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Investment Advisers and Employee Trades

Friday, March 24, 2017

One area of compliance commonly overlooked by many registered investment advisers is that of employee personal trading. In most instances, this is because many registered investment advisers assume they have good employees that would never execute trades that would be considered an issue or their employee(s) would not have access to information that would allow them to make trades that could be an issue.

When addressing the monitoring of employee personal securities transactions, the first thing that needs to be addressed is the written supervisory procedures/compliance manual. Many investment advisers will pay for, or obtain from business associate, a template compliance manual. In my experience working in compliance in the securities regulatory industry is that even though everyone signs the attestation to receiving and reviewing the written compliance manual of the adviser, most have never even read the table of contents.

A word of warning, whether you are registered by the SEC, and required to adopt a written code of ethics, or with one or more states that do not require the adoption of a code of ethics, and have purchased or acquired a template compliance manual, in most instances that manual will contain a code of ethics. Pursuant to CFR Title 17, § 275.204A-1, require the code of ethics to include language that requires employees to submit initial and quarterly holdings and transaction reports to the chief compliance officer and for the chief compliance officer to review these reports. Although the Adviser may not be registered with the SEC, please be aware that the compliance manual that has been purchased, or acquired, will most definitely contain a code of ethics. And if it is in the compliance manual, the regulators expect the procedures to be followed.

So, for those that are not registered with the SEC, and the State, or States, in which the adviser is registered have not adopted the Uniform Securities Act and do not require a written code of ethics, the adviser can still be cited for a violating its written compliance manual if employee personal securities holdings and trades are not being reviewed pursuant to the code of ethics contained within the manual.

For those out there that operate within a jurisdiction whose statutes do not require the written code of ethics, and are thinking that the code of ethics can just be removed from the manual, technically you are correct. However, be advised that if a client is harmed, or an employee executes a trade or trades that are deemed to be in violation of any securities statutes, because a code of ethics or policy regarding the review of employee holdings and trading has not been adopted, the adviser is going to be cited for not having adequate written supervisory procedures, and quite possibly for violating its fiduciary responsibility to its clients.

Some may be thinking that your business is so small that there is no way that any employee’s trades could possibly harm a client, or be of any issue or concern. Do not underestimate how one employee could cause serious regulatory issues. As an example; an adviser has one registered representative (usually the owner of the adviser, who also acts as the adviser’s chief compliance officer) and administrative employee. The registered representative does not discuss trading strategies or what is being bought or sold in client accounts with the admin employee. However, one day this individual overhears a phone call between the registered rep and a colleague in which the rep speaks about a large position that is going to be taken for all the adviser’s clients. The admin person calls their spouse and tells them to buy the same security in their account. Although there is no way that the position taken by the registered rep will be large enough to move the price of the stock, if the admin employee trade is entered at a better price that the adviser’s clients, this could cause an issue with the regulators.

Bottom line is never assume that employees do not have personal trading accounts, that their spouses do not have personal trading accounts, or that an employee will never be in a position to execute a trade that could cause issues with the regulators. If your registered investment adviser is registered in a jurisdiction that does not require a code of ethics, or the review of employee trades, do yourself a favor and adopt some sort of procedure to one, request information in writing from employees regarding their and the immediate members of their household personal securities trading accounts, and a periodic review of those that indicate that they have accounts.

About Red Oak Compliance Solutions

Red Oak Compliance Solutions is the global advertising review software of choice in the financial services industry. It is a comprehensive suite of SEC 17A-4 compliant features that are 100% books and records compliant and provides clients with 35% faster approvals and 70% fewer touches or better. We also offer Smart Review(SM), which solves for the storage and maintenance of disclosures, helping firms reduce risk, decrease review times, and increase the speed of distribution of marketing materials. Smart Registration(SM) automates the licensing and registration management process to help reduce regulatory risk and time spent on manual processes. Overall, Red Oak allows firms to minimize risk, reduce costs, and increase compliance review process effectiveness and efficiencies.

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