October 30, 2000

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Personal Trading: Keeping Track of the Paperwork

Personal trading has frequently been on the lips of SEC regulators this year, and the warnings have been stern. Advisers need to be careful that they can prove their personnel are not breaking any rules when they trade their own securities.

That message was underscored this summer by the SEC's Cynthia Fornelli in a June 5 speech on the role of compliance staff. She warned adviser compliance staff to be "ever vigilant" and not to let violations occur on their watch. The SEC wants to see that firms have policies to prevent insider trading or other personal trading violations, preclearance procedures, lists-of access persons, their personal transaction reports, and reports of preclearance of trades, she said.

For fund advisers, that means adhering to Rule 17J-1 of the Investment Company Act, which contained provisions that went into effect this year. And for independent advisers, that means looking to 204-2 (13) of the Investment Advisers Act.

The provisions in the Investment Advisers Act state that advisers need a record of the title and amount of the security a staff person purchased or sold, the price, and the name of the broker, dealer or bank that effected the transaction. The transaction must be recorded by the end of the quarter.

However, that language leaves out many details of record keeping, such as how long to keep such records, and where to store them, according to Richard A. Levan, of Levan Friedman, LLP and a former SEC enforcement official. "There is a tremendous gulf between what is currently required and what is a best or even acceptable practice," Levan told IA Week. "Prohibitions are almost bare bones."

Levan recommends that independent advisers keep records for two years on the premises and three years thereafter in a readily acceptable place.

"You want to have your ducks in a line," Levan said. Advisers should keep records up-to-date and have them ready if and when a regulator appears, he added. That can make or break an enforcement case.

"The tone is set for an examination at the outset," he said. "One easy way to appear in control is to have your records organized and available for an inspection."

An adviser should have a dedicated area such as a filing cabinet under the control of the appropriate compliance person, he said. In cases where a company or the SEC is investigating a possible case of insider trading, a compliance officer may want to have those records under lock and key, he said. "It's not beyond people to find and dispose of documents," he said.

Documents can be kept on a reliable computer system as well, he noted, although those records can be more difficult to secure.

According to Levan, independent advisers should consider keeping records of:

The preclearance of personal trades for covered personnel.
A staff person's written certification when they begin employment that they have disclosed all of their current securities holdings and that they will or have complied with the adviser's personal trading policies.
Written policies regarding personal trades. "It creates a defense for the adviser in the event misconduct occurs and a charge of failure to supervise is leveled," Levan said.
Black out periods for personal trading policies, depending on size of trades relative to the "public float" of the securities.
Restrictions on purchase of initial public offering (IPO) shares.
Records reflecting that adviser staff have "scrutinized and responded to any questionable trading."

For fund advisers, Rule 17J -1 under the Investment Company Act requires proof that compliance staff have worked hard to prevent personal trading violations, according to Mitch Kraskin, president of Compliance Tools, Inc., which produces a software package fund advisers can use to monitor personal trading.

Since amendments to the rule went into effect this spring, he has gained clients. He has 40 now, and anticipates gaining another 10 by the end of the year.

Fund advisers with more than 30 employees need to seriously consider using a computer to handle compliance issues, especially personal record keeping issues, he said. "If you have a high volume and have not automated that somehow, you're not going to satisfy the regulators," he said.

His software keeps track of what. He sees as necessary paperwork, including:

Employee trade requests by employees;
Preclearance of trades;
Trade confirmations from brokers such as Charles Schwab or Fidelity;
Lists of holdings for each employee;
Quarterly transactions; and
Annual holding reports.

"Compliance departments have to start thinking in a more automated fashion," he said. "Often [they] lag in that a bit. They're oriented to having documents and lots of paper. [But] a lot of them are saying now it is time to automate."