The Conundrum of Compliant Employee Trading

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I have written about this subject a few times only because it is a hard subject to manage. I ran into a couple of interesting situations that may be compliance headaches without a good solution, but may be good candidates for addition to your Code of Ethics.

In one scenario, the firm invested client assets in various money managers. Each account was separate so access to individual security information was easily attainable. Some employees were mimicking the money manager’s portfolio in their own accounts. You would think this is illegal, but as far as I know it is not. Since the employee trades are being executed after the client, employees are not front-running the client. As a compliance officer it is very hard to discover this scenario and I am not sure it is worth it. It may be worth putting in your Code of Ethics that employees may not use any information attained in a portfolio, including position information, for personal gain.

In another scenario, an adviser was utilizing position level information from mutual fund companies to manage client portfolios and his personal portfolio. Typically, mutual fund companies do not report their top holdings until three to six months after the fact. As a fiduciary, this is a long time to keep the portfolio on hold before making a decision, and could lead to heavy losses. A compliance officer should ensure that all advisers have their methodology for portfolio management clear, and perform periodic tests.

Employee trading is a tough subject because it requires a clear and concise method of gathering data and managing data. There will always be instances of “gray,” like in the above examples, but continuously trying to understand how employees perform their function is a great way to catch gaps.

Ash Bhatnagar, CFP®
President
RIA Independence Co.
Princeton, N.J.

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