By Electronic Mail
March 15, 2004
Jonathan G. Katz, Secretary
Re: File No. S7-04-04
Dear Mr. Katz:
Thank you for giving us the opportunity to comment on File No. S7-04-04, Proposed Rule: Investment Adviser Codes of Ethics ("Proposing Release").
We understand and appreciate the need for all federally regulated investment advisers to have adequate procedures in place for the protection of the investing public. We note that the Commission has recently adopted rules requiring all investment advisers to adopt and implement written policies and procedures in Release No. IA-2204 Compliance Programs of Investment Companies and Investment Advisers (December 24, 2003). It is noteworthy that in announcing the final rules relating to investment adviser procedures, the Commission stated:
Rule 206(4)-7 does not enumerate specific elements that advisers must include in their policies and procedures. (footnote omitted) Commenters agreed with our assessment that funds and advisers are too varied in their operations for the rules to impose a single set of universally applicable required elements. Each adviser should adopt policies and procedures that take into consideration the nature of that firm's operations.
That rule, effective October 2004, is, indeed, flexible and requires that investment advisers "(a)dopt and implement written policies and procedures reasonably designed to prevent violation, by (the investment adviser) and (its) supervised persons, of the Act and the rules the Commission has adopted under the Act…." The adopting release suggests a number of areas that should be addressed, depending on the nature of the business of the investment adviser, but does not mandate specific procedures. This made logical sense given the variety of investment adviser operations.
Now, the Commission is proposing that all investment advisers adopt a Code of Ethics ("Code"). In the proposed rule, the Commission is requiring specific procedures to be implemented that it had declined to mandate in actual compliance procedures. While a Code of Ethics might make sense in framing the general ethical considerations by which a particular investment adviser might conduct its business, it is questionable whether such a Code should, in essence, take the place of actual compliance procedures.
Further, for the reasons set forth below, the proposed Code and other rule amendments are unclear and would impose substantial burdens on many investment advisers that would outweigh the anticipated benefits.
The Term "Access Persons" is Unclear
The proposed rules place a number of restrictions and/or requirements on "access persons." The rule defines an "access person" to include any supervised person who "has access to nonpublic information regarding any clients' (sic) purchase or sale of securities," or who is "involved in making securities recommendations to clients, or has access to such recommendations that are nonpublic." This definition is unclear and for many investment advisers could include a large number of persons.
PRIMEVEST Financial Services, like many investment advisers, is a registered broker-dealer as well as a registered investment adviser. As such, a large number of our registered representatives are also investment adviser representatives ("IAR"s). These IARs regularly make recommendations to their advisory clients. As a rule, PRIMEVEST Financial Services does not make such recommendations from a central location. A strict interpretation of the definition would mean that not only would each of our IARs be considered an "access person," but also all of his/her office personnel and administrative assistants. The rule, as written, could also be interpreted to include all of the broker-dealer operations personnel who effect the trades for advisory clients. While these persons may not know of the recommendations being made by an IAR, they certainly have access to customer purchase and sale information. Although the Proposing Release states that access persons would not include employees of "affiliated organizations such as broker-dealers," it does not clarify that this exemption applies in the case of dual registrants. Further, even if one reads the explanatory material in the proposing release to exclude our brokerage personnel who process the trades, the rule itself includes no such exception.
While we understand that the proposed rules are modeled after Rule 17j-1 of the Investment Company Act, many of the considerations in that rule do not apply to investment adviser/broker-dealers such as PRIMEVEST Financial Services. Further, even Rule 17j-1 does not include such an expansive definition of "access person." Greater clarification in the rule of the term "access person" is necessary.
The Commission is requesting comment on whether the term "access person" should include employees of companies that control or are controlled by the adviser. We believe that extension of the definition in this manner would be unworkable. We are owned by a large financial institution. Theoretically, for us such an expansion of the term could include upwards of 10,000 persons, almost none of whom would be in the position to know or take advantage of any of our investment adviser recommendations or client information.
The Reporting Requirements of the Rule are Overbroad and Unclear
The proposed Code would require "access persons" to submit reports of current holdings and transaction reports. Depending on the definition of "access person," this requirement could be extremely burdensome and of questionable value.1 If the term "access person" includes the individuals described above, this requirement will result in firms, such as ours, receiving such a large number of records that meaningful review and supervision will become virtually impossible. We note that the transaction reports will not be required where trade confirmations would duplicate information required by the rule. However, trade confirmations do not always include all of the information required in the proposed transaction report. Further clarification in the rule in this regard is necessary.
Similarly, it is not clear why, in addition to transaction reports, the proposed Code would require holdings reports. It is also not clear whether the holdings reports which are proposed to be required on at least an annual basis, must contain information in addition to trade confirmations, if trade confirmations are deemed sufficient for transaction reports. Should the Commission determine to require a holdings report, it is requested that clarification in any adopting release be made as to when such reports would be required of existing personnel.
The Commission is proposing to amend current Rule 204-2 to apparently incorporate the requirements of the Code of Ethics. It would appear more appropriate to include the proposed Code provisions in the books and records rule than in a Code of Ethics.
Pre-Clearance of Certain Transactions
The proposed Code would require that "access persons" obtain pre-approval of purchases, directly or indirectly, in an initial public offering or private placement offering. The release explains that this provision is to prevent investment adviser employees from misappropriating an investment opportunity that should first be offered to eligible clients. However, this provision is of questionable value for investment advisers who do not advise a fund that may also invest in such securities or to dual registrants that do not participate in the underwriting of securities. Further, for those dual registrants that do participate in underwritings, such a prohibition should not include securities that are not underwritten by the firm. We believe that it should be left to the individual investment advisers to determine if such a restriction makes sense based on the nature of the business conducted.
Books and Records
It is troublesome that the proposed amendments to Rule 204-2 of the Advisers Act would require personal transaction reports to be maintained electronically in an accessible computer database. For many firms, such as ours, this would require development of a computer database that currently does not exist resulting in substantial programming and possible inputting costs. Maintenance of such records should be left to the investment adviser to determined based on existing resources. The Commission notes in the Proposing Release its belief that "all but the smallest firms currently use client portfolio management software platforms that could easily be used by access persons to report their holding and transactions…." However, in the case of firms such as ours that are dual registrants with independent contractor representatives, there is no central platform in use for the investment adviser entity, nor do all of our IARs use such software. Those IARs that do use portfolio management software have the ability to choose among a number of available programs. Further, as currently defined, the term "access persons" certainly would include a number of individuals who have no need to use portfolio management software because they do not manage customer accounts. There would be substantial costs associated with providing these individuals with software solely for the purpose of reporting their personal transactions.
We note the Commission's statement that added costs for compliance with the proposed rule may be passed on to clients in the form of advisory fees. We question the benefit of these added costs to the investing public by requiring electronic maintenance of the records.
Amendment to Form ADV
We do not believe that the rule should require that a description of the Code be included in the firm's Form ADV. Clients of brokerage firms and investment advisers currently do not have access to firms' written supervisory and compliance procedures. Inasmuch as the Code, as proposed, is essentially a supervisory procedures document, there appears to be little reason to provide it to clients. Should the Code take on a more generic nature describing a firm's general ethical requirements, it would be appropriate for clients to have access to such a document. In this case, placing the Code on a firm's web site and referencing that web site should suffice. Requiring yet more information to be included in a firm's Form ADV might detract from other, more important information.
While the proposed Code permits supervised persons to report violations to the chief compliance officer or "other designated persons," it requires that holdings and transaction reports be made to the chief compliance officer. An investment adviser should be permitted to designate a person other than the chief compliance officer to receive such reports and be charged with supervision of them. In the securities arena, there is often a distinction between a compliance officer and a supervisor and dual registrants should be free to continue to keep these functions separate. This distinction gives a compliance officer greater ability to advise management without apparent conflicts of interest.
The Commission requests comment on whether rules addressing insider trading should be included in the Code. For dual registrants, there are already provisions in the Securities and Exchange Act of 1934 prohibiting insider trading. There seems little purpose in duplicating a rule in a Code of Ethics.
Similarly, proposed Rule 204A-1(a)(2) would require "provisions requiring (the investment adviser's) supervised persons to comply with applicable securities laws." Our "supervised persons" are already required to comply with applicable securities laws and there seems little reason to mandate such a statement in a Code of Ethics.
For the reasons set forth above, it is respectfully submitted that the proposed Code be substantially amended to differentiate between compliance and supervisory procedures and ethical considerations. Having rightly decided to decline to mandate specific procedures in investment advisory compliance programs, the Commission should not set out specific procedures in a "Code of Ethics."
It is further requested that substantial clarification of the issues above be made and that any such rule implementation be given more flexibility for entities that are dual registrants.