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Advisers Should Review Their Employment Agreements and Policies for Restrictions on Employee Reporting to SEC

SEC Rule 21F-17, spun out of Dodd-Frank, prohibits any person or entity under SEC jurisdiction from taking “any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement.” In 2015-16, the SEC brought several enforcement actions against investment adviser firms whose employment agreements (e.g., offer letters, confidentiality agreements, and severance agreements) either required the employee to waive his or her whistleblower rights or more subtlety impeded that ability, e.g., by stating that an employee must report a possible violation internally to compliance or management before reporting out to the SEC.

Since those actions, OCIE followed up with a risk alert stating that it will review advisers’ “compliance manuals, codes of ethics, employment agreements, and severance agreements to determine whether provisions in those documents pertaining to confidentiality of information and reporting of possible securities law violations may raise concerns under Rule 21F-17.” This means that no internal document is safe from  review for what the SEC may deem restrictive reporting language. Accordingly, advisers should take a second look at all employment agreements as well as internal policies (e.g., Code of Ethics) containing confidentiality language. Those sections should clearly provide that an employee may directly report out to the SEC (without prior notice to the firm) if the employee believes that there is a possible securities law violation.


Investment Advisers Should Review Their Codes of Ethics For Conformity with SEC Fiduciary Interpretation

On June 5, 2019, the SEC approved a package of rule-making and interpretations designed to harmonize (or bring closer) the standards of conduct for brokers (BDs) and investment advisers (RIAs). The lion share of attention has been focused on the elimination, effective June 30, 2020, of the “suitability” standard governing retail brokerage accounts in favor of a version of the “best interests” standard. There has been less attention, however, paid to the SEC’s explicit guidance and parsing of RIAs’ fiduciary duties to clients, set forth in the SEC’s Fiduciary Interpretation. Because that interpretation went into effect on July 12, 2019, Advisers who have not reviewed their internal and disclosure documents for conformity should do so immediately or risk OCIE deficiencies or worse.

SEC Rule 204A-1 requires every RIA to establish, maintain and enforce a written code of ethics that contains a minimum set of standards, including “[a] standard (or standards) of business conduct that the adviser requires of each supervised person, which standard must reflect the adviser’s fiduciary obligations and those of its supervised persons.” Under the SEC’s Fiduciary Interpretation (and case law), all RIAs have the following duties: (1) a duty of care, and (2) a duty of loyalty.

The Interpretation goes on to detail those duties. For example, the duty of care requires the adviser to: (1) provide advice that is in the best interest of the client, (2) seek best execution of a client’s transactions, and (3) provide advice and monitoring over the course of the relationship. To act in the client’s best interest, an adviser must have both: (a) a reasonable understanding of the client’s objectives, and (b) a reasonable belief that the advice it provides is in the best interest of the client based on the client’s objectives.

The above items are just a small part of the important interpretive guidance in the Fiduciary Interpretation. RIAs should review their existing codes of ethics and other documents, and, where appropriate, make changes to conform to the new guidance.

Here is a link to the June 5, 2019 SEC Release.

Click to access ia-5248.pdf