March 11, 2004
Mr. Jonathan G. Katz
Re: Proposed Rule: Investment Adviser Code of Ethics, Release Nos. IA-2209, IC-26337; File No. S7-04-04
Dear Mr. Katz:
The Investment Counsel Association of America1 appreciates the opportunity to submit comments on proposed rule 204A-1 under the Investment Advisers Act of 1940 and related rule amendments.2 The ICAA strongly supports the premise that every investment adviser should adopt a written code of ethics and we applaud the Commission for issuing this important proposal.
Proposed rule 204A-1 would require all investment advisers registered with the Commission to adopt codes of ethics that: (1) set forth standards of conduct expected of advisory personnel (including compliance with the federal securities laws); (2) safeguard material nonpublic information about client transactions; (3) require advisers' "access persons" to report their personal securities transactions, including transactions in any mutual fund managed by the adviser; (4) require advisers' access persons to obtain prior approval before investing in an initial public offering or private placement; (5) require prompt reporting to the adviser's chief compliance officer or other designated person of any violations of the code; and (6) require that each supervised person of the adviser acknowledge in writing receipt of a copy of the code and any amendments to the code.
I. The ICAA Supports the SEC's Code of Ethics Proposal
Since the founding of our organization in 1937, the ICAA has endorsed standards that emphasize an investment adviser's fiduciary duty and suggest principles of conduct that investment advisers should follow in the practice of their profession. Over the years, many of these principles have been used by Congress and the Commission as the basis for laws and regulations governing the conduct of investment advisers, and by the U.S. Supreme Court in defining the standards of fiduciary conduct applicable to all investment advisers. In addition, the ICAA has been a strong advocate of written codes of ethics. As noted in the proposal3, the ICAA has specifically endorsed the view that all investment advisers should develop and follow written codes of ethics that contain appropriate restrictions on personal trading, insider trading, and relationships with brokers, vendors and other third parties.4
In addition, the ICAA recently informed the Commission that it is developing a model code of ethics for investment advisers.5 This initiative is intended to bolster efforts to enhance investor protection, to assist investment advisory firms in complying with the Commission's new regulations, to promote practices that go beyond mere strict adherence to the "black letter" rule of law, and to help educate advisory personnel of their fiduciary responsibilities. We anticipate providing the Commission with our model code in the near future.
We strongly support the SEC's proposal to require codes of ethics, with the following modifications and comments: (1) we urge the Commission to eliminate the proposed requirement that various trading records be maintained electronically; (2) we request certain clarifications regarding the proposed requirement to restrict access to nonpublic information; (3) we support flexible standards for codes of ethics; and (4) we recommend exempting non-U.S. government securities from the reporting requirements. We would be pleased to provide additional information on any of these issues and we look forward to working with the Commission in implementing this significant proposal.
II. The SEC Should Not Mandate Electronic Record-Keeping
The SEC has proposed to require that records of access persons' personal securities reports, and duplicate brokerage confirmations or account statements in lieu of those reports, be maintained electronically in an accessible computer database. We oppose this proposed requirement. Such a mandate would impose significant and unnecessary costs and burdens, particularly on small and mid-sized investment advisers. Of particular concern is the potential need to transfer duplicate brokerage confirmations and account statements into electronic format, either by scanning them or by manually transcribing the information into a computer. We understand that many brokers do not provide these documents in a format that can be readily electronically integrated into a firm's computer database, and no corresponding broker-dealer rule requires them to do so.
We believe the proposed record-keeping requirement is premature, given current practices among many investment advisory firms. We are certainly mindful of the fact that the securities industry is continuing to make progress in achieving a variety of electronic efficiencies in trading and operations. Thus, the proposed record-keeping requirement may be less onerous to implement at some point in the future. In the meantime, however, we urge the Commission to provide flexibility for advisers to maintain personal securities transaction records either electronically or on paper.
With respect to the other record-keeping provisions in general, we applaud the Commission for simplifying rules 204-2(a)(12) and (13). The new provisions are written more clearly and will be easier for advisers to comprehend.
III. The ICAA Requests Clarification of the Provision Regarding Access to Nonpublic Information
We also request that the Commission clarify the proposed requirement to "prevent access to material nonpublic information about the adviser's securities recommendations, and client securities holdings and transactions, unless those individuals need the information to perform their duties."6 Although we believe that this provision is intended to control confidential information from being disseminated outside the firm, we are concerned that the wording of this "need to know" standard may be construed to apply to employees within the advisory firm. We ask that the Commission clarify that this requirement only applies to the dissemination of material confidential information outside the firm. Internal restrictions are not necessary: long-standing fiduciary principles already prohibit firms and all of their supervised persons from revealing client confidences and firm's codes of ethics must be designed to prevent supervised persons from taking advantage of any nonpublic client information.
The proposed rule would permit the adviser to provide necessary information to persons providing services to the adviser or the account, such as brokers, accountants, custodians, and fund transfer agents, as well as to clients. Additionally, we believe the rule should permit disclosure of fund or model portfolio holdings information to prospective clients and their consultants, who routinely request such information in order to select an adviser. Similarly, the rule should permit disclosure of portfolio holdings information to a new client's transition manager. In such situations, an adviser could either provide stale, or non-material, portfolio holdings, or provide more up-to-date information subject to a confidentiality agreement.
IV. The ICAA Supports Flexible Standards for Codes of Ethics
We note that the proposal would require an adviser's code of ethics to include provisions requiring supervised persons to comply with "applicable federal securities laws."7 We ask the Commission to clarify that the scope of this obligation extends only to the Investment Advisers Act for investment advisers that do not manage investment companies registered under the Investment Company Act of 1940. This interpretation is consistent with newly adopted Investment Advisers Act Rule 206(4)-7, which requires investment advisers to adopt formal compliance programs.
Additionally, in several instances the proposal requests comment as to whether the proposed rule should be more restrictive or specific. We believe that the rule as proposed has struck the right balance, that is, a flexible approach that allows the diverse members of the advisory profession to tailor their codes of ethics to accommodate their particular size and business activity. We support this flexible approach.
For example, it is not necessary or appropriate for the proposed rule to: (1) specify particular standards of conduct; (2) require segregation of computer files containing nonpublic information; (3) require the adviser to include the advisers' insider trading policies and procedures in the code of ethics rather than in a separate policy or compliance manual; (4) require by law an adviser's code to include various current best practices (although we encourage advisers to consider adopting the ICAA's best practice recommendations); or (5) require advisers to document the factors they considered in developing their procedures.
V. The Rule Should Exempt Non-U.S. Government Securities
The proposal exempts several securities from the reporting requirements, including: (1) money market instruments; (2) U.S. government securities; and (3) mutual funds for which the adviser or its control affiliate does not act as adviser or principal underwriter. Given the global nature of many investment advisory firms, the ICAA recommends that the exemption be extended to all government securities, including non-U.S. government securities. Similar to U.S. government securities, non-U.S. government securities "appear to present little opportunity for the type of improper trading that the access person reports are designed to uncover."8
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We enthusiastically support the Commission's goal of seeking to develop a rule that will encourage the investment advisory profession to renew its commitment to fiduciary standards. We would be pleased to work with the Commission to implement these initiatives and appreciate the opportunity to comment on the effects of the current proposal. Please do not hesitate to contact the undersigned or ICAA General Counsel Karen L. Barr to discuss any questions the Commission or its staff may have with respect to our comments.