MNPI within a company, finding that companies either failed to have adequate policies in place or a failed to identify and include all of the value-add investors that should be held to these targeted rules. EXAMS staff also found that firms failed to have policies and procedures related to expert network consultants who are paid professionals outside of the firm who performs specialized services for the firm and regularly access a company’s MPNI.
Common deficiencies associated with the Code of Ethics Rule were problems identifying access persons within the company to whom heightened rules should apply and problems implementing rules already in place and obtaining consistent compliance and cooperation from all access persons within the company.
Based on these findings, EXAMS urges advisors to review their current policies and procedures to check for these deficiencies and ensure that their practices are in compliance with the Advisors Act and the Code of Ethics Rules.