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(Article from Registered Funds Regulatory Update, July 2022)

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On April 26, 2022, the SEC’s Division of Examinations issued a Risk Alert describing notable deficiencies related to Section 204A of the Advisers Act and Rule 204A-1 thereunder. Section 204A of the Advisers Act requires investment advisers to adopt written compliance policies and procedures that are designed to prevent the misuse of material non-public information (“MNPI”) whereas Rule 204A-1 requires advisers to adopt a code of ethics that sets forth the standards of business conduct expected from the adviser’s supervised persons. The Risk Alert described certain common deficiencies with respect to advisers’ compliance policies and procedures and codes of ethics.

Consistent with the general trend toward a more expansive SEC view of what constitutes MNPI as reflected in several recent enforcement actions—certain of which are alluded to but not cited in the Risk Alert—the Risk Alert reflects heightened regulatory expectations with respect to how advisers monitor their intake and treatment of MNPI at both the firm and employee level. Specifically, the Staff observed inadequate adoption or implementation of Section 204A compliance policies and procedures with respect to:

• the potential receipt and use of MNPI from non-traditional data sources (g., social media, internet search data, and satellite imagery), including deficient diligence processes (including periodic diligence subsequent to on-boarding), as well as failures to memorialize implementation of applicable policies;
• the identification of, and tracking of relationships with, “value-add” investors or key persons who are likely to possess MNPI, such as officers or directors of a public company; and
• tracking communications with expert network consultants who may be related to publicly traded companies or have access to MNPI, and associated trading activity.

The Risk Alert also identified common deficiencies related to an adviser’s code of ethics, including:

• failing to identify all access persons;
• access persons failing to obtain pre-approval for investments in initial public offerings or limited offerings;
• failing to follow reporting requirements for personal securities transactions and holdings;
• failing to provide a copy of the code of ethics or obtaining written acknowledgment of receipt of the code;
• trading of securities that are on the adviser’s restricted list; and
• failing to allocate investment opportunities in accordance with the written code of ethics.

Investment Adviser MNPI Compliance Issues, Division of Examinations, SEC (April 26, 2022), available at https://www.sec.gov/files/code-ethics-risk-alert.pdf.