Personal trading policy

A personal trading policy establishes rules that govern how hedge fund employees can trade securities in their own personal investment accounts. These policies address a fundamental challenge in the hedge fund industry: employees often have access to valuable, non-public information about the fund's trading strategies and positions that could give them unfair advantages in their personal investing.

The policy serves as a critical compliance tool that prevents several problematic practices. It stops "front-running," where employees might buy or sell securities ahead of the fund's larger trades to benefit from expected price movements. It also prevents conflicts of interest that could arise when employees' personal financial interests compete with their duty to act in the fund's best interests.

These policies are not optional for registered investment advisers Registered investment adviser (RIA) A registered investment adviser (RIA) is a hedge fund manager or other investment adviser that has registered with the SEC or state securities regulators. These advisers must follow comprehensive rules including fiduciary duties, compliance requirements, and regular examinations. . They form a required component of the broader code of ethics that investment advisers must establish under federal securities law. The policies recognize that hedge fund personnel regularly encounter material non-public information Material non-public information Material non-public information is data about a company that is not publicly available and would likely affect the market price of its securities if disclosed, which hedge funds must establish policies to identify and prevent trading upon to avoid insider trading violations. that could create significant advantages in personal trading if not properly controlled.

Personal trading policies derive their legal foundation from Rule 204A-1Investment Advisers Act regulation requiring registered investment advisers to establish and enforce written codes of ethics that address personal securities transactions by firm personnel, particularly access persons. under the Investment Advisers Act Investment Advisers Act of 1940 The Investment Advisers Act of 1940 is the primary U.S. legislation regulating investment advisers, including hedge fund managers, establishing registration requirements, fiduciary duties, disclosure obligations, and compliance standards for advisers meeting certain thresholds. . This rule requires all registered investment advisers to establish and enforce comprehensive codes of ethics that specifically address personal securities transactions by firm personnel.

The rule focuses on a specific category of employees called "access persons." These individuals face stricter requirements because of their potential exposure to sensitive information. According to the Advisers Act, access persons include any supervised person who meets one of two criteria: they either have access to non-public information about fund purchases and sales, or they participate in making securities recommendations for the funds.

The rule also covers supervised persons who have access to non-public investment recommendations that could affect fund trading decisions. This broad definition recognizes that valuable information can flow through many different channels within a hedge fund organization.

Determining who qualifies as an access person requires careful analysis of each employee's role and information access. The regulation generally assumes that directors, officers, and partners are access persons unless they can demonstrate they lack access to fund portfolio holdings and do not make investment decisions for any fund.

Many hedge fund managers simplify this determination process by treating all employees as access persons. This approach eliminates the need to continuously evaluate whether specific individuals meet the technical definition of access person, which can change as job responsibilities evolve. This comprehensive approach also provides broader protection against potential conflicts of interest.

Firms must also consider individuals beyond direct employees. Consultants and other non-employees may qualify as "supervised persons" or "access persons" if they have the requisite access to information or decision-making authority. These individuals would then need to comply with the investment adviser's code of ethics requirements.

Rule 204A-1 establishes minimum pre-clearance requirements that access persons must follow. At a minimum, access persons must obtain approval before participating in any initial public offering (IPO) or limited offering. Limited offerings typically include private offerings that are exempt from registration under the Securities Act Securities Act of 1933 The Securities Act of 1933 is the primary U.S. law that governs how securities are offered to investors. It requires companies to register their securities with the SEC and provide detailed information to potential investors, unless they qualify for specific exemptions. Hedge funds typically avoid the costly and complex registration process by using private offering exemptions, particularly those found under Regulation D. , such as investments in hedge funds or private equity funds that rely on exemptions like Section 4(a)(2)Securities Act exemption for private offerings that allows issuers to sell securities without registration to accredited or sophisticated investors without general solicitation., Section 4(a)(5)Securities Act exemption for certain transactions by persons other than issuers, underwriters, or dealers, typically used for limited private sales of securities., or Rules 504 through 506 of Regulation D SEC Regulation D Regulation D provides exemptions from SEC registration requirements for private placements of securities, with hedge funds typically relying on Rule 506(b) for traditional private offerings or Rule 506(c) for offerings involving general solicitation. .

However, most hedge fund managers implement more comprehensive pre-clearance requirements that exceed these regulatory minimums. Many firms require access persons to obtain approval for all personal trades, regardless of the type of security involved. Others focus their pre-clearance requirements on specific categories that pose higher conflict risks.

Common enhanced pre-clearance approaches include requiring approval for trades in securities that the hedge fund currently holds, is considering for investment, or that would be appropriate for the fund given its stated investment strategy. Some firms extend pre-clearance requirements to entire industries or sectors where the fund actively invests.

Personal trading policies typically employ multiple restriction strategies tailored to the specific risks associated with the fund's investment approach. The restrictions aim to minimize the potential for conflicts while allowing employees reasonable personal investment opportunities.

One common approach limits personal trading to large-cap securities, where individual trades are less likely to impact market prices or create conflicts with fund positions. The logic underlying this approach is that large, widely-traded securities are less susceptible to information advantages and market manipulation concerns.

Many managers prohibit personal trading in any securities that the fund currently holds or is actively considering. These restrictions often include "blackout periods" during which access persons cannot trade certain securities, such as immediately before or after the fund makes significant position changes.

Minimum holding periods represent another popular restriction method. These requirements prevent short-term trading by mandating that access persons hold positions for specified time periods, such as 30 or 90 days, before selling. Some hedge fund managers take a more restrictive approach by prohibiting most or all personal securities trading by access persons.

Access persons must submit two types of periodic reports that provide transparency into their personal trading activities. Holdings reports detail all securities positions in personal accounts, while transaction reports document all trading activity during specific periods.

New access persons must submit initial holdings reports within ten days of becoming subject to the code of ethics. Thereafter, they must submit updated holdings reports at least annually. These reports provide a comprehensive snapshot of personal securities positions that compliance personnel can review for potential conflicts.

Transaction reports must be submitted quarterly, no later than thirty days after the end of each calendar quarter. These reports detail all personal securities transactions during the reporting period, allowing compliance staff to monitor trading patterns and identify potential violations.

To streamline the quarterly reporting process, many investment advisers allow access persons to satisfy reporting requirements by providing brokerage statements and trade confirmations. Firms may accept these documents in paper format or through electronic feeds directly from brokerage firms, reducing administrative burden while maintaining oversight capabilities.

Compliance personnel play a crucial role in ensuring personal trading policy effectiveness through regular monitoring and review processes. The compliance team typically reviews quarterly transaction reports to identify potential violations and ensure adherence to firm policies.

The review process often involves comparing access person trades against several benchmarks and requirements. Compliance staff may check trades against pre-clearance requests to ensure proper approval was obtained. They also compare personal trades against the firm's restricted securities list and client transaction records to identify potential conflicts or front-running.

The specific monitoring approach varies by firm, but all effective programs share common elements: clearly articulated policies that employees can understand and follow, comprehensive recordkeeping that captures all relevant transactions and approvals, and regular monitoring and testing procedures that can identify violations before they become significant problems.

Registered investment advisers must maintain comprehensive records related to their codes of ethics and personal trading policies. Rule 204-2Investment Advisers Act regulation requiring registered investment advisers to maintain comprehensive books and records, including codes of ethics documentation, for specified retention periods. specifies that firms must preserve these records for at least five years from the date of creation.

Required records include copies of all codes of ethics that have been in effect, written acknowledgments from employees confirming they have received and understand the policies, and all transaction and holdings reports submitted by access persons. Firms must also maintain lists of all individuals who have been designated as access persons within the past five years.

Documentation of any violations discovered and the actions taken in response must be preserved, along with records of any special approvals granted for investments in IPOs or limited offerings. This comprehensive recordkeeping requirement ensures that regulators can effectively review firm compliance efforts during examinations.

The failure to collect and maintain all required reports represents one of the most common deficiencies that SEC examination staff identify during hedge fund manager reviews. Firms must establish systematic processes to ensure timely collection and proper preservation of all required documentation.

The SEC has consistently emphasized personal trading policy compliance as a priority area during hedge fund manager examinations. These policies represent a fundamental element of the fiduciary dutyLegal obligation to act in the best interests of another party, requiring utmost good faith and loyalty. that investment advisers owe to their clients, making violations particularly serious from a regulatory perspective.

Examination data demonstrates the significance of this focus area. During the 2017 fiscal year, SEC examination staff in the New York Regional Office found code of ethics-related deficiencies in 21% of examinations conducted. This high percentage underscores both the importance of these policies and the challenges firms face in implementing them effectively.

Common deficiencies identified during examinations include several recurring themes. Many firms fail to require access persons to submit personal securities transactions for required pre-clearance approval. Others incorrectly identify which employees qualify as "access persons," potentially missing individuals who should be subject to enhanced requirements. Additionally, many firms struggle with the timing requirements for transaction and holdings reports, failing to ensure that access persons submit required documentation within regulatory deadlines.