Publications: Articles Authored by Julius J. Brecht

Investment Adviser Code of Ethics
By Julius J. Brecht [1]
For The Alaska Journal of Commerce

The Securities and Exchange Commission recently adopted a final rule requiring certain investment advisers each to have a written code of ethics (Rule 204A-1). The rule became effective August 31, 2004, and advisers must comply with it as of January 7, 2005.

In the event you have, or contemplate seeking out, an investment adviser, how does this rule affect your relationship to the adviser? What might you expect in the way of changes as compared to past conduct of the adviser?

The new rule applies to investment advisers registered under the federal Investment Advisers Act of 1940 ("Advisers Act"). It requires an adviser to adopt a written code of ethics applying to the adviser and the adviser's supervised persons. At a minimum, the code must include the following:

The rule defines an "access person" as a supervised person who has access to nonpublic information regarding any clients' purchase or sale of securities, or nonpublic information regarding the portfolio holdings of a reportable fund. In the alternative, the term is also defined as a supervised person who is involved in making securities recommendations to clients or who has access to such recommendations that are nonpublic.

The rule further includes in the definition, where providing investment advice is the adviser's primary business, a presumption that all of the directors, officers and partners of the adviser are access persons.

Under the rule, a "reportable fund" is defined as a fund for which the adviser serves as such under the Advisers Act. In the alternative, it is also defined as a fund whose investment adviser or principal underwriter controls, is controlled by, or is under common control with, the adviser.

The new rule sets forth specific requirements as to the content of access person transaction and holding reports and the timeliness of filing of them with the adviser. It also sets forth certain limited exceptions to the reporting requirements, including those applying to an adviser having only one access person, i.e., the adviser.

The new rule further requires that a code provide that an access person must obtain the adviser's approval before the person directly or indirectly acquires beneficial ownership in any security in an initial public offering or in a limited offering. The term "initial public offering" is defined in the rule as a registered offering under the federal Securities Act of 1933 where the issuer, immediately before the registration, was not subject to the reporting requirements of the federal Securities Exchange Act of 1934. The term "limited offering" is defined in the rule as an offering exempt from registration under specific private offering and investor exemptions provided in the 1933 act.

While the new rule requires the code to set forth a standard of business conduct, it does not require the adviser to adopt a specific writing of that standard. Furthermore, the new rule requires that the standard chosen by the adviser must reflect the adviser's fiduciary obligations and those of its supervised persons.

The release on the new rule cautions an adviser in crafting the adviser's code to take great care and thought in its preparation. The release further states that the code should be more than a compliance manual. That is, the code should express the adviser's ideals for ethical conduct premised upon fundamental principles of openness, integrity, honesty and trust.

The release proffers as guidance in fashioning a code that it convey to employees the value the adviser places on ethical conduct. The release urges that the code challenge those supervised to live up to the letter of the law as well as the ideals of the adviser.

The Advisers Act expressly provides that an adviser regulated as an investment adviser in a state in which it maintains its principal office and place of business is not to register under the act, with limited exception. The exception is when either the adviser has assets under management of not less than $25 million (or otherwise as the SEC may, from time to time, set) or is an adviser to an investment company under other provisions of that act.

If your investment adviser is registered under the Advisers Act, the adviser is subject to the new rule and, by the end of this year, should have a code of ethics in place. However, an adviser who advises certain investment companies under the federal Investment Company Act of 1940, e.g., mutual funds, is already subject to rules adopted under that act requiring a code of ethics similar to that required under the new rule.

Under the procedures of the new rule, an adviser is required to provide a copy of the code upon request of a client.

Should your adviser not be registered under the Advisers Act based upon the dollar amount of assets under management, that adviser is subject to state regulation as an investment adviser. In this instance, the requirement for a code of ethics under the new rule does not directly apply. However, the state in which the adviser is regulated may have separate rules pertaining to a code of ethics and the relationship between the adviser and the client.

More specifically, investment advisers subject to state law in Alaska are regulated under the Alaska Securities Act. Neither that act nor regulations adopted under it at present specifically require an adviser to adopt a code of ethics. However, the act prohibits an adviser from engaging in fraudulent, dishonest or unethical practices.

Nevertheless, an adviser subject to the Alaska Securities Act may wish seriously to consider adopting such a code as a statement of the adviser's resolve to treat clients in an ethical manner.

In summary, if you contemplate using an investment adviser or presently retain one, ask to see a copy of the adviser's code and any amendments to it. Ask also whether the access person with whom you deal (or are to deal) has filed any transaction or holding reports pertaining to securities which are in, or which you contemplate for, or which the access person has recommended for, your portfolio. In this way you will better understand, based upon the responses received, the credibility of the advice given by the adviser and how well the adviser is working for your best interests.

[1] Mr. Brecht is an attorney in private practice and shareholder with the law firm of Wohlforth, Johnson, Brecht, Cartledge & Brooking, A Professional Corporation, with offices in Anchorage, Alaska. Mr. Brecht's concentration of practice is in state and federal securities law and corporate and finance law. The content of this article was not prepared as, and must not be construed as, legal or investment advice to anyone. He may be reached at .

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