SEC demands more diligence on personal trading

The commission will not allow advisers to exempt personal accounts handled by third party managers from Code of Ethics reporting.

The Division of Investment Management at the US Securities and Exchange Commission (SEC) has issued a guidance update on how to monitor employee trading, providing more clarity on a difficult task that every private equity chief compliance officer (CCO) confronts.

The new guidance warns that delegating discretion over an employee’s personal account to a third party is not enough to exempt that account from Code of Ethics reporting.

The Code of Ethics Rule in the Investment Advisers Act of 1940 (Rule 204A-1) requires supervised persons to report their personal securities holdings and transactions, but offers an exception provided that the supervised person has “no direct or indirect influence or control” over transactions.

The guidance clarifies that moving management authority over an employee’s trust or account to a third party does not necessarily establish that the employee has no control over the account, because such an arrangement would not prevent the employee from directing the purchase or sale of investments or suggesting trades to the third-party manager.

To ensure that the access person does not have control, the SEC suggests using blind trusts and adopting certain policies and procedures. For example, CCOs should provide employees with the exact wording of the reporting exception and a clear definition of “no direct or indirect influence or control”; collect information about the relationship between the employee and the third-party manager; and obtain periodic specific certifications about communications between the employee and the third-party manager.

For CCOs who have been strictly interpreting the rule and mandating that employees establish blind trusts, the guidance will come as a relief, as their interpretation has been correct, noted Doug Cornelius, CCO at Beacon Capital Partners and author of the blog Compliance Building. Those who have taken a more liberal approach, however, will have to update their policies to comply.