[Federal Register Volume 69, Number 17 (Tuesday, January 27, 2004)]
[Proposed Rules]
[Pages 4040-4056]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-1669]



[[Page 4039]]

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Part V





Securities and Exchange Commission





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17 CFR Parts 270, 275 and 279



Investment Adviser Codes of Ethics; Proposed Rule

  Federal Register / Vol. 69, No. 17 / Tuesday, January 27, 2004 / 
Proposed Rules  

[[Page 4040]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270, 275 and 279

[Release Nos. IA-2209, IC-26337; File No. S7-04-04]
RIN 3235-AJ08


Investment Adviser Codes of Ethics

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Commission is proposing for comment a new rule and related 
rule amendments under the Investment Advisers Act of 1940 that would 
require registered advisers to adopt codes of ethics. The codes of 
ethics would set forth standards of conduct expected of advisory 
personnel, safeguard material nonpublic information about client 
transactions, and address conflicts that arise from personal trading by 
advisory personnel. Among other things, the rule would require 
advisers' supervised persons to report their personal securities 
transactions, including transactions in any mutual fund managed by the 
adviser. The rule and rule amendments are designed to promote 
compliance with fiduciary standards by advisers and their personnel.

DATES: Comments must be received on or before March 15, 2004.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by hard copy or e-mail, but not by 
both methods.
    Comments sent by hardcopy should be submitted in triplicate to 
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 
Fifth Street, NW., Washington, DC 20549-0609. Comments may instead be 
submitted electronically at the following e-mail address: [email protected]. All comment letters should refer to File No. S7-04-
04; if e-mail is used, this file number should be included on the 
subject line. Comment letters will be available for public inspection 
and copying in the Commission's Public Reference Room, 450 Fifth 
Street, NW., Washington, DC 20549. Electronically submitted comment 
letters also will be posted on the Commission's Internet Web site 
(http://www.sec.gov).\1\
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    \1\ We do not edit personal or identifying information, such as 
names or e-mail addresses, from electronic submissions. Submit only 
information you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Robert L. Tuleya, Attorney-Adviser, or 
Jennifer Sawin, Assistant Director, at 202-942-0719, Office of 
Investment Adviser Regulation, Division of Investment Management, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
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DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'' or ``SEC'') is requesting public comment on proposed 
rule 204A-1 [17 CFR 275.204A-1] under the Investment Advisers Act of 
1940 [15 U.S.C. 80b] (``Advisers Act'' or ``Act'') and proposed 
amendments to rule 204-2 [17 CFR 275.204-2] and Form ADV [17 CFR 279.1] 
under the Advisers Act and to rule 17j-1 [17 CFR 270.17j-1] under the 
Investment Company Act of 1940 [15 U.S.C. 80a] (``Company Act'').\2\

    \2\ Unless otherwise noted, when we refer to rule 17j-1 or any 
paragraph of the rule, we are referring to 17 CFR 270.17j-1 of the 
Code of Federal Regulations in which the rule is published; and when 
we refer to rule 204-2 or any paragraph of the rule, we are 
referring to 17 CFR 275.204-2 of the Code of Federal Regulations in 
which the rule is published.

I. Background
II. Discussion
    A. Standards of Conduct and Compliance with Laws
    B. Protection of Material Nonpublic Information
    C. Personal Securities Trading
    1. Personal Trading Procedures
    2. Persons Subject to the Reporting Requirements
    3. Reportable Securities and Beneficial Ownership
    4. Reporting of Investment Company Shares
    5. Initial and Annual Holdings Reports
    6. Periodic Transactions Reports
    7. Duplicate Broker Confirms and Statements
    D. Initial Public Offerings and Private Placements
    E. Reporting of Violations
    F. Acknowledged Receipt of Code of Ethics
    G. Other Code of Ethics Provisions
    H. Adviser Review and Enforcement
    I. Recordkeeping
    J. Amendment to Form ADV
    K. Investment Company Advisers
III. General Request for Comment
IV. Cost-Benefit Analysis
V. Effects on Competition, Efficiency and Capital Formation
VI. Paperwork Reduction Act
VII. Initial Regulatory Flexibility Analysis
VIII. Statutory Authority
Text of Proposed Rules and Form Amendments

I. Background

    Advisers are fiduciaries that owe their clients a duty of undivided 
loyalty.\3\ The Commission has become concerned that the obligations 
attendant to this duty were lost on the growing number of advisers we 
see each month on our enforcement calendar. Recently, we have brought 
actions against advisory personnel who divulged portfolio information 
about their mutual funds, permitting favored clients to exploit the 
funds' investors,\4\ and against an adviser we allege failed to take 
adequate steps to detect and deter its portfolio managers' short-term 
trading in affiliated funds.\5\ There have been too many other cases in 
which we have had to bring enforcement actions against advisers or 
their personnel alleging violations of their fiduciary obligations to 
their clients.\6\
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    \3\ SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 
181-82 (1963).
    \4\ See, e.g., Gary L. Pilgrim, Harold J. Baxter, and Pilgrim 
Baxter & Associates, Ltd, Litigation Release No. 18474 (Nov. 20, 
2003) (alleged disclosure of nonpublic fund portfolio information by 
adviser's principal permitted certain investors to exploit 
mispricing of the mutual fund's net asset value); In the Matter of 
Alliance Capital Management, L.P., Investment Advisers Act Release 
No. 2205 (Dec. 18, 2003) (disclosure of material nonpublic 
information about certain mutual fund portfolio holdings permitted 
favored client to profit from market timing).
    \5\ In the Matter of Putnam Investment Management LLC, 
Investment Advisers Act Release No. 2192 (Nov. 13, 2003).
    \6\ Other recent enforcement actions against advisers and 
advisory personnel include In the Matter of Paul Joseph Sheehan dba 
Paul J. Sheehan & Associates, Investment Advisers Act Release No. 
2207 (Dec. 29, 2003) (investment adviser alleged to have ``cherry 
picked'' millions of dollars of profitable trades for his own 
accounts); In the Matter of Robert T. Littell and Wilfred Meckel, 
Investment Advisers Act Release No. 2203 (Dec. 15, 2003) (portfolio 
manager of hedge fund made misrepresentations to investors and 
potential investors concerning performance, management oversight, 
and risk management practices); SEC v. Heartland Advisors et al., 
Litigation Release No. 18505 (Dec. 12, 2003) (adviser and employees 
allegedly engaged in fraudulent pricing, misrepresentation, insider 
trading and other violations of fiduciary duties); In the Matter of 
Zion Capital Management LLC and Ricky A. Lang, Investment Advisers 
Act Release No. 2200 (Dec. 11, 2003) (in allocating securities 
trades, investment adviser favored an account in which its principal 
had a financial interest over account of client); In the Matter of 
George F. Fahey, Investment Advisers Act Release No. 2196 (Nov. 24, 
2003) (president of investment adviser made misrepresentations to 
clients as to risk of investment strategy and value of investments); 
In the Matter of Wendell D. Belden, Investment Advisers Act Release 
No. 2191 (Nov. 6, 2003) (associate of adviser defrauded clients by 
misleading them about their investment options and the security of 
their invested principal and by investing their money in a manner 
calculated to enrich himself at their expense); In the Matter of 
Marshall E. Melton and Asset Management & Research, Inc., Investment 
Advisers Act Release No. 2151 (Jul. 25, 2003) (investment adviser 
made material misrepresentations to its clients to induce them to 
invest their funds in limited liability companies controlled by 
adviser's principal).
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    In order to educate their employees, protect the reputation of the 
firm, and guard against violating the securities laws, many advisers 
have adopted codes of ethics, establishing standards of conduct to 
which their employees must adhere. Codes of ethics often remind 
employees that they are in a position of trust, which requires them to 
act at all

[[Page 4041]]

times with the utmost integrity. Many impose ethical obligations that 
exceed those imposed by law, for example, requiring personnel to avoid 
even the appearance of a conflict with clients. Codes of ethics also 
establish procedures for employees to follow so that the adviser may 
determine whether the employee is complying with the firm's principles. 
In addition, the procedures laid out in a code of ethics can offer 
employees guidance and certainty as to whether certain actions are, or 
are not, permissible. Codes of ethics ultimately protect the interests 
of both clients and advisers by demanding that advisory personnel 
perform their duties with complete propriety and do not take advantage 
of their position.
    Recently we adopted rules designed to deter and detect violations 
of the Act,\7\ proposed to require better disclosures by mutual 
funds,\8\ and proposed safeguards against late trading.\9\ Today we are 
proposing a rule under the Investment Advisers Act of 1940 requiring 
each adviser registered with us to adopt and enforce a code of ethics 
applicable to its supervised persons. The rule is designed to prevent 
fraud by reinforcing fiduciary principles that must govern the conduct 
of advisory firms and their personnel.
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    \7\ Compliance Programs of Investment Companies and Investment 
Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003) 
[68 FR 74714 (Dec. 24, 2003)] (``Compliance Adopting Release'').
    \8\ Disclosure Regarding Market Timing and Selective Disclosure 
of Portfolio Holdings, Investment Company Act Release No. 26287 
(Dec. 11, 2003) [68 FR 70402 (Dec. 17, 2003)].
    \9\ Amendments to Rules Governing Pricing of Mutual Fund Shares, 
Investment Company Act Release No. 26288 (Dec. 11, 2003) [68 FR 
70388 (Dec. 17, 2003)].
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II. Discussion

    The Commission is proposing for comment new rule 204A-1, and 
related rule amendments, that would require advisers to adopt codes of 
ethics. Each adviser's code of ethics would be required to (i) set 
forth standards of conduct expected of advisory personnel (including 
compliance with the federal securities laws), (ii) safeguard material 
nonpublic information about client transactions, and (iii) require 
advisers' ``access persons'' to report their personal securities 
transactions, including transactions in any mutual fund managed by the 
adviser. The code of ethics would also have to require access persons 
to obtain the adviser's approval before investing in an initial public 
offering (``IPO'') or private placement. The code of ethics would have 
to require prompt reporting, to the adviser's chief compliance officer 
or another person designated in the code of ethics, of any violations 
of the code.\10\ Finally, the code of ethics would have to require the 
adviser to provide each supervised person with a copy of the code and 
any amendments, and require the supervised persons to acknowledge, in 
writing, their receipt of these copies.
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    \10\ Congress recently required public companies to disclose 
whether (and if not, why not) they have adopted codes of ethics for 
their senior financial officers. ``Codes of ethics'' in section 406 
of the Sarbanes-Oxley Act of 2002 are standards reasonably necessary 
to promote honest and ethical conduct, compliance with regulations, 
and full and fair disclosure. Pub. L. 107-204, 116 Stat. 745 (2002). 
The Commission's rules adopted under section 406 also refer to 
standards to promote avoidance of conflicts of interest as well as 
prompt reporting of any violations of the code of ethics. 17 CFR 
229.406. Investment advisers that are themselves public companies 
are subject to the Sarbanes-Oxley Act and the Commission's rules 
under section 406.
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    The rule would apply to each adviser registered with the 
Commission, although as we discuss below firms with only one employee 
would be exempt from some provisions.\11\ We have drafted the rule 
broadly so that each adviser will be able to develop a code that takes 
into consideration the nature of its business, as it does when drafting 
its procedures under section 204A of the Act.\12\
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    \11\ The rule would thus not apply to an adviser not registered 
with us in reliance on an exemption in section 203(b) of the Act [15 
U.S.C. 80b-3(b)], nor to an adviser that is registered with state 
authorities and prohibited by section 203A of the Act [15 U.S.C. 
80b-3a] from registering with us.
    \12\ Section 204A of the Advisers Act [15 U.S.C. 80b-4a], 
requires that each adviser take into consideration the nature of its 
business when establishing and enforcing procedures reasonably 
designed to prevent misuse of material nonpublic information by the 
investment adviser or any person associated with the investment 
adviser. See also H.R. Rep. No. 100-910, at 21-22 (Sep. 9, 1988) 
(recognizing that policies and procedures to prevent insider trading 
may reasonably differ among investment advisers, depending on the 
firm's operations, business structure, and the nature and scope of 
its business); Report of the Division of Investment Management, SEC, 
Personal Investment Activities of Investment Company Personnel at 4 
(Sep. 1994) (``PIA Report'') (noting that rule 17j-1 allows funds to 
tailor personal trading restrictions and procedures to the funds' 
circumstances because that flexibility puts the funds in the best 
position to oversee access persons' investment activities).
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    The proposed rule, would not, of course, preclude an adviser from 
adopting a code of ethics covering additional matters. We encourage 
advisers to adopt broader codes, and request comment on whether we 
should require advisers to adopt them. What matters should they 
address?

A. Standards of Conduct and Compliance With Laws

    We propose that each code of ethics set forth a standard of 
business conduct that the adviser requires of all its supervised 
persons.\13\ This standard must reflect the adviser's fiduciary 
obligations and those of its supervised persons, and must require 
compliance with the federal securities laws. These obligations are 
imposed by law, and thus would establish a minimum requirement for a 
code of ethics complying with the rule. Advisers would be free, 
however, to require higher standards such as those we described above.
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    \13\ Proposed rule 204A-1(a)(1).
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    We request comment on these requirements. Is our formulation of the 
business conduct element of the code of ethics appropriate? Should we 
specify a particular standard of conduct that all codes of ethics must 
incorporate? What standard should we adopt? Should the code of ethics 
require supervised persons to comply with all applicable laws and 
regulations, rather than only the federal securities laws?

B. Protection of Material Nonpublic Information

    Tight controls on access to sensitive client information are a 
first line of defense against misuse of that information.\14\ 
Therefore, we also propose that each code of ethics include provisions 
reasonably designed to prevent access to material nonpublic information 
about the adviser's securities recommendations, and client securities 
holdings and transactions, unless those individuals need the 
information to perform their duties.\15\ The proposed rule would 
require advisers to restrict access to client information on a ``need 
to know'' basis, but would not preclude the adviser from providing 
necessary information to persons providing services to the adviser or 
the account, i.e., brokers, accountants, custodians, and fund transfer 
agents.\16\
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    \14\ Section 204A of the Act both requires advisers to establish 
policies to prevent misuse of material nonpublic information, and 
gives us authority to adopt rules requiring advisers to adopt 
specific policies and procedures to prevent nonpublic information 
from being misused.
    \15\ Proposed rule 204A-1(a)(3). We would expect many advisers 
would incorporate, into their code of ethics, their written policies 
and procedures to guard against misuse of material nonpublic 
information required by section 204A.
    \16\ Cf. sections 248.13 and 248.14 of Regulation S-P [17 CFR 
248.13 and 248.14] (permitting financial institutions to share, with 
nonaffiliated third parties, without providing the consumer an opt 
out, information about the consumer in order to permit the third 
party to provide services to the financial institution or to the 
consumer's account).
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    [sbull] Are these criteria adequate? Are there alternative 
formulations we should use?
    [sbull] Some advisers' codes of ethics require that computer files 
containing nonpublic information be identified and segregated. Should 
we require all

[[Page 4042]]

advisers to incorporate this safeguard into their codes of ethics?
    [sbull] Advisers' required procedures under section 204A usually 
contain a summary of the law on insider trading and procedures for 
determining whether information has become public. Should we require 
these to be integrated into the code of ethics?

C. Personal Securities Trading

    Investment advisers and their personnel face inherent conflicts of 
interest when they trade in securities for their own accounts. They 
have access to information about their clients' securities 
transactions, which they can exploit for their own benefit.\17\ In 
several of our enforcement cases involving personal trading, advisers 
profited from ``front-running'' client trades.\18\ More recently, our 
enforcement cases have involved advisory personnel profiting unfairly 
through short-term trading in funds they managed, or alerting friends 
to do likewise.\19\
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    \17\ In most cases, an advisory firm and its personnel have 
access to such information because they have investment discretion 
to effect trades on behalf of their clients, including the 
investment companies (``funds'') that the adviser manages. 
Approximately 80% of the advisers registered with the Commission 
manage client securities portfolios on a discretionary basis, and 
another 10% manage them only on a non-discretionary basis.
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    Misuse of client information violates the adviser's fiduciary duty 
as well as the Act's prohibitions against fraud and other provisions of 
the federal securities laws that prohibit insider trading. See, e.g., 
section 10(b) of the Securities Exchange Act of 1934 [15 U.S.C. 78j] 
and rule 10b-5 thereunder [17 CFR 240.10b-5], section 17(j) of the 
Company Act [15 U.S.C. 80a-17(j)] and rule 17j-1 thereunder, and 
section 206 of the Advisers Act [15 U.S.C. 80b-6]. See also, e.g., In 
the Matter of Gintel Asset Management, Inc., Gintel & Co. LLC, Robert 
M. Gintel, and Stephen G. Stavrides, Investment Advisers Act Release 
No. 2079 (Nov. 8, 2002) (adviser violated rule 17j-1 by permitting 
principal to make repeated personal trades in securities to be acquired 
by fund and other advisory clients; adviser violated section 204A and 
affiliated broker-dealer violated section 15(f) of Securities Exchange 
Act in connection with misuse of material nonpublic information about 
planned trades for client accounts).
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    \18\ See, e.g., In the Matter of Roger W. Honour, Investment 
Advisers Act Release No. 1527 (Sept. 29, 1995). See also SEC v. 
Capital Gains, supra note at 181-82 (``scalping'' operates as a 
fraud or deceit on advisory clients).
    \19\ See supra notes 4 and 5.
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    To prevent the personal securities trading of advisers' personnel 
from harming clients, each adviser's code of ethics would have to 
require personal trading reports from ``access persons'' of the 
adviser. The rule would, however, contain an exception for an adviser 
with only one employee (i.e., the adviser himself); the sole employee 
would not be required to make reports of personal securities 
transactions and holdings, but would be required to maintain records of 
his personal trades and provide them to our examiners upon request.\20\ 
These small advisers would be subject to the other provisions of the 
rule, including the requirements to adopt a code of ethics and 
safeguard material nonpublic client information.
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    \20\ Proposed rule 204A-1(d). These advisers would also be 
excused from pre-clearing investments in IPOs and private 
placements. Id. It would make little sense to require the sole 
employee to make reports to himself or to pre-clear investments with 
himself.
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    [sbull] Are there other advisers we should exempt from provisions 
of the rule?
    Our proposed requirements for reporting of personal securities 
trading are modeled largely on rule 17j-1 under the Company Act, which 
we adopted in 1980.\21\ Rule 17j-1 requires that advisers to investment 
companies have procedures in place to prevent their personnel from 
abusing their access to information about the fund's securities 
trading, and requires ``access persons'' to submit reports periodically 
containing information about their personal securities holdings and 
transactions.\22\ These procedures are an important part of these 
advisers' efforts to deter fraudulent personal trading by their 
personnel.
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    \21\ Prevention of Certain Unlawful Activities With Respect to 
Registered Investment Companies, Investment Company Act Release No. 
11421 (Oct. 31, 1980) [45 FR 73915 (Nov. 7, 1980)] (adopting rule 
17j-1) (``Rule 17j-1 1980 Adopting Release'').
    We have also required advisers registered with us to keep 
records of transactions in which the firm or certain personnel have 
a beneficial ownership interest. Advisers Act rule 204-2(a)(12) and 
(13). As discussed in more detail below, we propose to modify these 
recordkeeping rules.
    \22\ Rule 17j-1(c)(1) and (d) under the Investment Company Act. 
Most investment companies, and therefore most advisers to investment 
companies, must have codes of ethics under rule 17j-1. Money market 
funds and funds that invest only in certain non-covered securities, 
however, are not required to adopt codes of ethics. Rule 17j-
1(c)(1)(i). As of December 10, 2003, approximately 1500 advisers, or 
18-19% of the firms registered with us, reported that they manage 
portfolios for investment companies.
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    We have, however, made a number of changes to better apply the 
provisions on personal securities reporting to the many smaller 
advisory firms registered with us that do not advise an investment 
company. Appendix A to this Release contains a table comparing our 
proposal with rule 17j-1. We request comment on whether the 
differences, the most significant of which we describe below, make 
sense. Are there provisions in rule 17j-1 that we have omitted from 
proposed rule 204A-1 but that should be included? Conversely, are there 
changes we are proposing that should be extended to rule 17j-1? Is 
there a significant need for rule 204A-1 and rule 17j-1 to be as 
uniform as possible--in the event we adopt rule 204A-1 with changes 
from this proposal, should we make parallel changes to rule 17j-1?
    The code of ethics would have to require the adviser's ``access 
persons''--generally, its personnel who have access to nonpublic 
information regarding client securities recommendations, trading and 
holdings--to periodically report their personal securities transactions 
and holdings to the adviser's chief compliance officer.\23\ As 
discussed in more detail below, these reports would allow advisers as 
well as the Commission's examination staff to identify trades or 
patterns of trading by access persons that may be improper.
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    \23\ Proposed rule 204A-1(a)(4).
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1. Personal Trading Procedures
    In order to give advisers flexibility to adopt codes appropriate 
for their businesses, we are not proposing specific provisions 
regarding personal trading, other than pre-clearance of certain 
investments as discussed below. Firms that have already adopted a code 
of ethics, however, commonly include many of the following elements, or 
address the following issues, which we believe all advisers should 
consider in crafting their own procedures for employees' personal 
securities trading.
    [sbull] Prior written approval before access persons can place a 
personal securities transaction (``pre-clearance'').\24\
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    \24\ In some organizations, all personnel must pre-clear all 
trades with the firm's compliance personnel. In other firms, only 
access persons must pre-clear, or only certain types of transactions 
must be pre-cleared. Some advisers have begun using compliance 
software to pre-clear personal trades on an automated basis, rather 
than have compliance personnel process the requests.
    Pre-clearance procedures may also identify who has authority to 
approve a trade request, the length of time an approval is valid, 
and procedures for revoking an approval, as well as procedures for 
verifying post-trade reports or duplicate confirmations against the 
log of pre-clearance approvals.

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[[Page 4043]]

    [sbull] Maintenance of ``restricted lists'' of issuers of 
securities that the advisory firm is analyzing or recommending for 
client transactions, and prohibitions on personal trading in securities 
of those issuers.
    [sbull] ``Blackout periods'' when client securities trades are 
being placed or recommendations are being made and access persons are 
not permitted to place personal securities transactions.\25\
    [sbull] Reminders that investment opportunities must be offered 
first to clients before the adviser or its employees may act on them, 
and procedures to implement this principle.\26\
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    \25\ Advisers may use blackout periods to guard against 
employees trading ahead of clients or on the same day as clients' 
trades are placed. See Roger Honour, supra note 18. Prohibiting 
personal trading at the same time as client trading can also serve 
as a measure to prevent personnel from allocating trades in a manner 
that defrauds clients. See, e.g., In the Matter of Nicholas-
Applegate Capital Management, Investment Advisers Act Release No. 
1741 (Aug. 12, 1998) (adviser's senior trader placed personal trades 
alongside trades for employee plan, allocating profitable trades to 
his personal account and unprofitable ones to the employee plan's 
account); SEC v. Moran, 922 F.Supp. 867 (SDNY 1996) (advisory 
principal allocated shares to his family and personal accounts even 
though additional shares would need to be purchased for client 
accounts on the following day at higher prices). The Commission has 
previously indicated its approval of blackout periods for advisory 
personnel. See Report of the Securities and Exchange Commission on 
the Public Policy Implications of Investment Company Growth (1966) 
(``PPI Report'') at 196 (noting with approval that the staff's 1962-
63 Special Study of the Securities Markets had concluded that all 
investment companies and advisers should have policies precluding 
certain insiders from buying and selling securities at the same time 
as a fund they manage).
    \26\ In several of our enforcement cases involving personal 
trading, advisory personnel took investment opportunities for 
themselves (or for an account in which they had an interest) instead 
of for clients, even where the investment became available only 
because of the client's other securities purchases. See In the 
Matter of Joan Conan, Investment Advisers Act Release No. 1446 
(Sept. 30, 1994); In the Matter of Kemper Financial Services, Inc., 
Investment Advisers Act Release No. 1494 (June 6, 1995).
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    [sbull] Prohibitions or restrictions on ``short-swing'' trading and 
market timing.\27\
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    \27\ Advisers that prohibit short-term trading generally mandate 
disgorgement of any profits if an employee effects a short-term 
trade.
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    [sbull] Requirements to trade only through certain brokers, or 
limitations on the number of brokerage accounts permitted.
    [sbull] Requirements to provide the adviser with duplicate trade 
confirmations and account statements.
    [sbull] Procedures for assigning new securities analyses to 
employees whose personal holdings do not present apparent conflicts of 
interest.\28\
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    \28\ Our proposal to have codes of ethics require initial and 
annual holdings reports would facilitate an adviser's assessment of 
whether an individual's personal securities holdings present a 
conflict of interest.
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    We request comment on whether the rule should require that any of 
the above ``best practice'' procedures regarding personal securities 
trading be in advisers'' codes of ethics.
    [sbull] Are there other common elements or procedures, in addition 
to the above, that all advisers should consider as best practices, and, 
if so, should we include these in our adopting release? Commenters 
favoring additional policies and procedures should give specific 
recommendations.
    [sbull] Should advisers be required to document the factors they 
considered in developing their procedures?
2. Persons Subject to the Reporting Requirements
    Under proposed rule 204A-1, the adviser's code must require certain 
supervised persons, called ``access persons,'' to report their personal 
securities transactions and holdings.\29\ An access person is a 
supervised person who has access to nonpublic information regarding 
clients' purchase or sale of securities, is involved in making 
securities recommendations to clients or who has access to such 
recommendations that are nonpublic.\30\
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    \29\ Proposed rule 204A-1(a)(4). Section 202(a)(25) of the 
Advisers Act [15 U.S.C. 80b-2(a)(25)] defines the term ``supervised 
person.'' An adviser's supervised persons are its partners, 
officers, directors (or other persons occupying a similar status or 
performing similar functions) and employees, as well as any other 
persons who provide advice on behalf of the adviser and are subject 
to the adviser's supervision and control.
    \30\ Proposed rule 204A-1(e)(1). A supervised person who has 
access to nonpublic information regarding the portfolio holdings of 
affiliated mutual funds would also be an access person. See 
discussion infra at Section II.C.4 of this Release.
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    Access persons would include portfolio management personnel.\31\ In 
some organizations, they would also include client service 
representatives who communicate investment advice to clients. These 
employees have information about investment recommendations whose 
effect may not yet be felt in the marketplace; as such, they may be in 
a position to exploit their inside knowledge. Administrative, 
technical, and clerical personnel may also be access persons if their 
functions or duties make them privy to nonpublic information. 
Organizations where employees have broad responsibilities, and where 
information barriers are few, may see a larger percentage of their 
staff subject to the reporting requirements. In contrast, organizations 
that keep strict controls on sensitive information may have fewer 
access persons.
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    \31\ Proposed rule 204A-1(e)(1)(i)(B).
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    Persons who are not ``supervised persons'' of the investment 
adviser would not be access persons under the proposed rule. Thus, 
employees of other organizations, including affiliated organizations 
such as broker-dealers, custodians, and banks that may acquire 
information about client securities transactions in the course of their 
duties, would not be subject to reporting requirements.\32\ It may be 
impractical to apply the adviser's code of ethics to these persons, who 
may in any event be subject to ethical restrictions imposed by their 
own employers.\33\ As discussed earlier, proposed rule 204A-1 would 
require advisers' codes of ethics to safeguard material nonpublic 
information, so that the number of persons outside the firm who have 
access should be few.\34\ Moreover, advisers' fiduciary duty of care 
already requires them to exercise caution when disclosing client 
information to third parties, even those who are affiliates. Should the 
rule require advisers to undertake specific safeguards in this regard, 
and if so, what should they be?
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    \32\ Our recordkeeping rules have required advisers to keep 
records of personal securities transactions of employees of 
companies affiliated with the adviser, if those employees have 
access to prior information about the adviser's clients' trades. 
Rule 204-2(a)(12)(iii)(A). We amended our recordkeeping rule to 
include personal securities transactions of these persons in 1975, 
in recognition that they may possess inside knowledge that could 
lead to ``scalping'' or front-running. Revised Definition of Term 
``Advisory Representative'' and Limitation of Record-Keeping 
Requirements for Certain Persons, Investment Advisers Act Release 
No. 436 (Feb. 21, 1975) [40 FR 8548 (Feb. 28, 1975)].
    \33\ Advisers are currently subject to detailed rules that may 
require them to keep records of the personal securities transactions 
of some of these persons. Because we believe requiring advisers to 
monitor the personal securities trading of employees of other firms 
may not be practical, we believe it may be more effective to 
eliminate these recordkeeping requirements. See Section II.I of this 
Release, below. Instead, our proposed rule would encourage tighter 
controls on material nonpublic information by imposing a general 
requirement that the adviser safeguard access to such information.
    \34\ Proposed rule 204A-1(a)(3).
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    We request comment on the scope of the definition of access person 
under the proposed rule:
    [sbull] Is the definition too broad? Are there additional persons 
who should be excluded?
    [sbull] Is the definition too narrow `` are there personnel at 
advisory firms who would not be access persons but who may be in a 
position to misuse nonpublic information?

[[Page 4044]]

    [sbull] Should access persons include employees of companies that 
control or are controlled by the adviser?
    Whether directors and partners of an adviser have access to client 
securities information may vary significantly between organizations. In 
some large organizations with multiple lines of business, not all 
officers may have access to the type of information the proposed rule 
is designed to protect. Rule 17j-1 creates special rules for advisory 
firms that are ``primarily engaged'' in a business other than advising 
funds or advisory clients, and sets out a test based on the firm's 
sources of revenue.\35\ In order to achieve the same result, proposed 
rule 204A-1 would create a legal presumption that, if the firm's 
primary business is providing investment advice, then all of its 
directors, officers and partners are access persons.\36\ If the firm 
has another primary business, then whether a director, officer or 
partner is an access person would turn on whether the individual has 
access to nonpublic client information.
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    \35\ Rule 17j-1(a)(1)(i) (A) and (B). See also rule 204-
2(a)(13)(iii)(D).
    \36\ Proposed rule 204A-1(e)(1)(ii).
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    [sbull] Is there a continuing need for the rule to specify a test 
for the adviser's ``primary'' business? If so, should the new rule use 
the revenue-based test currently in rule 17j-1 or is there another 
measure that would be more effective?
    [sbull] Should we amend rule 17j-1 to create a legal presumption 
rather than using the current revenue-based test?
3. Reportable Securities and Beneficial Ownership
    Several types of securities would appear to present little 
opportunity for the type of improper trading that the access person 
reports are designed to uncover. Money market instruments `` bankers'' 
acceptances, bank certificates of deposit, commercial paper, repurchase 
agreements and other high quality short-term debt instruments--and 
direct obligations of the Government of the United States would be 
exempt from reporting requirements.\37\ Shares of money market funds 
would also be exempt.\38\ Transactions and holdings in shares of other 
types of mutual funds would not be reportable unless the adviser or a 
control affiliate acts as the investment adviser or principal 
underwriter for the fund.\39\
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    \37\ Proposed rule 204A-1(b)(1)(i)(A) and (e)(10) (i) and (ii). 
The Commission interprets ``high quality short-term debt 
instrument'' to mean any instrument having a maturity at issuance of 
less than 366 days and which is rated in one of the highest two 
rating categories by a Nationally Recognized Statistical Rating 
Organization, or which is unrated but is of comparable quality. 
Personal Investment Activities of Investment Company Personnel and 
Codes of Ethics of Investment Companies and Their Investment 
Advisers and Principal Underwriters, Investment Company Act Release 
No. 21341 (Sept. 8, 1995) [60 FR 47844 (Sept. 14, 1995)] (proposing 
amendments to rule 17j-1) at note 66.
    \38\ Proposed rule 204A-1(e)(10)(iii).
    \39\ Proposed rule 204A-1(e)(9) and (10)(iv). Transactions and 
holdings in shares of closed-end investment companies would be 
reportable regardless of affiliation.
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    [sbull] Are there other types of mutual funds, in addition to money 
market funds, that we should exempt from access persons' holdings and 
transactions reporting requirements--for example, should reporting on 
transactions in index funds be required? Should investments in variable 
annuity contracts be excluded from reporting requirements?
    Access persons would be required to report holdings and 
transactions in securities in which they have beneficial ownership. In 
1999, we clarified that beneficial ownership under rule 17j-1 should be 
interpreted in the same manner as for purposes of rule 16a-1(a)(2) 
under the Securities Exchange Act of 1934 in determining whether a 
person has beneficial ownership of a security for purposes of section 
16 of that Act. \40\ We are proposing to include that same provision in 
rule 204A-1.\41\ Because it is the same as the standard under rule 17j-
1, advisers to investment companies will not have to apply two 
different standards.\42\
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    \40\ See Personal Investment Activities of Investment Company 
Personnel, Investment Company Act Release No. 23958 (Aug. 20, 1999) 
[64 FR 46821 (Aug. 27, 1999)] (``Rule 17j-1 1999 Adopting 
Release''). See also rule 204-2(a)(12)(iii)(B).
    \41\ Proposed rule 204A-1(e)(3).
    \42\ As under rule 17j-1, any report required under rule 204A-1 
would be permitted to contain a disclaimer of beneficial ownership 
by the person making the report.
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4. Reporting of Investment Company Shares
    Proposed rule 204A-1 would require access persons of an adviser to 
report their holdings and transactions in shares of investment 
companies managed by the adviser or a control affiliate (``reportable 
funds'').\43\ We are proposing these reporting requirements in order to 
close a regulatory gap under the Company Act.
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    \43\ A fund is a ``reportable fund'' under proposed rule 204A-
1(e)(9) if the adviser acts as investment adviser to the fund, or if 
certain control affiliates of the adviser serve as either investment 
adviser or principal underwriter to the fund. Those control 
affiliates are persons who control the adviser, who are controlled 
by the adviser, or who are under common control with the adviser. 
For many advisers to investment companies, their reportable funds 
will be only those they manage, because these advisers have no 
control affiliates that are other advisers or broker-dealers. A 
large financial services complex with multiple advisory and 
brokerage firms under common control will have a greater number of 
reportable funds.
---------------------------------------------------------------------------

    Section 17(j) of the Company Act authorizes us to adopt rules 
preventing fraud or deceptive practices in connection with the purchase 
or sale of ``any security held or to be acquired'' by an investment 
company. As a result, rule 17j-1 does not require access persons of 
investment companies to report personal securities trades in mutual 
funds they manage. Moreover, the exclusion of mutual funds reflects an 
assumption that trading in mutual fund shares posed little risk of 
abuse, because those shares are priced at net asset value daily.\44\
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    \44\ See Rule 17j-1 1980 Adopting Release, supra note 21 (the 
Commission exempted shares of mutual funds from the rule's reporting 
requirements because they ``present very little opportunity for the 
type of improper trading that the rule is intended to cover'').
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    Our enforcement actions against fund managers who we allege to have 
engaged in market timing of their funds based upon their knowledge that 
portfolio securities were mispriced indicates that this assumption was 
false.\45\ Therefore, we propose to require all advisers' codes of 
ethics to call for reporting of holdings and transactions in affiliated 
mutual funds.\46\
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    \45\ See supra note 5.
    \46\ In addition, we would expand the definition of ``access 
person'' from that in rule 17j-1. Access persons under rule 17j-1 
include advisory personnel who make trading recommendations or 
decisions for the fund or have information about the fund's 
purchases and sales of securities. Access persons under rule 204A-1 
would also expressly include supervised persons who have nonpublic 
information about a reportable fund's portfolio securities holdings.
---------------------------------------------------------------------------

    [sbull] Should the proposed rule require reporting of transactions 
and holdings in all mutual fund shares, rather than only affiliated 
funds? Does the proposed rule draw an appropriate line regarding which 
funds should be covered, and if not, where should that line be drawn?
    [sbull] Proposed rule 204A-1 would include, as access persons, 
individuals who obtain information about the existing securities 
holdings in the adviser's investment companies. Should these 
individuals be considered access persons? Should we amend rule 17j-1 
under the Investment Company Act to conform the definitions?
    [sbull] Should supervised persons who have information about the 
holdings of non-fund clients also be included as access persons?
5. Initial and Annual Holdings Reports
    Proposed rule 204A-1 would require a complete report of each access

[[Page 4045]]

person's securities holdings.\47\ Holdings reports would be required at 
the time the person becomes an access person and at least once a year 
thereafter.\48\ We require similar holdings reports under rule 17j-
1.\49\
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    \47\ In contrast, our current recordkeeping rules require only 
that advisers retain records of certain personal securities 
transactions of their employees. Rule 204-2(a)(12)(i) and (13)(i). 
The rules do not require reports on holdings acquired before the 
employee joined the adviser, nor do they require reports showing 
cumulative holdings in securities. Both the adviser and our 
examiners, however, may also need to see a complete picture of all 
securities held by the access person in order to identify potential 
or actual conflicts of interest. Without knowledge of all those 
securities, including securities acquired before the person became 
an access person, it would, for example, be difficult for an adviser 
to determine whether the access person is recommending purchases for 
clients based solely on the clients' best interest or based on the 
securities that the access person holds in his or her own portfolio.
    \48\ Proposed rule 204A-1(b)(1)(ii).
    \49\ Rule 17j-1(d)(1)(i) and (iii). We recognize that some 
persons may already be reporting their securities holdings and 
brokerage accounts to the adviser. We believe that, as under rule 
17j-1, an access person would satisfy the initial holdings report 
requirement and would not have to submit a separate report, if the 
adviser maintains a composite record of the information required to 
be disclosed in the initial report and the access person confirms in 
writing (which writing may be electronic) the accuracy of the record 
within 10 days after becoming subject to this provision. See Rule 
17j-1 1999 Adopting Release, supra note 40, at n. 34. The proposed 
rule would not, however, permit an access person to avoid filing an 
initial holdings report simply because all information has been 
provided over a period of time in various transaction reports. One 
reason for requiring a holdings report is so that the adviser's 
compliance personnel and our examiners have ready access to a 
``snapshot'' of the access person's holdings and are not required to 
piece the information together from transaction reports.
---------------------------------------------------------------------------

    [sbull] Should we require holdings reports to be more frequent?
    [sbull] If we require holdings reports more often than annually, 
should we make parallel changes to rule 17j-1?
6. Periodic Transactions Reports
    Proposed rule 204A-1 would require quarterly reports of all 
personal securities transactions by access persons.\50\ The reports 
would be due no later than 10 days after the close of the calendar 
quarter. In the event an access person had no personal securities 
transactions during the quarter, the report would contain a statement 
to that effect and would still be required.
---------------------------------------------------------------------------

    \50\ Proposed rule 204A-1(b)(2).
---------------------------------------------------------------------------

    [sbull] We request comment on the required timing of these reports.
    [sbull] If we require more frequent transaction reports or a 
shorter deadline for reporting, should we make parallel changes to rule 
17j-1?
    Transactions effected pursuant to an automatic investment plan 
would not have to be reported.\51\ Automatic investment plan 
participants must determine, well in advance, what their investments 
will be, and that pre-determined schedule does not leave the individual 
in a position to time their own trades against clients' trades, or to 
act on newly discovered confidential information. Often, however, a 
participant in an automatic investment plan will effect a transaction 
that overrides the pre-set schedule or allocations of the plan; such 
transactions would have to be reported in a quarterly transaction 
report.
---------------------------------------------------------------------------

    \51\ Proposed rule 204A-1(b)(3)(ii).
---------------------------------------------------------------------------

    [sbull] Are there other types of transactions that should be exempt 
from quarterly transactions reports? For example, some advisers that 
have overall pre-clearance requirements permit employees to purchase 
securities pursuant to an exercise of rights issued pro rata, or 
certain corporate actions such as stock splits, without pre-clearing 
the purchase. Should those transactions also be exempt from quarterly 
transactions reports? Commenters are requested to specify which 
corporate actions should qualify for any exemption.
    [sbull] Should small transactions be exempt if the issuer has a 
large market capitalization? If so, what should be the thresholds for 
the size of the transaction and for the size of the issuer?
    [sbull] Should transactions pursuant to automatic investment plans, 
or other types of transactions, also be exempt from quarterly reporting 
under rule 17j-1?
7. Duplicate Broker Confirms and Statements
    Many advisory firms already receive copies of their employees' 
trade confirmations or account statements covering personal securities 
transactions. Proposed rule 204A-1 would not require access persons to 
submit transaction reports that would duplicate information contained 
in trade confirmations or account statements that the adviser holds in 
its records. A duplicate trade confirmation or account statement would 
be required to be received by the adviser within 10 days after the end 
of the quarter in which the transaction takes place.
    [sbull] The proposed rule does not require all of the information 
required in a transaction report to appear in the duplicate trade 
confirmation or account statement. That is, some of the required 
information could appear in the confirm or statement, and the remainder 
could appear elsewhere in the adviser's records. Is this clear in the 
proposed rule, or should the rule contain an express provision on this 
point? Does this practice fragment the information such that a complete 
picture of the access person's securities trades is harder to obtain?

D. Initial Public Offerings and Private Placements

    The code of ethics would have to require that access persons obtain 
the adviser's approval before investing in an initial public offering 
(``IPO'') or private placement.\52\ We added a similar provision to 
rule 17j-1 in 1999.\53\ Because most individuals rarely have the 
opportunity to invest in these types of securities, an access person's 
IPO or private placement purchase may, for example, raise questions as 
to whether the employee is misappropriating an investment opportunity 
that should first be offered to eligible clients, or whether a 
portfolio manager is receiving a personal benefit for directing client 
business or brokerage.\54\
---------------------------------------------------------------------------

    \52\ Proposed rule 204A-1(c).
    \53\ See Rule 17j-1 1999 Adopting Release, supra note 40.
    \54\ See, e.g., In the Matter of Monetta Financial Services, 
Inc., Robert S. Bacarella, and Richard D. Russo, Investment Advisers 
Act Release No. 2136 (Jun. 9, 2003) (investment adviser to mutual 
funds improperly allocated IPO shares in which funds could have 
invested to certain access persons of the funds without adequate 
disclosure or approval); In the Matter of Ronald V. Speaker and 
Janus Capital Corporation, Investment Company Act Release No. 22461 
(Jan. 13, 1997) (portfolio manager made a profit on same day 
purchase and sale of debentures in which fund could have invested, 
and failed to disclose transactions to the fund or obtain prior 
consent of the fund); U.S. v. Ostrander, 999 F.2d 27 (2d Cir. 1993) 
(affirming conviction of portfolio manager for accepting unlawful 
compensation where she purchased privately offered warrants of a 
company whose securities she acquired for the fund).
---------------------------------------------------------------------------

    [sbull] Many advisers prohibit their employees from participating 
in initial public offerings and private placements.\55\ Should the rule 
prohibit access persons from making these investments for their 
personal accounts?
---------------------------------------------------------------------------

    \55\ Guidelines on personal investing endorsed by the Investment 
Counsel Association of America recommend prohibiting advisory 
personnel from acquiring securities in an IPO. Investment Counsel 
Association of America, Inc., Guidelines on Personal Investing (Feb. 
1995). Similarly, the advisory group to the Investment Company 
Institute recommended prohibiting investment personnel from 
acquiring IPO shares. Investment Company Institute Report of the 
Advisory Group on Personal Investing at 32 (May 9, 1994). Of course, 
the proposed rule would not require an adviser that prohibited these 
transactions to include provisions in its code of ethics requiring 
their pre-clearance.
---------------------------------------------------------------------------

E. Reporting of Violations

    The code of ethics would have to require prompt internal reporting 
of any violations of the code.\56\ Reports of violations would have to 
be made to the adviser's chief compliance officer or to another person 
designated in the code of

[[Page 4046]]

ethics.\57\ The sooner the adviser learns of a violation by a 
supervised person, the sooner the firm can take corrective 
measures.\58\ But no compliance officer can be everywhere within the 
firm at all times. Reports may come from violators themselves, as would 
be likely in the case of inadvertent and some technical violations of 
the code of ethics, or may come from others within the firm who learn 
of a fellow employee's inappropriate actions.
---------------------------------------------------------------------------

    \56\ Proposed rule 204A-1(a)(5).
    \57\ As we discussed in adopting a similar provision under 
section 406 of the Sarbanes-Oxley Act, see supra note 10, the person 
to whom violations are reported should not be a person involved in 
the matter giving rise to the violation, and if the person is not 
the adviser's chief compliance officer, should have sufficient 
status within the organization to engender respect for the code of 
ethics. See Disclosure Required by Sections 406 and 407 of the 
Sarbanes-Oxley Act of 2002, Securities Act Release No. 8177 (Jan 23, 
2003) [68 FR 5109 (Jan 31, 2003)] at n.45.
    \58\ As discussed below at Section II.I of this Release, 
advisers would be required to keep records of violations of the code 
of ethics and of actions taken as a result of the violation.
---------------------------------------------------------------------------

    We ask for comment on this provision of the proposals. Should 
advisers identify at least two persons to whom reports of violations 
can be submitted, in case one of the designated persons is involved in 
the violation?
    [sbull] Should the code of ethics require reporting of apparent 
violations as well?

F. Acknowledged Receipt of Code of Ethics

    The code of ethics would have to require the adviser to provide 
each supervised person with a copy of the code of ethics and any 
amendments, and require each supervised person to acknowledge, in 
writing, his receipt of those copies.\59\ An investment adviser's 
procedures for informing its employees about its code of ethics are 
critical to obtaining good compliance and avoiding inadvertent 
violations of the code.
---------------------------------------------------------------------------

    \59\ Proposed rule 204A-1(a)(6).
---------------------------------------------------------------------------

    [sbull] Advisers' codes of ethics often contain procedures for the 
firm to educate employees about the code of ethics, including the 
reporting requirements, and to advise employees periodically of changes 
made to the code.\60\ Should we mandate that all adviser codes of 
ethics contain such procedures?
---------------------------------------------------------------------------

    \60\ Some advisers may hold orientation sessions periodically 
for new or existing employees to remind them of the requirements of 
the firm's code of ethics.
---------------------------------------------------------------------------

    [sbull] Advisers' codes also often require employees to certify 
that they have read and understood the code of ethics, and require 
annual recertification that the employee has re-read, understands and 
has complied with the code. Should rule 204A-1 expressly impose these 
requirements?

G. Other Code of Ethics Provisions

    As discussed above, advisers that have adopted codes of ethics 
often include a variety of provisions designed to guard against 
impropriety and conflict, and designed to ensure that the firm can 
implement the code it has adopted.\61\ They may include other 
provisions such as:
---------------------------------------------------------------------------

    \61\ See PPI Report, supra note 25 at 199 (noting that failure 
to adopt appropriate procedures for implementing codes to prevent 
insider trading, or to fix responsibility for such implementation, 
``impairs the value of even the most carefully drafted code'').
---------------------------------------------------------------------------

    [sbull] Limitations on acceptance of gifts.
    [sbull] Limitations on the circumstances under which an access 
person may serve as a director of a publicly traded company.
    [sbull] Detailed identification of who is considered an access 
person within the organization.
    [sbull] Procedures for the firm and its compliance personnel to 
review periodically the code of ethics as well as to review reports 
made pursuant to it.
    [sbull] Discussion of penalties for violating the code of 
ethics.\62\
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    \62\ Our understanding is that penalties for violations vary 
from one firm to another, and depend on the type of violation 
involved. Employees may be required to cancel trades, disgorge 
profits or sell positions at a loss, and may face internal 
reprimands, fines, or firing.
---------------------------------------------------------------------------

    Should any of these be required elements of an adviser's code of 
ethics?

H. Adviser Review and Enforcement

    Proposed rule 204A-1 would require that advisers maintain and 
enforce the provisions of their codes of ethics.\63\ Enforcement of the 
code would include reviewing the securities holdings and transaction 
reports of the adviser's access persons.\64\ We expect that the 
responsibility for enforcing the adviser's code of ethics will lie 
substantially with the adviser's chief compliance officer, to whom 
personal trading reports must be submitted.\65\
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    \63\ Proposed rule 204A-1(a).
    \64\ Proposed rule 204A-1(a)(4).
    \65\ Proposed rule 204A-1(b)(1) and (2). We recently adopted 
rule 206(4)-7 under the Advisers Act [17 CFR 275.206(4)-7], which, 
among other things, requires every adviser registered with us to 
appoint a chief compliance officer. Compliance Adopting Release, 
supra note 7. Under our proposal, reports of violations of the code 
of ethics would also go to the chief compliance officer or to 
another person designated in the code. Proposed rule 204A-1(a)(5).
---------------------------------------------------------------------------

I. Recordkeeping

    We are also proposing to amend rule 204-2 under the Advisers Act to 
reflect the codes of ethics that advisers would adopt under rule 204A-1 
and to eliminate details that rule 204A-1 would make unnecessary. As a 
result, advisers should find it easier to understand and meet their 
recordkeeping obligations.
    Currently, rules 204-2(a)(12) and (13) lay out fairly complex 
requirements for the information that advisers must keep regarding 
personal securities transactions.\66\ Our proposed amendments would 
simplify recordkeeping by, instead, relying on and referring to the 
adviser's required code of ethics. Advisers would have to keep copies 
of their code of ethics and their supervised persons' written 
acknowledgment of receipt of the code. They would have to keep records 
of violations of the code, and records of action taken as a result of 
violations.\67\ In addition, advisers would have to keep a record of 
the names of their access persons under rule 204A-1, holdings and 
transaction reports made by access persons, and records of decisions 
approving access persons' acquisition of securities in IPOs and limited 
offerings.\68\
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    \66\ Rule 204-2(a)(13) repeats virtually all of rule 204-
2(a)(12), but applies specifically to investment advisers who are 
primarily engaged in a business other than advising funds or other 
advisory clients.
    \67\ Proposed amended rule 204-2(a)(12).
    \68\ Proposed amended rule 204-2(a)(13). Advisers would be 
required to maintain the records required under proposed amended 
rule 204-2(a)(12) and (13) in an easily accessible place for five 
years, the first two years in an appropriate office of the 
investment adviser. These are the standard retention requirements 
for books and records under rule 204-2.
---------------------------------------------------------------------------

    [sbull] We ask comment on whether the proposed recordkeeping 
requirements are appropriate.
    [sbull] Should the rule require advisers to keep records of any 
code of ethics waivers or exemptions they grant to a supervised person?
    We propose to require that records of access persons' personal 
securities reports (and duplicate brokerage confirmations or account 
statements in lieu of those reports) be maintained electronically in an 
accessible computer database.\69\ In all but the smallest advisory 
organizations, it may be impractical for the adviser or our examiners 
to review paper trading reports for patterns that may indicate abuse. 
\70\ Electronic records need not be costly or burdensome to maintain. 
In a small firm, a spreadsheet may be sufficient. Larger firms may 
monitor

[[Page 4047]]

employees' trading by opening up ``client'' accounts for each employee 
so that the firm's existing portfolio analysis programs can track the 
employees' trades.
---------------------------------------------------------------------------

    \69\ These records would be subject to the special safeguards 
and other requirements for electronic storage contained in rule 204-
2(g).
    \70\ Under current rule 204-2(a)(12) and (13), duplicate 
confirmations and account statements can substitute for transaction 
reports otherwise required, so long as any paper copies are 
organized so as to allow easy access to and retrieval of any 
particular confirmation or statement.
---------------------------------------------------------------------------

    [sbull] We ask comment on our understanding that requiring these 
records to be kept electronically would not be burdensome. Is there a 
need to exempt some smaller firms from the electronic recordkeeping 
requirement, or to modify the electronic recordkeeping requirement for 
these firms?

J. Amendment to Form ADV

    We are proposing to amend Part II of Form ADV to require advisers 
to describe their codes of ethics to clients and, upon request, to 
furnish clients with a copy of the code of ethics.\71\ We emphasized 
the importance of disclosure in 1999 when we amended rule 17j-1 to 
require funds' codes of ethics to be filed with us electronically and 
thus available to the public.\72\ This disclosure would help clients 
understand the ethical culture and standards at the advisory firm, how 
the adviser controls sensitive information and what steps it has taken 
to prevent employees from misusing their inside positions at the 
expense of clients. Clients would be able to select advisers whose 
ethical commitment meets their expectations. Disclosure should also 
serve to encourage advisers to implement more effective procedures.\73\
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    \71\ We are proposing to amend Item 9 of Form ADV Part II, which 
asks whether the adviser or a ``related person'' (that is, a person 
that controls the adviser, is controlled by the adviser, or is under 
common control with the adviser) participates or has an interest in 
client transactions. In April 2000, we proposed a new version of 
Part 2 that called for a narrative disclosure brochure, and which 
moved this disclosure topic to Item 10.
    \72\ See Rule 17j-1 1999 Adopting Release, supra note 40.
    \73\ The provisions of section 206 of the Advisers Act would be 
applicable to an investment adviser that disclosed its policies and 
procedures but then materially deviated from them.
---------------------------------------------------------------------------

    [sbull] Is a general disclosure requirement adequate? Commenters 
urging that more specific disclosure be required should provide sample 
text.

K. Investment Company Advisers

    Approximately 19 percent of the advisers registered with us advise 
registered investment companies and are therefore also subject to rule 
17j-1. We would not want those advisers to be subject to conflicting 
responsibilities under that rule and our new proposals.
    Currently, access persons under rule 17j-1 need not make a 
quarterly transaction report under that rule if ``all of'' the 
information in the report would duplicate information required to be 
recorded under Advisers Act rules.\74\ We are proposing to revise that 
to state that no report would be required under rule 17j-1 ``to the 
extent that'' the report would duplicate information required under the 
Advisers Act recordkeeping rules, because the reports we propose to 
require under the Advisers Act are not identical to those that rule 
17j-1 would require. To avoid duplicative reports, some advisers to 
investment companies may require their access persons to provide 
reports that cover all information required under rule 17j-1 and all 
information required under the Advisers Act code of ethics `` for 
example, an access person's quarterly report might include information 
on new securities accounts (required under rule 17j-1) as well as on 
transactions in affiliated mutual funds (required under rule 204A-1).
---------------------------------------------------------------------------

    \74\ Rule 17j-1(d)(2)(iv).
---------------------------------------------------------------------------

    [sbull] We ask comment on whether there are alternative approaches 
to better reconcile this issue.

III. General Request for Comment

    The Commission requests comment on the rule and amendments proposed 
in this release, suggestions for other additions to the rule and 
amendments, and comment on other matters that might have an effect on 
the proposals contained in this release. For purposes of the Small 
Business Regulatory Enforcement Fairness Act of 1996, the Commission 
also requests information regarding the potential impact of the 
proposed rule and amendments on the economy on an annual basis. 
Commenters should provide empirical data to support their views.

IV. Cost-Benefit Analysis

    We are sensitive to the costs and benefits that result from our 
rules. Proposed rule 204A-1 would require investment advisers to 
establish, maintain, and enforce codes of ethics for their supervised 
persons. These codes of ethics would establish standards of business 
conduct reflecting the fiduciary obligations of the adviser and its 
personnel and impose measures designed to prevent supervised persons 
from abusing their access to information about clients' securities 
transactions. We are also proposing related recordkeeping and client 
disclosure amendments.\75\ We have identified certain costs and 
benefits, which are discussed below, that may result from these 
proposed rules. We request comment on the costs and benefits of the 
proposed rules. We encourage commenters to identify, discuss, analyze, 
and supply relevant data regarding these or any additional costs and 
benefits.
---------------------------------------------------------------------------

    \75\ We are proposing amendments to Advisers Act rule 204-2, the 
adviser recordkeeping rule, to address documentation of advisers' 
compliance with rule 204A-1. We are also proposing to amend Part II 
of Form ADV, which specifies certain information investment advisers 
must disclose to their clients, to require advisers to include a 
discussion of their codes of ethics and make copies available to 
clients upon request.
---------------------------------------------------------------------------

A. Benefits

    We anticipate that advisory firm clients and the firms themselves 
would benefit from the proposed rules, though these benefits are 
difficult to quantify. Codes of ethics under proposed rule 204A-1 would 
impress upon supervised persons the significance of the fiduciary 
aspects of their professional responsibilities, formulating these into 
standards of conduct to which their employers will hold these 
individuals accountable. Codes of ethics would also be an important 
part of advisers' efforts to prevent fraudulent personal trading by 
their supervised persons. As a result, these codes should increase 
investor protection by forestalling supervised persons from engaging in 
misconduct that defrauds clients. In addition, requiring advisers to 
describe their codes of ethics to clients and to furnish copies to 
clients upon request should put clients in a better position to 
evaluate whether their advisers' codes of ethics meet their 
expectations. If a client is not confident that an advisory firm has 
taken appropriate measures to prevent its personnel from placing their 
own interests ahead of their clients' interests, the client would be 
able to seek a different adviser whose measures he approves.
    Proposed rule 204A-1 would reinforce existing measures that require 
investment advisers to guard against employee misconduct. It would go 
beyond section 204A of the Advisers Act, which focuses on policies and 
procedures to prevent misuse of material nonpublic information by 
advisory firm personnel, and expand advisers' policies to address other 
situations in which such personnel could potentially benefit at the 
expense of firm clients. It would also go beyond Company Act rule 17j-
1, which focuses on fraud in connection with securities held or to be 
acquired by an investment company advised by an adviser, and expand 
advisers' policies to address advisory personnel's holdings and 
transactions in shares of investment companies managed by the adviser. 
Codes of ethics should also assist advisers in meeting their 
obligations under Advisers Act rule 206(4)-7 to adopt policies and 
procedures reasonably designed to prevent their

[[Page 4048]]

supervised persons from violating the Advisers Act.
    Proposed rule 204A-1 would benefit investment advisers by 
diminishing the likelihood their firms will be embroiled in securities 
violations, Commission enforcement actions, and private litigation. For 
an adviser, the potential costs associated with a securities law 
violation may consist of much more than merely the fines or other 
penalties levied by the Commission or civil liability. The reputation 
of an adviser may be significantly tarnished, resulting in lost 
clients. Advisers may be denied eligibility to advise funds.\76\ In 
addition, advisers could be precluded from serving in other 
capacities.\77\
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    \76\ Section 9(a) of the Investment Company Act [15 U.S.C. 80a-
9(a)] prohibits a person from serving as an adviser to a fund if, 
within the past 10 years, the person has been convicted of certain 
crimes or is subject to an order, judgment, or decree of a court 
prohibiting the person from serving in certain capacities with a 
fund, or prohibiting the person from engaging in certain conduct or 
practice.
    \77\ See, e.g., 29 U.S.C. 1111(a) (prohibiting a person from 
acting in various capacities for an employee benefit plan, if within 
the past 13 years, the person has been convicted of, or has been 
imprisoned as a result of, any crime described in section 9(a)(1) of 
the Investment Company Act [15 U.S.C. 80a-9(a)(1)]).
---------------------------------------------------------------------------

    Our proposal to revise advisers' recordkeeping obligations for 
personal securities transactions should also benefit investment 
advisers. The proposed rules are easier to understand than the complex 
provisions currently contained in Advisers Act rule 204-2(a)(12) and 
(13). In addition, by requiring investment advisers to maintain 
information about their access persons' personal securities 
transactions electronically in an accessible database, we would make it 
more likely that firms could detect patterns that may indicate abuse. 
In all but the smallest advisory organizations, it may be impractical 
to try to identify such patterns by reviewing paper records. The 
requirement that each access person provide initial and annual holdings 
reports will allow investment advisers to better monitor conflicts that 
may arise when an access person participates in investment decisions 
involving securities the access person holds in his or her portfolio, 
and to assess whether access persons are filing accurate quarterly 
transaction reports.

B. Costs

    The proposed rules would result in some additional costs for 
advisers, and advisers may pass these costs along to their clients in 
the form of advisory fees. However, since advisers are already required 
to maintain various policies and procedures that would constitute core 
elements of their codes of ethics, many of these costs are already 
reflected in fees clients currently pay. Advisers are required to 
maintain written policies and procedures reasonably designed to prevent 
the misuse of material nonpublic information under section 204A of the 
Advisers Act. Also, the approximately 1,500 advisers who advise 
registered investment companies currently have codes of ethics to 
prevent their ``access persons'' from abusing their access to 
information about the fund's securities trading, pursuant to Company 
Act rule 17j-1.\78\ In addition, advisers are required under Advisers 
Act rule 206(4)-7 to adopt policies and procedures reasonably designed 
to prevent their supervised persons from violating the Advisers Act. 
Accordingly, we believe requiring codes of ethics will impose few new 
costs on advisers.
---------------------------------------------------------------------------

    \78\ Based on our records of information submitted to us by 
investment advisers in Part 1 of Form ADV through December 10, 2003, 
approximately 1,500 advisers report that they manage portfolios for 
investment companies.
---------------------------------------------------------------------------

    Similarly, our proposals to require access persons to report 
personal securities transactions should cause only minor cost 
increases. Advisers are already required to maintain records of their 
advisory representatives' personal securities transactions on a 
quarterly basis under Advisers Act rule 204-2(a)(12) and (13). The 
additional reporting required of access persons under our proposed 
rules `` routine quarterly reports indicating that no transactions were 
effected, and an annual report of securities holdings `` should impose 
only minor additional costs. Because most SEC-registered investment 
advisers have so few employees, we believe the cost of these additional 
reports will be minor. As of December 2003, 49% of investment advisers 
registered with us reported that they had five or fewer non-clerical 
employees, and another 18% reported that they had only six to ten non-
clerical employees.\79\ The majority of larger SEC-registered advisers 
are already subject to Company Act rule 17j-1 because they advise 
investment companies, and consequently obtain annual reports from their 
``access persons'' that contain virtually the same information as would 
be required under our proposals. These larger firms are also in a 
position to limit the number of supervised persons subject to the 
reporting requirements, by imposing stringent controls on who obtains 
access to client securities information.
---------------------------------------------------------------------------

    \79\ This is based on Form ADV data (under Item 5.A of Part 1A) 
submitted to us by 8,019 SEC-registered investment advisers through 
December 9, 2003.
---------------------------------------------------------------------------

    Our proposal to require advisers to maintain information about 
their access persons' personal securities transactions electronically 
in an accessible database would be new. However, we do not expect 
advisers would be required to acquire new computer equipment or 
software to implement this approach. We understand that all but the 
smallest firms currently use client portfolio management software 
platforms that could easily be used by access persons to report their 
holdings and transactions under proposed rule 204A-1. Smaller firms 
could also easily require access persons to submit their reports in 
common electronic spreadsheet formats.\80\
---------------------------------------------------------------------------

    \80\ Firms could also require access persons to conduct their 
personal securities activities through the same broker-dealers from 
which the firm obtains electronic reporting of client transactions, 
and obtain access persons' information electronically from the 
broker-dealers.
---------------------------------------------------------------------------

    We expect only minor cost increases from our proposals to require 
access persons to obtain their advisers' approval before investing in 
an initial public offering or private placement. Our experience 
administering the same requirement under Company Act rule 17j-1 has 
been that such proposals are infrequent, even at larger advisory firms.
    Finally, we expect only minor cost increases from our proposal to 
require advisers to describe their codes of ethics to clients and 
provide copies on request. Advisers would include the description in 
the disclosure brochure they are already required to provide to 
clients. The description should be sufficient for most clients, and it 
should not impose substantial costs to provide a copy of the code of 
ethics to the few clients that request it.

C. Request for Comment

    We request comment on the potential costs and benefits identified 
in the proposal and any other costs or benefits that may result from 
the proposed rules. Commenters are requested to identify, discuss, 
analyze, and supply relevant data to support their views.

V. Effects on Competition, Efficiency and Capital Formation

    Section 202(c) of the Advisers Act [15 U.S.C. 80b-2(c)] mandates 
that the Commission, when engaging in rulemaking that requires it to 
consider or determine whether an action is necessary or appropriate in 
the public interest, to consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition, and 
capital formation.
    As discussed above, the proposed rule would require investment 
advisers to

[[Page 4049]]

adopt codes of ethics applicable to their supervised persons. These 
codes of ethics would establish standards of business conduct 
reflecting the fiduciary obligations of the adviser and its personnel 
and impose measures designed to prevent supervised persons from abusing 
their access to information about clients' securities transactions. We 
expect that the proposed rule may indirectly increase efficiency. These 
codes of ethics should increase efficiency by forestalling supervised 
persons from engaging in misconduct that defrauds clients and harms the 
advisory firm, or by facilitating the adviser's early intervention to 
protect its clients. In addition, the existence of an industry-wide 
code of ethics requirement may enhance efficiency further by 
encouraging third parties to create new informational resources and 
guidance to which industry participants can refer in establishing and 
improving their codes.
    Since the proposed rule would apply equally to all registered 
advisers, we do not anticipate that it would introduce any competitive 
disadvantages. We expect that the proposed rule may indirectly foster 
capital formation by bolstering investor confidence. To the extent that 
investors know that advisory firms have taken measures designed to 
prevent their supervised persons from placing their interests ahead of 
their clients' interests, clients are more likely to make assets 
available through advisers for investment in the capital markets.

VI. Paperwork Reduction Act

    The proposed rule and amendments contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995.\81\ One of the collections of information is 
new. The Commission has submitted this new collection to the Office of 
Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The title of this new collection is ``Rule 
204A-1;'' OMB has not yet assigned it a control number. The other 
collection of information takes the form of amendments to two 
currently-approved collections titled ``Rule 204-2'' under OMB control 
number 3235-0278, and ``Form ADV'' under OMB control number 3235-0049. 
The Commission has also submitted the amendments to these collections 
to the OMB for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number.
---------------------------------------------------------------------------

    \81\ 44 U.S.C. 3501 to 3520.
---------------------------------------------------------------------------

    The collection of information under rule 204A-1 is necessary to 
establish standards of business conduct for supervised persons of 
investment advisers and to facilitate investment advisers' efforts to 
prevent fraudulent personal trading by their supervised persons. The 
collection of information is mandatory. The respondents are investment 
advisers registered with us, and certain of their supervised persons 
who must submit reports of their personal trading activities to their 
firms. These investment advisers use the information collected to 
control and assess the personal trading activities of their supervised 
persons. Responses to the reporting requirements will be kept 
confidential to the extent each investment adviser provides 
confidentiality under its particular practices and procedures.
    The collection of information under rule 204-2 is necessary for the 
Commission staff to use in its examination and oversight program. This 
collection of information is mandatory. The respondents are investment 
advisers registered with us. Responses provided to the Commission in 
the context of its examination and oversight program are generally kept 
confidential.\82\ The records that an adviser must keep in accordance 
with rule 204-2 must generally be retained for not less than five 
years.\83\
---------------------------------------------------------------------------

    \82\ See section 210(b) of the Advisers Act [15 U.S.C. 80b-
10(b)].
    \83\ See rule 204-2(e) [17 CFR 275.204-2(e)].
---------------------------------------------------------------------------

    The collection of information under Form ADV is necessary to 
provide advisory clients and prospective clients with information about 
an adviser's code of ethics. This collection of information is 
mandatory. The respondents are investment advisers registered with us. 
Clients of these investment advisers use the information collected to 
assess measures the adviser has taken to prevent its supervised persons 
from placing their own interests ahead of their clients' interests. 
Responses to the disclosure requirements are not kept confidential.

A. Rule 204A-1

    Rule 204A-1 would require SEC-registered investment advisers to 
establish a written code of ethics for their supervised persons. These 
codes of ethics would establish standards of business conduct 
reflecting the fiduciary obligations of the adviser and its personnel 
and impose measures designed to prevent supervised persons from abusing 
their access to information about clients' securities transactions.\84\ 
We estimate that each adviser would be required to spend six hours 
annually, on average, documenting its code of ethics. In preparing this 
estimate, we have taken into account that investment advisers currently 
maintain certain policies and procedures that could serve as the core 
of their codes of ethics. Advisers are required to maintain written 
policies and procedures reasonably designed to prevent the misuse of 
material nonpublic information, and to keep records of their advisory 
representatives' personal securities transactions.\85\ Also, the 
approximately 1,500 advisers who advise investment companies currently 
have codes of ethics pursuant to Investment Company Act rule 17j-1.\86\ 
In addition, investment advisers are required to adopt policies and 
procedures reasonably designed to prevent their supervised persons from 
violating the Advisers Act.\87\ We further estimate that 8,019 
investment advisers will incur this burden, for a total of 48,114 
hours.\88\
---------------------------------------------------------------------------

    \84\ Proposed rule 204A-1(a). Some firms have already adopted a 
code of ethics. These codes typically remind employees that they 
occupy positions of trust requiring them to act with the utmost 
integrity and include measures to restrict personal trading in 
securities being recommended to or traded for clients and to limit 
access to material nonpublic information. They also include 
reporting and other measures for the firm to monitor employees' 
personal securities transactions.
    \85\ See section 204A of the Advisers Act and Advisers Act rule 
204-2(a)(12)-(13).
    \86\ Based on our records of information submitted to us by 
investment advisers in Part 1A of Form ADV through December 10, 
2003, approximately 1,500 advisers report that they manage 
portfolios for investment companies. Under Investment Company Act 
rule 17j-1, advisers to investment companies generally must have a 
code of ethics to prevent their ``access persons'' from abusing 
their access to information about the fund's securities trading. 
Access persons must also submit reports containing information about 
their personal securities transactions and holding.
    \87\ Rule 206(4)-7 under the Advisers Act.
    \88\ As of December 9, 2003, there were 8,019 investment 
advisers registered with the Commission. 8,019 advisers x 6 hours = 
48,114 total annual hours.
---------------------------------------------------------------------------

    Rule 204A-1 would also require each adviser's code of ethics to 
include provisions under which the adviser's ``access persons'' report 
their personal securities transactions and holdings to the adviser.\89\ 
``Access persons'' are supervised persons of the adviser who have 
access to certain client securities information or recommendations.\90\ 
For purposes of estimating the paperwork burden for access persons 
under proposed rule 204A-1, we assume that advisers will treat all 
their non-clerical

[[Page 4050]]

employees as access persons.\91\ We estimate that investment advisers 
have 84 non-clerical employees on average, although this estimate 
overstates the number of such employees at the majority of advisory 
firms.\92\ Based on this average, we estimate that 673,596 access 
persons would be subject to the collection of information under the 
proposed rule.\93\
---------------------------------------------------------------------------

    \89\ Proposed rule 204A-1(a)(4).
    \90\ Proposed rule 204A-1(e)(1). See notes 29-30, supra, and 
accompanying text.
    \91\ This may overestimate the number of access persons to the 
extent investment advisers prevent some of their employees from 
having access to client securities information, or may underestimate 
the number of access persons to the extent clerical employees of 
some advisers have access to such information. On the basis of data 
submitted to us by SEC-registered investment advisers in Part 1 of 
Form ADV, it is difficult to estimate how many supervised persons of 
an investment adviser would be access persons; in addition, the 
internal controls on sensitive information will vary among advisers. 
We are aware that many investment advisers currently elect to treat 
all employees as ``advisory representatives'' or ``access persons'' 
for purposes of personal securities reporting under Advisers Act 
rule 204-2(a)(12) and Company Act rule 17j-1, respectively.
    \92\ This average is based on Form ADV data (under Item 5.A of 
Part 1A) submitted to us by 8,019 advisers through December 9, 2003. 
If we exclude the top 100 advisers who reported the greatest number 
of nonclerical employees, the average for the remaining 7,919 
advisers (who report their employees by range) is only 31 employees. 
Moreover, half of these advisers reported that they had five or 
fewer nonclerical employees.
    \93\ 84 access persons x 8,019 investment advisers = 673,596. 
Access persons of a firm with only one supervised person would 
generally be exempted from submitting personal securities activity 
reports. Proposed rule 204A-1(d). We have not attempted to exclude 
these access persons in preparing this estimate. On the basis of 
information submitted to us by SEC-registered investment advisers in 
Part 1A of Form ADV, it is difficult to estimate how many of the 
8,019 advisers registered with us have only one supervised person.
---------------------------------------------------------------------------

    These access persons would be required to file an initial report of 
their personal securities holdings upon becoming access persons, and an 
annual holdings report at least once a year thereafter.\94\ We estimate 
access persons would spend 0.7 hours on average completing each such 
report. These access persons would also be required to file transaction 
reports once each quarter stating whether the access person had any 
personal securities transactions that quarter and giving basic 
information about any such transactions.\95\ We estimate access persons 
would spend 0.6 hours on average completing such reports each year.\96\ 
Thus, the total annual burden hours for all access persons under the 
proposed would be 875,675 hours.\97\
---------------------------------------------------------------------------

    \94\ Proposed rule 204A-1(b)(1). These reports require basic 
information about securities in which the access person has a 
beneficial ownership interest (subject to exceptions for certain 
categories of securities) and the name of any broker, dealer or bank 
with which the access person maintains accounts to hold interests in 
securities.
    \95\ Proposed rule 204A-1(b)(2).
    \96\ In preparing this 0.6 hour annual estimate, we assumed 
advisory persons would have no transactions to report for three 
quarters each year (at 0.1 hours to complete each report affirming 
no activity) and one transaction to report one quarter each year (at 
0.3 hours to complete such report listing the transaction). Although 
some access persons make frequent personal securities transactions, 
we are aware that many trade infrequently. See PIA Report, supra 
note 12, at 2 (noting that 43.5% of fund managers whose 1993 
personal securities transactions the Commission examined in the 
study did not buy or sell securities at all).
    \97\ (0.7 hours holdings report + 0.6 hours transactions report) 
x 673,596 access persons = 875,675 hours.
---------------------------------------------------------------------------

    Rule 204A-1 would also require each adviser's code of ethics to 
include provisions under which the adviser provides each supervised 
person with a copy of the code of ethics and any amendments, and 
obtains written acknowledgment of receipt from the supervised person. 
We estimate that each investment adviser has 100 supervised persons on 
average, although this estimate overstates the number of supervised 
persons at the majority of advisory firms.\98\ We further estimate that 
each adviser will be required to provide a copy and obtain an 
acknowledgment 55 times each year, on average. This is based on our 
estimate that advisers will amend their codes every other year and hire 
five new supervised persons each year.\99\ We further estimate each 
iteration will take an investment adviser 0.05 hours on average, for an 
annual burden of 2.75 hours per adviser and a total burden increase of 
22,052.25 hours for all advisers.\100\
---------------------------------------------------------------------------

    \98\ This estimate is based on the same Form ADV data we use to 
estimate the average number of non-clerical employees, as discussed 
in notes 91-92, supra. Since Form ADV does not require advisers to 
submit data about their clerical employees, we assume advisers have 
16 clerical employees on average (or approximately one clerical 
employee for every 5 non-clerical employees). 16 clerical employees 
+ 84 non-clerical employees = 100 employees.
    \99\ Over any two-year period, 100 copies of amendments in year 
1 + 10 copies of complete code for new supervised persons in year 1 
through 2 = 110 copies, divided by 2 years = 55 copies.
    \100\ 0.05 hours per copy x 55 copies per year = 2.75 hours. 
2.75 hours x 8,019 investment advisers = 22,052.25 hours total.
---------------------------------------------------------------------------

    Based on these estimates, the total annual burden for advisers and 
access persons under proposed rule 204A-1 would be 945,841.25 
hours.\101\
---------------------------------------------------------------------------

    \101\ 48,114 hours by advisers to record their codes of ethics + 
875,675 hours for reporting by access persons + 22,052.25 hours for 
advisers to deliver copies of codes and amendments = 945,841.25.
---------------------------------------------------------------------------

B. Rule 204-2

    In addition, the proposal would amend rule 204-2, the adviser 
recordkeeping rule. The currently-approved annual aggregate information 
collection burden under rule 204-2 is 1,651,324.2 hours. This approved 
annual aggregate burden was based on estimates that 7,790 advisers were 
subject to the rule, and each of these advisers spends an average of 
211.98 hours preparing and preserving records in accordance with the 
rule. Based upon the most recently available data, there are 8,019 
registered investment advisers. The increase in the number of 
registered investment advisers increases the total burden hours of 
current rule 204-2 from 1,651,324.2 to 1,699,867.6 hours.\102\
---------------------------------------------------------------------------

    \102\ 8,019 advisers x 211.98 hours = 1,699,867.6 aggregate 
hours.
---------------------------------------------------------------------------

    The proposed amendments would reduce the burden of collection under 
rule 204-2. The 211.98 hour burden estimate for the currently-approved 
collection includes a requirement that investment advisers retain 
records relating to the personal securities transactions of ``advisory 
representatives.''\103\ Advisers must record the personal securities 
transactions of their advisory representatives no later than ten days 
after the close of the quarter in which the transactions takes place. 
The proposed amendments to rule 204-2 would eliminate this requirement 
and instead require the adviser to retain the personal securities 
transaction information reported to it by its access persons under 
proposed rule 204A-1. We estimate this will reduce the burden on 
investment advisers under rule 204-2 by an average of 0.3 hours for 
each of the 84 access persons we estimate are at each firm.\104\ The 
annual hour burden estimate for rule 204-2 would correspondingly be 
reduced to 186.78 hours .\105\
---------------------------------------------------------------------------

    \103\ Rule 204-2(a)(12)-(13).
    \104\ As we discuss in note 96, supra, we estimate that access 
persons would make an average of one personal securities transaction 
each year. We estimate that it would take the adviser the same time 
to record the transaction as we estimate it would take the access 
person to report it under proposed rule 204A-1, i.e. 0.3 hours. As 
we discuss in notes 91-92, supra, we estimate advisers registered 
with the Commission have an average of 84 access persons.
    \105\ 0.3 hours per access person x 84 access persons per firm = 
25.2 hours--per firm. 211.98 hours--25.2 hours = 186.78 hours.
---------------------------------------------------------------------------

    The proposed amendments to rule 204-2 would also increase the types 
of information collected under the rule. We estimate these new 
collections would increase the annual burden by 5 hours on average, to 
191.78 hours. Advisers would be required to retain the personal 
securities holdings and transaction information submitted by their 
access persons under proposed rule 204A-1 and maintain it 
electronically in an accessible

[[Page 4051]]

database.\106\ Advisers would also be required to retain copies of 
their codes of ethics required under proposed rule 204A-1, and copies 
of the written acknowledgments they receive from supervised persons 
confirming their receipt of the code of ethics or amendments. In 
addition, advisers would be required to maintain a record of the names 
of their access persons, make a record of any violation of their codes 
of ethics and any action taken, and make a record of any decision under 
proposed rule 204A-1 to permit an access person to invest in an initial 
public offering or private placement.
---------------------------------------------------------------------------

    \106\ We do not expect advisory firms would incur costs for 
computer hardware or software under this requirement. Although some 
larger firms have developed special software to obtain and review 
personal securities transactions data, we understand that all but 
the smallest firms currently use client portfolio management 
software platforms that could easily be used by firm access persons 
to report their holdings and transactions under proposed rule 204A-
1. Smaller firms could also easily require access persons to submit 
their reports in common electronic spreadsheet formats. Firms could 
also require access persons to conduct their personal securities 
activities through the same broker-dealers from which the firm 
obtains electronic reporting of client transactions, and obtain 
access persons' information electronically from the broker-dealers.
---------------------------------------------------------------------------

    Accordingly, we estimate the proposed changes to rule 204-2 would 
decrease the annual aggregate information collection burden under the 
rule by 161,983.8 hours, from 1,699,867.6 hours to 1,537,883.8 
hours.\107\
---------------------------------------------------------------------------

    \107\ 191.78 hours per adviser x 8,019 advisers = 1,537,883.8 
hours.
---------------------------------------------------------------------------

C. Form ADV

    The proposal would also amend Part II of Form ADV, which specifies 
certain information investment advisers must disclose to their 
clients.\108\ The amendment would require advisers to describe their 
codes of ethics to clients and, upon request, furnish clients with a 
copy of their code of ethics. The currently-approved burden of the 
collection of information in Form ADV is 46,921 hours. We estimate that 
each investment adviser would spend 0.25 hours preparing a description 
of its code of ethics for Form ADV. We further estimate that each 
investment adviser has 670 clients on average,\109\ and 90 percent of 
such clients will find this description sufficiently informative, so at 
most 10 percent, or 67 clients on average, would request a copy of the 
adviser's code of ethics. We estimate it would take advisers 0.1 hour 
per client to deliver copies of their codes of ethics, or 6.7 hours on 
average per adviser. Accordingly, we estimate the proposed amendments 
would increase the annual aggregate information collection burden under 
Form ADV to 102,653 hours.\110\
---------------------------------------------------------------------------

    \108\ Form ADV and Advisers Act rule 204-3 [17 CFR 275.204-3].
    \109\ See Custody of Funds or Securities of Clients by 
Investment Advisers, Investment Advisers Act Release No. 2044 (July 
18, 2002) [67 FR 48579 (July 25, 2002)].
    \110\ (0.25 hours + 6.7 hours) x 8,019 advisers = 55,732 hours. 
46,921 hours (existing total) + 55,732 hour increase = 102,653 
hours.
---------------------------------------------------------------------------

D. Request for Comment

    We request comment whether these estimates are reasonable. Pursuant 
to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to:
    [sbull] evaluate whether the proposed collections of information 
are necessary for the proper performance of the functions of the 
Commission, including whether the information will have practical 
utility;
    [sbull] evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collections of information;
    [sbull] determine whether there are ways to enhance the quality, 
utility, and clarity of the information to be collected; and
    [sbull] determine whether there are ways to minimize the burden of 
the collections of information on those who are to respond, including 
through the use of automated collection techniques or other forms of 
information technology.
    Persons wishing to submit comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Room 3208, Washington, DC 
20503, and also should send a copy to Jonathan G. Katz, Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609 with reference to File No. S7-04-04. OMB is required to 
make a decision concerning the collections of information between 30 
and 60 days after publication, so a comment to OMB is best assured of 
having its full effect if OMB receives the comment within 30 days after 
publication of this release. Requests for materials submitted to OMB by 
the Commission with regard to these collections of information should 
be in writing, refer to File No. S7-04-04, and be submitted to the 
Securities and Exchange Commission, Records Management, Office of 
Filings and Information Services, 450 Fifth Street, NW., Washington, DC 
20549.

VII. Initial Regulatory Flexibility Analysis

    The Commission has prepared the following Initial Regulatory 
Flexibility Analysis (``IRFA'') in accordance with section 3(a) of the 
Regulatory Flexibility Act.\111\ It relates to proposed rule 204A-1 and 
proposed amendments to rule 204-2 and Form ADV under the Advisers Act 
and to proposed amendments to rule 17j-1 under the Company Act.
---------------------------------------------------------------------------

    \111\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

A. Reasons for Proposed Action

    Section I of this Release describes the background and reasons for 
the proposed new rule and rule amendments. As we discussed in detail 
above, these proposals are designed to promote compliance with 
fiduciary standards by advisers and their personnel.

B. Objectives and Legal Basis

    Section II of this Release discusses the objectives of the proposed 
new rule and rule amendments. As we discuss in detail above, these 
objectives include requiring SEC-registered investment advisers to 
adopt codes of ethics for their supervised persons, requiring advisers 
to retain certain records relating to their codes of ethics, and 
requiring advisers to disclose information about their codes of ethics 
to clients. Section VIII of this Release lists the statutory authority 
for the proposed new rule and rule amendments.

C. Small Entities Subject to Rule

    The proposed new rules and rule amendments under the Advisers Act 
would govern all advisers registered with the Commission, (and the 
amendments to rule 17j-1 would govern all investment companies,) 
including small entities. Under Commission rules, for purposes of the 
Regulatory Flexibility Act, an investment adviser generally is a small 
entity if it: (i) has assets under management having a total value of 
less than $25 million; (ii) did not have total assets of $5 million or 
more on the last day of its most recent fiscal year; and (iii) does not 
control, is not controlled by, and is not under common control with 
another investment adviser that has assets under management of $25 
million or more, or any person (other than a natural person) that had 
$5 million or more on the last day of its most recent fiscal year.\112\ 
The Commission estimates that as of December 10, 2003, there were 
approximately 545 investment advisers registered with us that were 
small entities that might potentially be affected by the proposed new 
rules and

[[Page 4052]]

rule amendments.\113\ We request comment on the effect and costs of the 
proposed new rules and rule amendments on small entities.
---------------------------------------------------------------------------

    \112\ 17 CFR 275.0-7(a).
    \113\ This estimate is based on the information submitted by 
SEC-registered advisers in Part 1A of Form ADV.
---------------------------------------------------------------------------

    For purposes of the Regulatory Flexibility Act, a registered 
investment company (``fund'') is a small business or small organization 
(collectively, ``small entity'') if the fund, together with other funds 
in the same group of related investment companies, has net assets of 
$50 million or less as of the end of its most recent fiscal year.\114\ 
Of approximately 5,124 registered investment companies, we estimate 
that approximately 204 are small entities.\115\ As discussed above, the 
proposed amendment to rule 17j-1 would allow advisers to rely on a 
reporting exception in the rule if the adviser already maintains 
duplicate information under records required by certain Advisers Act 
rules. Whether this proposed amendment to rule 17j-1 would affect small 
entities would depend on whether the small entities rely on the 
reporting exception in rule 17j-1. We request comment on the effect and 
costs of this proposed amendment on small entities.
---------------------------------------------------------------------------

    \114\ 17 CFR 270.0-10.
    \115\ This estimate, which is current as of June 2003, is 
derived from analyzing information from Form N-SAR and various 
databases including Lipper. Some or all of these entities may 
contain multiple series or portfolios. If a registered investment 
company is a small entity, the portfolios or series it contains are 
also small entities.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and other Compliance Requirements

    The proposed amendment to Form ADV would impose a new reporting 
requirement on advisers, requiring that they make an additional 
disclosure statement in their brochures describing their codes of 
ethics and noting that copies of the codes are available from the 
adviser upon request. Although the proposed rule and rule amendments 
would impose no other new reporting requirements on registered advisers 
themselves, proposed rule 204A-1 would require that advisers' codes of 
ethics impose a new reporting requirement on advisers' access persons 
by requiring certain new personal securities holdings and transaction 
reports. The proposed rule and rule amendments would also create 
certain new recordkeeping and compliance requirements. The proposed 
rule amendments would impose new recordkeeping requirements by 
requiring that advisers maintain certain records pertaining to their 
codes of ethics and requirements of such codes (including records of 
personal securities holdings and transaction reports).\116\ The 
proposed rule would impose new compliance requirements by requiring 
that SEC-registered investment advisers adopt codes of ethics, obtain 
written acknowledgments of their supervised persons' receipt of copies 
of the code and any amendments, review personal securities holdings and 
transaction reports filed by their access persons, and pre-approve 
investments by their access persons in IPOs and limited offerings.
---------------------------------------------------------------------------

    \116\ These records are: copies of the codes of ethics, records 
of violations of the codes of ethics, records of personal securities 
transactions and holdings reports, records of persons subject to 
reporting under the codes of ethics, records of decisions relating 
to approvals of investments in IPOs or limited offerings, and 
records of supervised person acknowledgments of the code of ethics. 
Advisers are generally required to retain these records for five 
years.
---------------------------------------------------------------------------

    Small entities registered with the Commission as investment 
advisers would for the most part be subject to these new reporting, 
recordkeeping and compliance requirements to the same extent larger 
advisers would be. With regard to reporting of securities holdings and 
transactions and to pre-approvals of certain investments, however, 
certain small advisers, possibly including some that are small 
entities, would not be subject to the new requirements. Additionally, 
we anticipate that most advisers would very rarely need to address 
violations to their codes of ethics and, similarly, should infrequently 
be asked by an access person to consider pre-approval of an investment 
in an IPO or limited offering. Small advisers would likely deal with 
violations or IPO and limited offering pre-approvals on an even more 
limited scale due to the smaller size of their operations. Furthermore, 
it is important to note that some of the proposed reporting, 
recordkeeping and compliance requirements replace, clarify or simplify 
existing requirements to which advisers, including those that are small 
entities, are already subject. To the extent that such requirements 
clarify or simplify existing requirements, the proposed rule and 
amendments may actually alleviate reporting, recordkeeping, or 
compliance burdens on advisers, including those that are small 
entities.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate or 
conflict with the proposed rule. Proposed rule 204A-1 and the proposed 
amendments to rule 204-2 overlap with provisions of rule 17j-1 under 
the Company Act to some extent. Rule 17j-1 requires certain investment 
advisers to adopt codes of ethics, review personal securities holdings 
and transaction reports of certain access persons, and pre-approve 
certain investments by access persons. The provisions of rule 17j-1 do 
not apply to all investment advisers registered with us, but only to 
those investment advisers that advise registered investment companies. 
Furthermore, our proposed rule and rule amendments are designed to 
coordinate with, rather than duplicate or conflict with, the 
obligations of an investment adviser subject to both rules.

F. Significant Alternatives

    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objectives, 
while minimizing any adverse impact on small entities. In connection 
with the proposed rule, the Commission considered the following 
alternatives: (i) the establishment of differing compliance or 
reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the rule for such small entities; (iii) the use of 
performance rather than design standards; and (iv) an exemption from 
coverage of the rule, or any part thereof, for such small entities.
    The Commission has drafted proposed rule 204A-1 to permit each firm 
subject to the rule to design and structure its own code of ethics in 
light of the firm's operational structure and the particular types of 
conflicts encountered by the firm in connection with its business and 
clients. In the same way, the proposed amendments to rule 204-2 would 
permit each firm to develop its own system for capturing and retaining 
the requisite information. In connection with considering whether to 
establish differing reporting, compliance or recordkeeping requirements 
or timetables for small entities, as well as whether to use performance 
rather than design standards, the Commission believes at this time that 
the flexibility already built into the proposal adequately addresses 
these alternatives.
    In considering whether to attempt to further clarify, consolidate, 
or simplify the reporting, compliance and recordkeeping requirements 
under the rule for small entities, the Commission believes at this time 
that the proposal achieves the appropriate balance between simplicity 
and investor protection. The compliance requirements, which are 
integral to the effectiveness of the rule, are not

[[Page 4053]]

technical or complex in any sense. The minimum criteria specified for 
codes of ethics (including provisions for establishment of standards of 
business conduct, protection of information, personal securities 
reporting and review of such reporting, and pre-approval of certain 
transactions) under proposed rule 204A-1 are designed to further 
adherence by advisers and their personnel to their fiduciary 
obligations and to prevent misuse of material nonpublic information. At 
this time, we believe elimination of some or all of these criteria, 
which are designed to ensure that advisers address these issues in a 
systematic fashion and actively oversee supervised persons' conduct, 
would potentially impede achievement of that objective. The proposed 
disclosure requirements would provide advisory clients with information 
about the adviser's code of ethics. Different disclosure requirements 
would leave some advisory clients without the requisite information to 
assess their adviser's ethical practices. Similarly, in establishing 
the categories of records to be retained under the proposed amendments 
to rule 204-2, the records described by the rule are designed to 
provide the Commission with sufficient information to be able to 
evaluate advisers' compliance with proposed rule 204A-1 as part of its 
inspection program.
    The proposed rule would, to the greatest extent possible, 
incorporate performance rather than design standards. The rule 
enumerates few elements required for codes of ethics, allowing all 
firms, including small firms, to tailor the remainder of their codes of 
ethics to the nature and scope of their business.
    Finally, the Commission believes at this time that it would be 
inconsistent with the purposes of the Advisers Act to entirely exempt 
small entities from the proposed rule and rule amendments. The proposed 
codes of ethics are designed to promote advisers' fulfillment of their 
fiduciary duty to clients and to guard against personal securities 
trading by advisers' access persons that may be contrary to clients' 
interests. Since the protections of the Advisers Act are intended to 
apply equally to clients of both large and small advisory firms, it 
would be inconsistent with the purposes of the Act to specify different 
requirements for small entities. To the extent we were able, however, 
the Commission has excepted certain small advisers, potentially 
including some small entities, from the requirements that access 
persons make personal securities reports and that access persons obtain 
pre-approval before making certain investments.

G. Solicitation of Comment

    We encourage written comments on matters discussed in the IRFA. In 
particular the Commission seeks comment on:
    [sbull] the number of small entities that would be affected by the 
proposed rule and rule amendments; and
    [sbull] whether the effects of the proposed rule and rule 
amendments on small entities would be economically significant.
    Commenters are asked to describe the nature of any effect and 
provide empirical data supporting the extent of the effect.

VIII. Statutory Authority

    We are proposing amendments to rule 17j-1 pursuant to our authority 
set forth in sections 17(j) and 38(a) of the Investment Company Act [15 
U.S.C. 80a-17(j) and 80a-37(a)] and sections 206(4) and 211(a) of the 
Advisers Act [15 U.S.C. 80b-4 and 80b-11(a)].
    We are proposing amendments to rule 204-2 pursuant to our authority 
set forth in sections 204 and 206(4) of the Advisers Act [15 U.S.C. 
80b-4 and 80b-6(4)].
    We are proposing new rule 204A-1 pursuant to our authority set 
forth in sections 202(a)(17), 204A, 206(4) and 211(a) of the Advisers 
Act [15 U.S.C. 80b-2(a)(17), 80b-4a, 80b-6(4) and 80b-11(a)].
    We are proposing amendments to Form ADV under section 19(a) of the 
Securities Act of 1933 [15 U.S.C. 77s(a)], sections 23(a) and 28(e)(2) 
of the Securities Exchange Act of 1934 [15 U.S.C. 78w(a) and 
78bb(e)(2)], section 319(a) of the Trust Indenture Act of 1939 [15 
U.S.C. 77sss(a)], section 38(a) of the Investment Company Act of 1940 
[15 U.S.C. 78a-37(a)], and sections 203(c)(1), 204, and 211(a) of the 
Investment Advisers Act of 1940 [15 U.S.C. 80b-3(c)(1), 80b-4, and 80b-
11(a)].

Text of Proposed Rules and Form Amendments

List of Subjects in 17 CFR Parts 270, 275 and 279

    Investment companies, Reporting and recordkeeping requirements, 
Securities.
    For reasons set forth in the preamble, Title 17, Chapter II of the 
Code of Federal Regulations is proposed to be amended as follows:

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    1. The authority citation for Part 270 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *
    2. Section 270.17j-1 is amended by revising paragraph (d)(2)(iv) to 
read as follows:


Sec.  270.17j-1  Personal investment activities of investment company 
personnel.

* * * * *
    (d) * * *
    (2) * * *
    (iv) An Access Person to an investment adviser need not make a 
separate report to the investment adviser under paragraph (d)(1) of 
this section to the extent the information in the report would 
duplicate information required to be recorded under Sec.  275.204-
2(a)(13) of this chapter.
* * * * *

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    3. The general authority citation for Part 275 is revised to read 
in part as follows:

    Authority: 15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *
    4. Section 275.204-2 is amended by revising paragraphs (a)(12), 
(a)(13), and (e)(1) to read as follows:


Sec.  275.204-2  Books and records to be maintained by investment 
advisers.

    (a) * * *
    (12)(i)A copy of the investment adviser's code of ethics adopted 
and implemented pursuant to Sec.  275.204A-1 that is in effect, or at 
any time within the past five years was in effect;
    (ii) A record of any violation of the code of ethics, and of any 
action taken as a result of the violation; and
    (iii)A record of all written acknowledgments as required by Sec.  
275.204A-1(a)(6) for each person who is currently, or within the past 
five years was, a supervised person of the investment adviser.
    (13)(i)A record of each report made by an access person as required 
by Sec.  275.204A-1(b), including any information provided under 
paragraph (b)(3)(iii) of that section in lieu of such reports, all such 
information, whether from a report made by an access person or from 
information provided in lieu of

[[Page 4054]]

a report, to be maintained electronically in an accessible computer 
database;
    (ii) A record of the names of persons who are currently, or within 
the past five years were, access persons of the investment adviser; and
    (iii) A record of any decision, and the reasons supporting the 
decision, to approve the acquisition of securities by access persons 
under Sec.  275.204A-1(c), for at least five years after the end of the 
fiscal year in which the approval is granted.
* * * * *
    (e)(1) All books and records required to be made under the 
provisions of paragraphs (a) to (c)(1)(i), inclusive, and (c)(2) of 
this section (except for books and records required to be made under 
the provisions of paragraphs (a)(11), (a)(12)(i), (a)(12)(iii), 
(a)(13)(ii), (a)(13)(iii), (a)(16), and (a)(17)(i) of this section), 
shall be maintained and preserved in an easily accessible place for a 
period of not less than five years from the end of the fiscal year 
during which the last entry was made on such record, the first two 
years in an appropriate office of the investment adviser.
* * * * *
    5. Section 275.204A-1 is added to read as follows:


Sec.  275.204A-1  Investment adviser codes of ethics.

    (a) Adoption of code of ethics. If you are an investment adviser 
registered or required to be registered under section 203 of the Act 
(15 U.S.C. 80b-3), you must establish, maintain and enforce a written 
code of ethics that, at a minimum, includes:
    (1) A standard (or standards) of business conduct that you require 
of your supervised persons, which standard must reflect your fiduciary 
obligations and those of your supervised persons;
    (2) Provisions requiring your supervised persons to comply with 
applicable federal securities laws;
    (3) Provisions reasonably designed to prevent access to material 
nonpublic information about your securities recommendations and your 
clients' securities holdings and transactions, by persons who do not 
need such information to perform their duties;
    (4) Provisions that require all of your access persons to report, 
and you to review, their personal securities transactions and holdings 
periodically as provided below;
    (5) Provisions requiring supervised persons to report any 
violations of your code of ethics promptly to your chief compliance 
officer or to another person you designate in your code of ethics; and
    (6) Provisions requiring you to provide each of your supervised 
persons with a copy of your code of ethics and any amendments, and 
requiring your supervised persons to provide you with a written 
acknowledgment of their receipt of the code and any amendments.
    (b) Reporting requirements. (1) Holdings reports. The code of 
ethics must require your access persons to submit to your chief 
compliance officer a report of the access person's current securities 
holdings that meets the following requirements:
    (i) Content of holdings reports. Each holdings report must contain, 
at a minimum:
    (A) The title and exchange ticker symbol or CUSIP number, type of 
security, number of shares and principal amount (if applicable) of each 
reportable security in which the access person has any direct or 
indirect beneficial ownership;
    (B) The name of any broker, dealer or bank with which the access 
person maintains an account in which any securities are held for the 
access person's direct or indirect benefit; and
    (C) The date the access person submits the report.
    (ii) Timing of holdings reports. Your access persons must each 
submit a holdings report:
    (A) No later than 10 days after the person becomes an access 
person, and the information must be current as of the date the person 
becomes an access person.
    (B) At least once each 12-month period thereafter on a date you 
select, and the information must be current as of a date no more than 
30 days prior to the date the report was submitted.
    (2) Transaction reports. The code of ethics must require access 
persons to submit to your chief compliance officer quarterly securities 
transactions reports that meet the following requirements:
    (i) Content of transaction reports. Each transaction report must 
contain, at a minimum, the following information about each transaction 
involving a reportable security in which the access person had, or as a 
result of the transaction acquired, any direct or indirect beneficial 
ownership:
    (A) The date of the transaction, the title and exchange ticker 
symbol or CUSIP number, the interest rate and maturity date (if 
applicable), the number of shares and the principal amount (if 
applicable) of each reportable security involved;
    (B) The nature of the transaction (i.e., purchase, sale or any 
other type of acquisition or disposition);
    (C) The price of the security at which the transaction was 
effected;
    (D) The name of the broker, dealer or bank with or through which 
the transaction was effected; and
    (E) The date the access person submits the report.
    (ii) Timing of transaction reports. Each access person must submit 
a transaction report no later than 10 days after the end of each 
calendar quarter, which report must cover, at a minimum, all 
transactions during the quarter. A report must be submitted even if the 
access person had no securities transactions during the period.
    (3) Exceptions from reporting requirements. Your code of ethics 
need not require an access person to submit:
    (i) Any report with respect to securities held in accounts over 
which the access person had no direct or indirect influence or control;
    (ii) A transaction report with respect to transactions effected 
pursuant to an automatic investment plan;
    (iii) A transaction report if the report would duplicate 
information contained in broker trade confirmations or account 
statements that you hold in your records so long as you receive the 
confirmations or statements no later than 10 days after the end of the 
applicable calendar quarter.
    (c) Pre-approval of certain investments. Your code of ethics must 
require your access persons to obtain your approval before they 
directly or indirectly acquire beneficial ownership in any security in 
an initial public offering or in a limited offering.
    (d) Small advisers. If you have only one supervised person (i.e., 
yourself), you are not required to submit reports to yourself or to 
obtain your own approval for investments in any security in an initial 
public offering or in a limited offering, if you maintain records of 
all of your holdings and transactions that this section would otherwise 
require you to report.
    (e) Definitions. For the purpose of this section:
    (1) Access person means:
    (i) Any of your supervised persons:
    (A) Who has access to nonpublic information regarding any clients' 
purchase or sale of securities, or information regarding the portfolio 
holdings of any reportable fund, or
    (B) Who is involved in making securities recommendations to 
clients, or who has access to such recommendations that are nonpublic.
    (ii) If providing investment advice is your primary business, all 
of your

[[Page 4055]]

directors, officers and partners are presumed to be access persons.
    (2) Automatic investment plan means a program in which regular 
periodic purchases (or withdrawals) are made automatically in (or from) 
investment accounts in accordance with a predetermined schedule and 
allocation. An automatic investment plan includes a dividend 
reinvestment plan.
    (3) Beneficial ownership is interpreted in the same manner as it 
would be under Sec.  240.16a-1(a)(2) of this chapter in determining 
whether a person has beneficial ownership of a security for purposes of 
section 16 of the Securities Exchange Act of 1934 (15 U.S.C. 78p) and 
the rules and regulations thereunder. Any report required by paragraph 
(b) of this section may contain a statement that the report will not be 
construed as an admission that the person making the report has any 
direct or indirect beneficial ownership in the security to which the 
report relates.
    (4) Federal securities laws means the Securities Act of 1933 (15 
U.S.C. 77a-aa), the Securities Exchange Act of 1934 (15 U.S.C. 78a--
mm), the Sarbanes-Oxley Act of 2002 (Pub. L. 107-204, 116 Stat. 745 
(2002)), the Investment Company Act of 1940 (15 U.S.C. 80a), the 
Investment Advisers Act of 1940 (15 U.S.C. 80b), Title V of the Gramm-
Leach-Bliley Act (Pub. L. No. 106-102, 113 Stat. 1338 (1999), any rules 
adopted by the Commission under any of these statutes, the Bank Secrecy 
Act (31 U.S.C. 5311--5314; 5316--5332) as it applies to funds and 
investment advisers, and any rules adopted thereunder by the Commission 
or the Department of the Treasury.
    (5) Fund means an investment company registered under the 
Investment Company Act.
    (6) Initial public offering means an offering of securities 
registered under the Securities Act of 1933 (15 U.S.C. 77a), the issuer 
of which, immediately before the registration, was not subject to the 
reporting requirements of sections 13 or 15(d) of the Securities 
Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)).
    (7) Limited offering means an offering that is exempt from 
registration under the Securities Act of 1933 pursuant to section 4(2) 
or section 4(6) (15 U.S.C. 77d(2) or 77d(6)) or pursuant to Sec. Sec.  
230.504, 230.505, or 230.506 of this chapter.
    (8) Purchase or sale of a security includes, among other things, 
the writing of an option to purchase or sell a security.
    (9) Reportable fund means: (i)Any fund for which you serve as an 
investment adviser as defined in section 2(a)(20) of the Investment 
Company Act of 1940 (15 U.S.C. 80a-2(a)(20)) (i.e., in most cases you 
must be approved by the fund's board of directors before you can 
serve); or
    (ii) Any fund whose investment adviser or principal underwriter 
controls you, is controlled by you, or is under common control with 
you. For purposes of this section, control has the same meaning as it 
does in section 2(a)(9) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(9)).
    (10) Reportable security means a security as defined in section 
202(a)(18) of the Act (15 U.S.C. 80b-2(a)(18)), except that it does not 
include:
    (i) Direct obligations of the Government of the United States;
    (ii) Bankers' acceptances, bank certificates of deposit, commercial 
paper and high quality short-term debt instruments, including 
repurchase agreements;
    (iii) Shares issued by money market funds; and
    (iv) Shares issued by open-end funds other than reportable funds.

PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 
1940

    6. The authority citation for Part 279 continues to read as 
follows:

    Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1, 
et seq.

    7. Form ADV (referenced in Sec.  279.1) is amended by:
    In Part II, at the end of Item 9 add ``Describe, on Schedule F, 
your code of ethics, and state that you will provide a copy of your 
code of ethics to any client or prospective client upon request.''

    Note: The text of Form ADV does not and this amendment will not 
appear in the Code of Federal Regulations.


    Dated: January 20, 2004.

    By the Commission.
Jill M. Peterson,
Assistant Secretary.

    Note: Appendix A to the preamble will not appear in the Code of 
Federal Regulations.

Appendix A

          Key Distinctions Between Existing and Proposed Rules
------------------------------------------------------------------------
 Advisers Act Proposed Rule 204A-1    Investment Company Act Rule 17j-1
------------------------------------------------------------------------
[sbull] Code of Ethics               [sbull] Code of Ethics
    Required for each investment        Required for each investment
     adviser registered with the         adviser of a registered
     Commission..                        investment company.
[sbull] Standards of Conduct         [sbull] Standards of Conduct
    Required element of code of         Not required.
     ethics..
[sbull] Compliance with Laws         [sbull] Compliance with Laws
    Required element of code of         Not required in code of ethics.
     ethics..
[sbull] Limited Access to Material   [sbull] Limited Access to Material
 Nonpublic Information                Nonpublic Information
    Required element of code of         Not required.
     ethics..
[sbull] Internal Reporting of Code   [sbull] Internal Reporting of Code
 Violations                           Violations
    Required element of code of         Not required in code of ethics.
     ethics..
[sbull] Employee Acknowledgment      [sbull] Employee Acknowledgment
    Employee must receive copy of       Not required.
     code of ethics and acknowledge
     in writing..
[sbull] Personal Securities Trading  [sbull] Personal Securities Trading
 Reports                              Reports
    Required element of code of         Required by rule.
     ethics..
[sbull] Reporting Personnel          [sbull] Reporting Personnel

[[Page 4056]]

 
    ``Access Persons''--partners,       ``Access Persons''--any
     officers, directors,                directors, Officers, general
     employees, and certain              partners of the adviser.
     controlled persons of adviser,  ``Advisory persons''--employees and
     who have access to nonpublic     certain control persons (and their
     information about client         employees) who obtain information
     securities transactions or       regarding fund securities
     recommendations, or holdings     transactions or recommendations.
     of affiliated mutual funds..    For advisers not primarily in the
    For advisers primarily in the     business of advising funds or
     business of providing advice,    advisory clients, access persons
     all of an adviser's directors,   only include directors, officers,
     officers and partners are        general partners, or advisory
     presumed to be Access Persons..  persons, who make or who obtain
                                      information concerning,
                                      recommendations made to fund.
[sbull] Reportable securities        [sbull] Reportable Securities
 exclude:                             exclude:
    [squf] Direct obligations of        [ssbox] Direct obligations of
     the U.S. government;.               the U.S. government;
    [ssbox] Money market                [ssbox] Money market
     instruments;.                       instruments;
    [ssbox] Shares issued by            [ssbox] Shares issued by open-
     unaffiliated open-end funds         end funds.
     and money market funds..
[sbull] Personal Securities Reports  [sbull] Personal Securities Reports
    [ssbox] Initial and Annual          [ssbox] Initial and Annual
     Holdings Reports.                   Holdings Reports
    [ssbox] Quarterly Transaction       [ssbox] Quarterly Transaction
     Reports.                            and New Account Reports
[sbull] Pre-Approval of Trades       [sbull] Pre-Approval of Trades
    Required for IPO and Limited        Required for IPO and Limited
     Offering..                          Offering.
[sbull] Recordkeeping                [sbull] Recordkeeping
    [ssbox] Copies of codes of          [ssbox] Copies of codes of
     ethics;.                            ethics;
    [ssbox] Employee                    [ssbox] Records of violations of
     acknowledgments;.                   code and responses to
                                         violations;
    [ssbox] Records of violations       [ssbox] Record of all persons
     of code and responses to            required to make or review
     violations;.                        reports;
    [ssbox] List of access persons;     [ssbox] Holdings and
                                         transactions reports;
    [ssbox] Holdings and                [ssbox] Record of adviser's
     transactions reports                approval of investments in IPOs
     (electronically).                   and limited offerings.
    [ssbox] Record of adviser's
     approval of investments in
     IPOs and limited offerings..
------------------------------------------------------------------------

[FR Doc. 04-1669 Filed 1-26-04; 8:45 am]
BILLING CODE 8010-01-P