Code of ethics

A code of ethics is a required written policy for investment advisers registered with the Securities and Exchange Commission (SEC). This document sets standards for how employees should conduct business, addresses , and requires certain employees to report their personal stock trades and investments.

The code serves two main purposes. First, it helps the firm meet regulatory requirements. Second, it provides a practical guide for maintaining integrity in investment management operations. Investment advisers use these codes to manage potential conflicts that could arise when employees make personal investments while also managing client money.

is the specific SEC regulation that spells out what investment advisers must include in their codes of ethics. This rule helps advisers manage situations where employee personal trading might conflict with client interests. It also requires firms to document their commitment to honest and professional conduct.

The rule sets several mandatory requirements. First, codes of ethics must include conduct standards for all that require compliance with federal securities laws. Second, the code must require employees to promptly report any violations to a designated compliance officer. Third, each employee must receive a copy of the code and provide written confirmation that they received it.

The code of ethics places special obligations on certain employees called "access persons." These are supervised employees who either have access to confidential information about fund purchases and sales, or who are involved in making investment recommendations for the funds.

In practice, directors, officers, and partners are generally considered access persons unless they can prove they have no access to fund portfolio information and do not participate in investment decisions for any fund. Many hedge fund managers simplify this process by treating all employees as access persons rather than making complex case-by-case determinations.

Access persons must file detailed reports about their personal investment activities. These reports come in two types: holdings reports and transaction reports.

Holdings reports provide a snapshot of what securities the access person owns. The report must include the security name and type, the ticker symbol or (a unique identifier for securities), the number of shares or principal amount, and the name of the broker, dealer, or bank where the account is held. New access persons must submit their first holdings report within ten days of becoming an access person, and then file updated reports at least once per year.

Transaction reports document each trade where the access person bought or sold a . These reports must be filed within thirty days after the end of each calendar quarter, covering all transactions from that three-month period.

Before access persons can invest in certain types of securities, they must obtain advance approval from the adviser. Rule 204A-1 specifically requires pre-clearance for two categories: initial public offerings (IPOs) and limited offerings.

Limited offerings typically include private offerings that are exempt from Securities Act registration requirements. Examples include under , hedge funds, and private equity funds. This category may even include funds managed by the access person's own firm.

When reviewing pre-clearance requests, advisers evaluate whether the proposed investment creates conflicts of interest. For example, they might reject a request if the investment opportunity duplicates something available to clients, or if the investment could lead to inappropriate sharing of client confidential information.

Investment advisers must keep detailed records related to their code of ethics for five years under . These records include copies of the code itself, written employee acknowledgments of receipt, all holdings and transaction reports from access persons, and a list of current and former access persons from the past five years.

The records must also include documentation of any code violations and corrective actions taken, as well as records of pre-clearance approvals granted for IPO and limited offering investments.

Compliance staff typically review the quarterly transaction reports to ensure employees are following the firm's policies and to identify potential problems like insider trading or market manipulation. This review process usually involves comparing access person transactions against approved pre-clearance requests, the firm's restricted securities list, and transactions executed for client accounts during the same time period.

Item 11 of Part 2A requires SEC-registered advisers to summarize their code of ethics in their client disclosure document and offer clients the opportunity to review the full code. This creates a balancing act for advisers when developing their codes. They must be comprehensive enough to be effective while also being appropriate for client review, since clients will see documentation of any violations that occur.

While Rule 204A-1 only requires pre-clearance for IPOs and limited offerings, many hedge fund managers go beyond these minimum requirements. These enhanced policies often require access persons to obtain advance approval for all personal trades, or at least for trades in securities that relate to the fund's investment strategy or companies the manager is actively considering.

Some common enhanced restrictions include limiting personal trading to large-cap publicly traded stocks where the trades are unlikely to affect market prices. Many firms prohibit or restrict trading in securities held by their funds. Others impose holding period requirements, meaning employees must hold investments for a minimum time period before selling.

Some managers create blackout windows during which employees cannot trade certain securities. Others restrict short-term trading by requiring minimum holding periods. The most restrictive policies prohibit personal trading in most or all security types to eliminate potential conflicts entirely.

Investment advisers who are not required to register with the SEC are not legally required to adopt a code of ethics under Rule 204A-1. However, many choose to implement one anyway. A code of ethics helps these advisers fulfill their to clients and meet market expectations. Many investors request to review an investment adviser's code of ethics and as part of their process before investing.

Some investment advisers extend their code of ethics beyond traditional securities to address personal transactions in other assets like cryptocurrencies and digital assets. This expansion typically occurs when employee trading in these assets could become a distraction or create conflicts of interest with client investment activities.

When considering whether to include these assets, advisers must evaluate whether they constitute under the rule and determine the appropriate scope of personal trading restrictions for their specific situation.

The SEC Division of Examinations continues to find code of ethics problems during regulatory examinations of investment advisers. The most frequently cited deficiency is failure to timely collect and maintain all required personal securities reports from access persons.

Recent enforcement actions highlight ongoing compliance challenges. A 2024 settlement with a private fund adviser involved violations related to access person pre-clearance failures and inadequate enforcement of personal trading restrictions. In that case, employees failed to obtain required approvals and used personal communication channels that bypassed compliance review processes.