New SEC Rule Toughens Trading Rules for Agency Employees

Daniel Fridman

February 13, 2024

Securities Law

As a former SEC Trial Attorney, I was always particularly mindful of the trading rules imposed on SEC staff. While I always understood that the rules were intended to prevent conflicts of interest, misuse of nonpublic information for personal gain, and appearance problems—all important goals—the restrictions often stood in the way of profitable trades available to other market participants.  Well, the conflict-of-interest rules prohibiting SEC staff from certain stock trades just got stricter.

For years, SEC employees have been prohibited from buying or selling stocks of firms under SEC investigation—obviously a necessary restriction. They have also been prohibited from engaging in certain types of transactions, such as short selling and buying on margin, and have been required to obtain pre-approval for their transactions.

Today, the SEC adopted rules banning employees from owning financial-industry sector funds. A sector funds is an investment fund that only invests in businesses that operate in a particular industry or sector of the economy. They are often structured as mutual funds or exchange traded funds. Financial sector funds are investment funds that invest solely in businesses in the financial industry, such as banks. Previously, SEC employees were prohibited from investing in stocks of entities directly regulated by the SEC, such as broker-dealers and investment advisers. The new rule expands the prohibited holdings restrictions to ban employees from investing in financial industry sector funds, because employee ownership of financial industry sector funds poses similar risks of conflicts of interest and appearance concerns.

The amendments also enhance data collection by authorizing financial institutions to transmit data on SEC staff’s covered securities transactions and holdings directly to the SEC through an automated electronic system. And, in order to make the best use of the agency’s limited resources, the amendments now exempt diversified mutual funds from the Supplemental Ethics Rule’s requirements because diversified mutual funds generally pose a low risk of conflicts of interest as compared to other types of securities. Of course, mutual funds that concentrate investments in a particular sector, industry, business, state, or country other than the United States remain subject to the rules.

Alejandro Soto is a former senior official with the SEC and leads Fridman Fels & Soto, PLLC’s Securities Litigation and SEC Enforcement Practice Group.