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RIA Code of Ethics SEC Requirements for Advisors

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A financial advisor smiles from behind her desk.

The Code of Ethics Rules is one of many U.S. Securities and Exchange Commission regulations that financial advisory firms must follow when they register with the federal agency. This rule, which was implemented in 2004, establishes the standards of conduct and behavior for registered investment advisors (RIAs) to promote integrity, transparency and accountability.

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What Is the SEC’s Code of Ethics Rule?

The SEC’s Code of Ethics Rule, officially designated as Rule 204A-1, constitutes a critical element of the regulatory framework that governs the conduct of investment advisors in the U.S.

Established as an amendment to the Investment Advisers Act of 1940, this rule was enacted in 2004 amidst a climate of financial unease precipitated by notorious scandals, notably those involving Enron in 2001 and WorldCom in 2002. These scandals not only led to investor losses but also exposed a weaknesses in financial reporting and corporate governance.

Consequently, Rule 204A-1 was introduced to strengthen the ethical standards of investment advisors and thereby restoring investor confidence and ensuring the integrity of financial markets.

Rule 204A-1 specifically applies to RIA firms, mandating that they adhere to high ethical standards. The rule has many provisions, including requirements that certain employees report personal securities transactions.

Rule 204A-1’s implementation has compelled advisors to adopt internal compliance programs to monitor adherence to these ethical guidelines. Investment advisors must now establish a code of ethics that sets forth standards of conduct expected of advisory personnel and addresses how the firm will enforce those standards.

What’s Required of an RIA’s Code of Ethics?

Financial advisors shake hands after a meeting.

Rule 204A-1 provides a detailed outline of what a firm’s code of ethics must include. A code of ethics is required, among other things, to describe the firm’s mechanisms for protecting material nonpublic information, lay out the rules that employees’ securities transactions and require violations to be reported internally. Here’s a closer look at these provisions and others contained in the Code of Ethics Rule:

Standards of Conduct and Compliance with Laws

Under Rule 204A-1, RIA firms must establish a standard of business conduct that reflects their fiduciary obligations and complies with federal securities laws. While the rule sets a minimum requirement, registered firms are encouraged to set higher standards that emphasize integrity and ethical conduct. A well-crafted code of ethics should convey the firm’s values, fostering ethical behavior beyond legal obligations.

Protection of Material Nonpublic Information

Firms also must enforce policies that prevent unauthorized access to “material nonpublic information about the advisor’s securities recommendations, and client securities holdings and transactions.” While segregating employees may be impractical for some firms, robust policies are essential to prevent the misuse of such sensitive data. As a fiduciary, an RIA has a duty of care that requires the safeguarding of sensitive information both internally and externally.

Personal Securities Trading

A code of ethics also has to require that access persons – individuals with access to nonpublic information about client transactions or portfolio holdings – report their personal securities transactions periodically for review. Firms may institute a pre-clearance procedure for personal securities transactions, maintain restricted lists and implement trading restrictions during certain windows.

Initial Public Offerings and Private Placements

To prevent conflicts of interest or the misuse of client opportunities, RIAs must approve an access person’s investment in IPOs or private placements. However, small advisory firms with only one access person may be exempt from pre-clearance requirements. This statute is designed to ensure fair treatment of clients and prevent personal benefit from client-related transactions.

Reporting Violations

A code of ethics also has to mandate that violations are reported to a firm’s chief compliance officer, which in turn can promote a culture of accountability and compliance. The RIA should instill a culture that protects employees when they report violations, and also consider measures like anonymity to encourage reporting. While fines or penalties aren’t mandated, some RIAs may include them in their codes to emphasize compliance importance.

Educating Employees

Advisors must provide copies of their code of ethics to all supervised persons, and in turn, receive an acknowledgment of receipt. Employee education on the principles and procedures of the code is critical for compliance and avoiding inadvertent violations. While not mandatory, periodic orientation sessions or certifications can reinforce employees’ understanding and adherence to the code.

Review and Enforcement

RIAs must maintain and enforce their code of ethics, with the chief compliance officer primarily responsible. Enforcement involves reviewing personal securities reports, and ensuring compliance with internal procedures and regulatory requirements.

Recordkeeping

RIAs must retain copies of their code of ethics, records of violations and access persons’ personal trading reports. The standard retention period for these records is five years, with codes of ethics and acknowledgments kept for the same duration. Although electronic recordkeeping isn’t required, it’s encouraged for effective review and monitoring of compliance.

Bottom Line

Employees of a registered investment adviser (RIA) sit down for a meeting about the firm's code of ethics.

By imposing a structured set of ethical guidelines, the SEC’s Code of Ethics Rule mandates RIAs to operate with the utmost professionalism, ensuring that the interests of clients are always at the forefront. Reporting obligations and the pre-approval of investments are pivotal to this framework, reinforcing the culture of compliance and safeguarding market integrity.

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