An adviser is a fiduciary: the adviser owes the client a duty of loyalty (put the client first, disclose and manage conflicts) and a duty of care (advice suited to the client, best execution, monitoring). This chapter covers the conduct rules that exist because employees of advisory firms see information, hold accounts and know people that can be used against clients.
Insider trading
Insider trading is trading a security while in possession of material, nonpublic information (MNPI) in breach of a duty of trust or confidence, or tipping that information to someone who trades. The prohibition comes from the antifraud rules (Exchange Act Section 10(b) and Rule 10b-5; Advisers Act Section 206) and not from a statute titled "insider trading."
- Material: a reasonable investor would consider it important to an investment decision or it would likely move the price (a pending merger, earnings before release, an FDA decision, a large contract, a pending SEC action).
- Nonpublic: not yet disseminated broadly to the investing public. Information is public once it has been disclosed in a way that lets the market absorb it, such as a press release or SEC filing.
- Insiders: classic insiders (officers, directors, employees), temporary or constructive insiders (lawyers, accountants, bankers, consultants who receive information in confidence), and people who misappropriate information from a source to whom they owe a duty. Tippers who give MNPI for a personal benefit and tippees who know or should know it was disclosed in breach of duty are both liable.
- Not insider trading: trading on research that pieces together public information and non-material nonpublic facts (the mosaic theory); trading on a rumor with no breach of duty.
- Penalties. Civil: disgorgement of profits plus a penalty of up to three times the profit gained or loss avoided; controlling persons (including a firm that failed to supervise) face the greater of $1,000,000 (the statutory figure, adjusted periodically for inflation) or three times the profit (15 U.S.C. 78u-1); criminal: up to 20 years and $5 million for an individual, and up to $25 million for an entity (15 U.S.C. 78ff). States have analogous laws.
Worked example. An analyst learns that a client company will be acquired at $60 a share, up from $45. The analyst buys 1,000 shares at $45; after the announcement the price is $58. Profit = 1,000 x (58 - 45) = $13,000. The civil penalty can reach 3 x 13,000 = $39,000 in addition to disgorging the $13,000.
What the adviser must have in place
Advisers Act Section 204A requires every registered adviser to establish, maintain and enforce written policies and procedures designed to prevent misuse of MNPI by the adviser and its associated persons. Typical controls:
- A restricted list and a watch list. When the firm holds MNPI about an issuer, it places the issuer on the restricted list and bars trading by the firm and employees.
- Information barriers ("Chinese walls") between units that hold MNPI and those that trade.
- Review of employees' personal trading and of trading before a significant announcement.
- Training, an escalation route to the chief compliance officer, and discipline.
An employee who inadvertently receives MNPI should stop trading, not tip anyone, and tell compliance, not "wait and see." Rule 10b5-1 provides an affirmative defense for trades made under a written, pre-arranged trading plan adopted before the person had MNPI; the 2022 amendments added cooling-off periods (for directors and officers, the later of 90 days after adoption or two business days after the company's 10-Q or 10-K disclosing results for the quarter in which the plan was adopted, up to a maximum of 120 days; 30 days for others) and a good-faith requirement (17 CFR 240.10b5-1(c)(1)).
Market manipulation
Manipulation is an act meant to mislead other investors about price or volume. Exchange Act Section 9(a) and 10(b) prohibit it.
| Practice | What it is |
|---|---|
| Wash sale (manipulative) | Buying and selling the same security with no change in beneficial ownership to create the appearance of volume |
| Matched orders | Two parties place offsetting orders in advance to simulate activity |
| Painting the tape | A series of trades, often between related accounts, designed to make the tape show activity or a price trend |
| Marking the close / marking the open | Placing trades near the close or open to push the reference price (used to value a portfolio or trigger a payment) |
| Pump and dump | Promoting a security with false or exaggerated statements after buying it, then selling into the price rise |
| Spoofing and layering | Entering orders with no intent to execute to move the price and then cancelling |
| Capping and pegging | Using options and orders to hold the price at or below (capping) or at a fixed level (pegging) |
| Cornering | Controlling supply to force others to pay a higher price |
| Bear raid | Short selling combined with spreading false negative rumors |
| Front running | Trading ahead of a known client order to profit from the price move it will cause |
Front running and marking the close are especially tested in the adviser context: an adviser who buys for his own account before placing a large client order, or who buys at the close to improve the month-end value of a client's account, breaches fiduciary duty.
Selling away
Selling away is when an agent or representative sells a security that the employing firm does not know about or has not approved, often a private placement, note, real estate deal or an investment product the representative also holds an interest in. For broker-dealer agents, FINRA Rule 3280 requires prior written notice to the firm and approval before any private securities transaction for compensation. (The SEC approved FINRA Rule 3290 on September 15, 2026, which will replace Rules 3270 and 3280 once FINRA announces an effective date; until then 3270 and 3280 remain in effect.) For investment adviser representatives, the issue is outside business activities and the duty of loyalty: an IAR who recommends an unapproved product to clients, particularly while receiving undisclosed compensation, violates the adviser's compliance policies and state rules on dishonest or unethical practices. Regulators in selling-away cases focus on the firm's failure to supervise because the transactions were hidden. Red flags: an employee's side business, clients writing checks to a third party instead of the custodian, and promissory-note offers. The adviser's remedy is policies requiring disclosure and approval of outside activities, and monitoring of mail and bank flows where possible.
Personal securities transactions: Rule 204A-1
An adviser must adopt a code of ethics (Rule 204A-1) that, at minimum, includes:
- Standards of conduct reflecting the adviser's fiduciary obligations.
- Compliance with federal securities laws.
- Reporting and review of personal securities holdings and transactions by access persons.
- Pre-approval of any investment in an initial public offering (IPO) or limited offering (private placement) by access persons.
- Reporting of violations promptly to the chief compliance officer.
- Delivery of the code to supervised persons and written acknowledgment of receipt.
An access person is a supervised person who has access to non-public information about clients' purchases or sales or about fund portfolio holdings, or who is involved in making securities recommendations to clients (or has access to such recommendations before they are public). If providing investment advice is the firm's business, all directors, officers and partners are presumed to be access persons.
Holdings and transaction reports
| Report | Due | Content |
|---|---|---|
| Initial holdings report | No later than 10 days after becoming an access person; information current as of a date no more than 45 days before | Title, type, ticker/CUSIP, number of shares and principal amount of each reportable security, and the broker or bank holding the account |
| Annual holdings report | At least once every 12 months, information current within 45 days | Same |
| Quarterly transaction report | No later than 30 days after quarter end | Each transaction: date, security, interest rate/maturity if any, shares and principal amount, nature (buy or sell), price, and the broker, dealer or bank |
Reports are reviewed by the CCO (or someone other than the reporting person) and retained for five years. Exceptions from reporting: direct obligations of the U.S. government, bank certificates of deposit, money market funds, shares of unaffiliated open-end funds, and holdings in accounts over which the access person has no direct or indirect influence or control (a true discretionary account). Reportable securities include ETFs, shares of affiliated funds, and private placements. A one-person firm need not report to itself.
Worked example. A portfolio analyst becomes an access person on March 1. The holdings report is due by March 11 (10 days) and must reflect holdings as of no earlier than January 15 (45 days before March 1). A transaction in a private placement on May 14 requires prior approval and appears in the quarterly report due by July 30 (30 days after June 30).
Outside securities accounts
A code of ethics typically requires employees to disclose every securities account in which they have a beneficial interest (including accounts of a spouse and dependents, and accounts they control), to maintain it at an approved broker where applicable, and to arrange for duplicate statements and trade confirmations to be sent to the compliance department. The purpose is to let compliance detect front running, trading ahead of clients, and trading on MNPI. Hiding an account is a serious violation, whatever the trades.
Other usual rules: a blackout or holding period so employees do not trade the same security on the same day as clients (or sooner), best-price allocation for aggregated orders, and a gift and entertainment policy.
Political contributions: pay-to-play
Rule 206(4)-5 is the SEC's pay-to-play rule. An adviser may not receive compensation for providing advisory services to a government entity (a state or local pension plan, a municipal fund, a 529 plan) for two years after the adviser or a covered associate makes a contribution to an official of that government entity (a person who can influence or is a candidate for an office that can influence hiring of the adviser).
- Covered associates: the adviser's general partners, managing members, executive officers, employees who solicit government clients, and the political action committees controlled by the adviser or those persons.
- De minimis exception: a natural person covered associate may give up to $350 per election to an official for whom the person can vote, and up to $150 per election to an official for whom the person cannot vote. A primary and a general election count separately.
- Return of contributions: a small mistaken contribution (not more than $350) discovered within four months may be cured if the contributor gets it back within 60 calendar days of discovery; the adviser can use this exception only a limited number of times each calendar year (two for a firm reporting 50 or fewer employees, three for larger) and only once for the same covered associate.
- Look-back: a person who becomes a covered associate is subject to the two-year ban for contributions made within two years before joining (six months if the person does not solicit government clients).
- Third-party solicitors: an adviser may not pay anyone to solicit a government entity unless that person is a regulated person (a registered broker-dealer that is a member of a registered national securities association with pay-to-play rules, a registered investment adviser, or a municipal advisor) subject to the same restrictions. Paying an unregistered friend of the mayor to get the pension business is banned.
- Bundling or soliciting contributions for an official, or paying to a political party in the state or locality, is prohibited as well (coordination).
Worked example. An executive officer who lives in State X gives $500 to a candidate for governor of State X (she can vote for that office). That is above the $350 limit. If she does not cure it, her firm cannot earn fees from State X's pension plan for two years from the contribution date. A $200 contribution to a candidate for mayor in a city where she cannot vote exceeds the $150 limit for non-voters, with the same result. A $300 contribution to a governor candidate for whom she can vote is within the exception.
Also relevant: MSRB Rule G-37 imposes a similar ban on municipal securities dealers who contribute to issuer officials, and FINRA Rule 2030 does the same for FINRA members soliciting government entities (Rule 2030, with the same two-year time-out and $350/$150 de minimis amounts).