Registered investment advisers must adopt a code of ethics under the Investment Advisers Act. While Exempt Reporting Advisers are not technically subject to this requirement, adopting a code of ethics is standard practice and is expected by institutional LPs conducting operational due diligence. A code of ethics establishes the standards of conduct for your firm and addresses the most common conflicts that arise in investment management.
What the Code Covers
A code of ethics sets standards of conduct for all "supervised persons" at the firm, which includes every officer, director, partner, and employee. The code should address the following areas:
- Fiduciary duty. A statement of the firm's fiduciary obligations to clients and fund investors, including the duty to act in their best interests and to place their interests ahead of the firm's own interests.
- Insider trading prohibitions. A clear prohibition on trading on or communicating material nonpublic information. This is particularly important for fund managers who may receive MNPI through board seats, deal processes, or co-investor relationships.
- Personal trading policies. Rules governing the personal securities transactions of supervised persons. These policies are designed to prevent employees from front-running fund trades or trading on information obtained through their positions.
- Gift and entertainment policies. Guidelines on accepting or giving gifts and entertainment to or from persons doing business with the firm. These policies address potential conflicts of interest and the appearance of impropriety.
- Outside business activities. Requirements for disclosing and obtaining approval for outside business activities, board positions, and other engagements that could create conflicts with the firm's advisory business.
- Confidentiality. Obligations to protect confidential information about fund investments, portfolio companies, and investor identities. This includes restrictions on sharing information with persons outside the firm.
- Violation reporting. Procedures for reporting known or suspected violations of the code, including protections for individuals who report in good faith.
Personal Trading
Personal trading policies are the most operationally intensive part of the code of ethics. They require ongoing monitoring and reporting by all supervised persons. The standard components include:
- Pre-clearance of personal trades. Supervised persons must obtain approval before executing personal securities transactions. The compliance officer reviews the proposed trade against the firm's restricted list and current investment activities to identify potential conflicts.
- Quarterly transaction reports. Within 30 days of each quarter-end, all supervised persons must submit reports listing every securities transaction in their personal accounts during the quarter. These reports are reviewed by the compliance officer.
- Annual holdings reports. At least once per year, all supervised persons must submit a complete list of securities held in their personal accounts. The report must be current within 45 days of submission.
- Restrictions on fund-related securities. Supervised persons should avoid trading in securities that the fund is actively considering, purchasing, or selling. The restricted list should be maintained and updated as the fund's investment activity changes.
- Broader restrictions. Some managers go further and prohibit supervised persons from holding individual securities entirely, requiring that personal investments be limited to broad-based index funds, ETFs, and other instruments that do not create conflicts.
Administration
The Chief Compliance Officer (or the person designated to perform this function) administers the code of ethics. Administration responsibilities include:
- Reviewing personal trading reports and holdings reports for potential violations
- Maintaining the restricted list of securities
- Processing pre-clearance requests
- Investigating potential violations and documenting findings
- Maintaining records of all code of ethics documentation
All supervised persons must acknowledge receipt of the code of ethics in writing upon hire and must re-acknowledge annually. These acknowledgments must be maintained as part of the firm's books and records. Any amendments to the code must be distributed to all supervised persons, and new acknowledgments must be obtained.
This article is for informational purposes only and does not constitute legal advice. Consult qualified professionals for guidance specific to your situation.