Category: Alerts

SEC Risk Alert Investment Adviser Principal and Agency Cross Trading Compliance Issues

A recent Risk Alert issued by the Office of Compliance Inspections and Examinations (OCIE), provides an overview of the most common compliance issues identified in examinations related to principal trading and agency cross transactions under Section 206(3) of the Advisers Act. Four common issues were identified:

Failing to follow the specific requirements of Section 206(3). Advisers that, acting as principal for their own accounts, had purchased securities from, and sold securities to, individual clients without recognizing that such principal trades were subject to Section 206(3). Thus, these advisers did not make the required written disclosures to the clients or obtain the required client consents.

Advisers that had recognized that they engaged in principal trades with a client, but did not meet all of the requirements of Section 206(3), such as:

  • Failing to obtain appropriate prior client consent for each principal trade.
  • Failing to provide sufficient disclosure regarding the potential conflicts of interest and terms of the transaction.

Advisers that had obtained client consent to a principal trade after the completion of the transaction.

Principal Trade issues related to pooled investment vehicles. Advisers that effected trades between advisory clients and an affiliated pooled investment vehicle, but failed to recognize that the adviser’s significant ownership interests in the pooled investment vehicle would cause the transaction to be subject to Section 206(3).

Advisers that effected principal trades between themselves and pooled investment vehicle clients, but did not obtain effective consent from the pooled investment vehicle prior to completing the transactions.

Agency Cross Transactions. Advisers that disclosed to clients that they would not engage in agency cross transactions, but in fact engaged in numerous agency cross transactions in reliance on Rule 206(3)-2.

Advisers that effected numerous agency cross transactions and purported to rely on Rule 206(3)-2, but could not produce any documentation that they had complied with the written consent, confirmation, or disclosure requirements of the rule.

Policies and procedures. Advisers engaged in principal trades and agency cross trades did not have written policies and procedures in place relating to Section 206(3), in some cases advisers failed to implement or follow policies and procedures that had been established.

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OCIE encourages advisers to assess their supervisory, compliance and/or other risk management systems related to these risks and to make any changes as may be appropriate to address or strengthen their compliance program. Advisers may want to begin this process with the review of their written policies and procedures and the implementation of those policies and procedures to ensure that they are compliant with principal trading and agency cross transaction provisions of the Advisers Act and the rules thereunder.

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