What Firms Are Getting Wrong With Their Code of Ethics

A Code of Ethics is the foundation of a firm’s commitment to integrity, transparency, and prioritizing clients.

It’s more than just a piece of paper; it’s the backbone of ethical conduct. For Registered Investment Advisers (RIAs) and broker-dealers, compliance with a Code of Ethics is mandatory. The SEC views it as a test of a firm’s compliance culture and takes violations seriously.

Let’s explore common pitfalls firms encounter with their Code of Ethics and how to avoid them.

Common Pitfalls

• Personal Trading Disclosures: Advisors must disclose all accounts they control, including personal, spousal, beneficiary, and any account they have control over. This is critical because the SEC examines personal trading activities to see if they conflict with the firm’s trading on behalf of clients. For instance, the SEC investigates whether advisors are trading against client strategies or leveraging insider knowledge. Failure to disclose these accounts can lead to serious consequences.
• Pre-Approval for Certain Investments: Many firms require pre-approval for investments, especially alternative ones, to prevent conflicts of interest. Ignoring these requirements, or simply being unaware of them, can lead to avoidable violations.
• Blacklisted Securities: Firms often maintain a “blacklist” of securities that employees are prohibited from trading. This is especially important if someone within the firm has insider information about a particular company. Trading securities on the firm’s blacklist is a clear breach of the Code of Ethics and can trigger insider trading investigations.
• Gifts and Entertainment: The Code of Ethics typically outlines rules surrounding gifts and entertainment, including the infamous “pay-to-play” rules. For example, if your firm provides services to a state pension fund and an employee makes a political contribution, the SEC could view this as an attempt to secure business through unethical means. The fallout could be severe, with the firm potentially being disqualified from providing services to the fund.
• Failure to Follow Firm Policies: Even actions not directly regulated by the SEC can violate the Code of Ethics if they breach internal firm policies outlined in compliance manuals. For example, failing to adhere to guidelines in the compliance manual after signing off on it is considered a serious compliance failure.

Proactive Measures for Compliance

• Educate Employees: Regular training sessions and updates ensure everyone understands the Code of Ethics and the consequences of non-compliance. Reinforcing these expectations is crucial.
• Monitor and Test Compliance: Regularly review personal trading, investment approvals, and policy adherence, utilizing automated tools for efficiency.
• Enforce Policies Consistently: Establish clear expectations and consequences for violations to strengthen the compliance culture. A lack of enforcement can erode the culture of compliance within the firm.
• Document Everything: Maintain thorough records of disclosures, pre-approvals, and compliance activities to provide evidence during SEC scrutiny. This well-documented trail can protect your firm if the SEC investigates.

A strong, enforced Code of Ethics protects your firm from conflicts of interest, regulatory violations, and reputational damage. It builds trust with clients and fosters accountability. Compliance isn’t just about avoiding fines; it’s about fostering trust with clients and creating a culture of accountability.

If you need to revisit your firm’s Code of Ethics, consider Compliance U. It offers a community of finance professionals and hands-on experience led by compliance attorneys and analysts to help build a robust compliance program by the end of 2025.