OCIE Risk Alert – Investment Adviser Principal and Agency Cross Trading Compliance Issues

On September 4, 2019, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert to encourage advisers to review their written policies and procedures and the implementation of those policies and procedures to ensure that they are compliant with the principal trading and agency cross transaction provisions under Section 206(3) of the Advisers Act and the rules thereunder.

Under Section 206(3), advisers are required to give a client written disclosure of the capacity in which the adviser is acting and to obtain the client’s consent prior to effecting any principal or agency trade. In addition, to ensure that a client’s consent to a principal trade or agency cross transaction is informed, the adviser is required to disclose facts necessary to alert the client to the adviser's potential conflicts of interest in a principal trade or agency cross transaction. Section 206(3)-2 notes that certain agency cross transactions are permitted without disclosure and consent prior to each transaction provided specific criteria is met. OCIE noted that the most common deficiencies or weaknesses were in connection to Section 206(3) and Rule 206(3)-2.
 
OCIE observed instances where advisers engaged in principal trades but either failed to obtain appropriate client consent for each principal trade or failed to provide sufficient disclosures regarding the potential conflicts of interest and terms of the transactions or both. These failures were observed in connection with advisers who recognized they were acting in a principal capacity as well as advisers who did not realize that the transactions would be subject to Rule 206(3) (e.g., advisers that effected trades between advisory clients and an affiliated pooled investment vehicle where the advisers’ significant ownership interests in the pooled investment vehicle would cause the transaction to be subject to the rule).
 
Issues regarding agency cross transactions involved advisers relying on Rule 206(3)-2 where they either failed to disclose that they would engage in agency cross transactions or where the adviser was unable to produce any documentation demonstrating it complied with the written consent, confirmation or disclosure requirements of the rule.
 
A number of advisers did not adopt or implement written policies and procedures relating to Section 206(3) even though the advisers engaged in trades and agency cross transactions. Lastly, OCIE noted instances where advisers maintained policies and procedures surrounding principal trades and agency cross transaction but failed to follow and enforce the advisers policies and procedures.
 
For further information, read the entire report here.

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