Jun. 3, 2021

Code of Ethics 101: What They Must – and May – Include (Part Two of Three)

Registered investment advisers are required by Rule 204A‑1 under the Investment Advisers Act of 1940 – the so-called “code of ethics rule” (Rule) – to establish, maintain and enforce written codes of ethics. The Rule spells out the minimum requirements for a code of ethics. In practice, however, most fund managers go beyond the basic requirements, such as including additional ethics-related policies and expanding the scope of individuals to which the code of ethics applies. This three-part series reviews the fundamentals of codes of ethics, focusing on the Rule’s three core elements: establish, maintain and enforce. This second article centers on the “establish” element, explaining what codes of ethics must include – and also what they may include. The third article, concentrating on the “maintain” and “enforce” elements, will discuss how to monitor compliance with codes of ethics, including the role of technology, and handle violations by employees. The first article outlined why fund managers need codes of ethics, as well as the consequences of failing to comply with the Rule’s requirements. For common questions fund managers ask about codes of ethics, see “ACA 2019 Hedge Fund Survey Examines SEC Exam Experience, Codes of Ethics, Electronic Communications and Expense Allocations (Part One of Two)” (Aug. 8, 2019).

Leveraging Policies and Culture: A Recipe for Success

When establishing and running their compliance programs, fund managers confront the tension between focusing on fostering a strong culture of compliance on one hand and guiding employee behavior by enacting and enforcing rules on the other. In a guest article, Anna Romberg, executive vice president of legal, compliance and governance at Getinge, a Swedish life sciences company, and Ann Sultan, a member at Miller & Chevalier, explore the differences between rules- and culture-based approaches toward ethics and compliance, drawing on their experiences working with U.S. and European companies. They also note differences in the application of ethics and compliance programs depending on geographical orientation. For more on fostering a culture of compliance, see “How CCOs Can Avoid Personal Liability for Organizations’ Compliance Failures” (Mar. 11, 2021); and “CFTC Enforcement Division Aims to Foster ‘True Culture of Compliance,’ According to Report” (Jan. 16, 2020).

Morgan Lewis Attorneys Discuss Updates to Exempt Offering Framework and Broker‑Dealer Registration Issues

Fund managers have to negotiate a range of complex regulatory requirements when raising capital. A recent panel at Morgan Lewis’ annual hedge fund event analyzed the SEC’s recent amendments to the exempt offering framework under the federal securities laws, which are aimed at facilitating capital formation. The panel also addressed the perennial issue of when marketing activities cross over into broker-dealer territory and a proposed SEC exemptive order that would make it easier for fund managers to engage finders. The program featured Morgan Lewis partners Amy Natterson Kroll and David A. Sirignano. This article distills their insights. For additional commentary from Kroll, see “MiFID II May Have Significant Ramifications on Research Payments Involving U.S. Managers With Cross-Border Operations” (Jul. 27, 2017).

FCA Consults on Proposed Changes to U.K. Version of MiFID

The U.K. Financial Conduct Authority (FCA) recently issued a consultation paper on proposed changes to the U.K. version of the Markets in Financial Instruments Directive that are intended to improve the available research on certain small- and medium-sized companies; clarify exemptions to the ban on providing so-called “inducements” in connection with trading commissions; and eliminate certain reporting requirements. This article examines the FCA’s proposals, with commentary from Tim Dolan, partner at Reed Smith, and Leonard Ng, partner at Sidley Austin. For further insights from Ng, see “The E.U. Sustainable Finance Disclosure Regulation: New Disclosures for U.S. Asset Managers” (May 6, 2021).

SEC Sanctions Adviser for Undisclosed Conflicts and Misleading Form ADV

Conflicts of interest are always top-of-mind for the SEC. A recently settled SEC enforcement proceeding against the principal of an investment adviser is an important reminder for all fund managers that all conflicts of interest – even those arising out of arrangements that may yield little or no financial benefit – must be fully and fairly disclosed, including on an adviser’s Form ADV. This article details the facts and circumstances that gave rise to the enforcement proceeding, the alleged conflicts of interest and the terms of the settlement order. See “Division of Examination’s 2021 Exam Priorities: Perennial Focus Areas for Private Fund Managers (Part Two of Two)” (Apr. 22, 2021); and “Practical Lessons From OCIE’s Risk Alert on Compliance Issues for Private Fund Managers (Part One of Two)” (Nov. 19, 2020).