In February 2015, the SEC’s Division of Investment Management issued guidance to the public with respect to the conflict of interest that arises when individuals and firms doing business, or hoping to do business, with a fund or investment adviser provide gifts, entertainment, favors or other forms of consideration to employees of the fund or adviser.
Section 17(e)(1) of the 1940 Act prohibits affiliated persons of a fund, such as a fund’s investment adviser and its personnel, from accepting any sort of compensation for the purchase or sale of property to or for the fund. This conflict is commonly addressed in investment advisers’ Codes of Ethics under the Investment Advisers Act of 1940 and by funds under the Investment Company Act of 1940. The prohibition in section 17(e)(1) generally applies when advisory personnel accept from any source any compensation (other than regular salary or wages) “for the purchase or sale of any property to or for the fund”.
The Guidance reminds investment advisers that “the receipt of gifts or entertainment by fund advisory personnel, among others, may violate section 17(e)(1) of the 1940 Act and, in the staff’s view, should be addressed by funds’ compliance policies and procedures under rule 38a-1. The particular policies and procedures concerning the receipt of gifts or entertainment that might be appropriate would depend on the nature of the adviser’s business, among other considerations.”
The Guidance noted that there are several ways that funds and advisers can ensure adequate policies and procedures are in place to prevent violation of SEC rules and regulations. Some firms employ a blanket prohibition on the receipt of gifts and entertainment, while others opt to employ a pre-clearance policy with thresholds clearly delineated for the acceptance of gifts or entertainment to assess whether a conflict is present. Firms should be sure to plainly and sufficiently explain the internal policies and procedures to employees during their annual compliance training and the importance of adhering to such guidelines.
Our Perspective
While this Guidance expressly cites section 17(e)(1) and is aimed at mutual funds, the same concept of gifts and entertainment creating a conflict of interest applies equally to private fund managers as noted in Rule 204A-1 under the Advisers Act which requires codes of ethics for investment advisers. Rule 206(4)-7 also requires advisers registered with the Commission to adopt and implement written policies and procedures to prevent violations of the Advisers Act by the adviser or any of its supervised persons. In our experience, many investment advisers have adopted limits on gifts and entertainment that mirror the limits imposed on broker dealers by FINRA for ease of use. We note that FINRA recently issued a rule review report that included possible increases to the gifts limits, so we may expect changes to the limits that broker dealers are currently subject to.
SEC3 can assist your firm in creating, implementing and maintaining your policies and procedures. For further information, please contact your SEC3 representative or contact us at info@seccc.com.
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