OCIE Risk Alert for Principal & Cross Trading Compliance

SEP 12, 2019 | PRACTUS LLP

OCIE Risk Alert for Principal & Cross Trading Compliance

Authored by Karen A. Aspinall, John H. Lively, J. Stephen King

Sept. 2019 Risk Alert: Investment Adviser Principal and Agency Cross Trading Compliance Issues

On September 4, 2019, the Office of Compliance Inspections and Examinations (OCIE) of the Securities and Exchange Commission (SEC) issued a risk alert addressing investment adviser principal and agency cross-trading compliance issues (Risk Alert).   The Risk Alert provides an overview of the most common compliance issues identified by OCIE related to principal trading and agency cross-transactions during their examinations of investment advisers.  OCIE encouraged advisers to review the content and implementation of their compliance policies and procedures to ensure that they are compliant with principal trading and agency cross-transaction provisions of the Investment Advisers Act of 1940 (Advisers Act) and the rules thereunder.  While OCIE may have the utmost respect for the late Admiral Hopper, it wants to see advisers get permission, not ask forgiveness.  

Advisers Act Provisions Governing Principal Trading and Agency Cross-Transactions

Principal Trades

Section 206(3) of the Advisers Act prohibits any investment adviser (whether registered or exempt reporting) acting as principal for its own account knowingly to (a) sell any security to a client or (b) purchase any security from a client (principal trades), unless it has:

  • disclosed to the client;
  • in writing;
  • before the transaction settles;1 
  • that the adviser is acting as principal; and
  • obtains the client’s consent.

An adviser cannot provide a blanket disclosure to a client before the fact that it will trade from time to time as principal.  Nor can an adviser obtain a blanket consent from a client to trade with it as principal.  Rather, it must provide disclosure and obtain consent each time it seeks to trade with a client as principal – blanket disclosure and consent are not permitted.

Agency Cross-Trades

Section 206(3) also prohibits an adviser, while acting as broker for a party other than an advisory client, from knowingly effecting any sale or purchase of any security for the account of that client (agency cross-transactions), without disclosing to that client in writing before the completion of the sale or purchase that the adviser is acting as a broker for the other party and obtaining the consent of the client to the sale or purchase. However, Rule 206(3)-2 under the Advisers Act permits an adviser to obtain blanket prior consent from a client to certain agency cross-transactions if, among other things: 

  • the adviser first provides the client with full written disclosure of the conflicts involved in agency cross-trades and other information required to be disclosed under the rule;
  • the client consent is in writing;
  • the adviser provides a written confirmation to the client at or before the completion of each transaction stating, among other things, the source and amount of any remuneration it received; 
  • the adviser provides a written disclosure statement to the client, at least annually, with a summary of all agency cross-transactions during the period; and 
  • the written disclosure documents and confirmations required by the rule conspicuously disclose that the client may revoke its consent at any time.

Principal and Agency Cross-Transactions with Affiliates of an Adviser

The SEC takes the position that Section 206(3) may apply to certain situations involving advisers that cause a client to enter into a principal or agency transaction through a broker- dealer that controls, is controlled by, or is under common control with, the adviser (Control Broker). 

Examples of Deficiencies Found

The staff noted a few instances where advisers were violating Section 206(3) or Rule 206(3)-2.

Failure to Comply with Section 206(3) Requirements

  • Advisers that, acting as principal for their own accounts, had purchased securities from, and sold securities to, individual clients without realizing that such principal trades were subject to Section 206(3). Thus, these advisers failed to make the required written disclosures to the clients or obtain the required client consents.
  • Advisers that had realized 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; or
    • Failing to provide sufficient disclosure regarding the potential conflicts of interest and terms of the transaction.
  • Advisers that obtained client consent only after the trade settled.   

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 interest in the pooled investment vehicle (greater than 25% of net assets) triggered the disclosure and consent requirements of 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 before completing the transactions.

Agency cross-transaction issues 

  • 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 claimed that they were relying 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.

Deficiencies Related to Policies and Procedures

  • Many advisers that engaged in principal and agency cross transactions in reliance on Section 206(3) did not have policies and procedures in place addressing compliance with that Section.
  • Other advisers that did have Section 206(3) policies and procedures in place failed to comply with them.  


Asking for forgiveness after the fact rather than permission before the fact may have worked for Admiral Grace Hopper.  With respect to principal and agency cross transactions, it may even work with an adviser’s clients.  However, it won’t work with the SEC.  

If you’re an adviser or a Control Broker and you want to enter into a single principal transaction with an advisory client, you need to need to: (i) disclose in writing the potential conflicts of interests posed by the transaction; and (ii) obtain consent to that transaction before it settles.  Each subsequent principal transaction will require its own separate disclosure and its own separate consent.  

The Authors
Karen A. Aspinall
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John H. Lively
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J. Stephen King
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Practus, LLP provides this information as a service to clients and others for educational purposes only. It should not be construed or relied on as legal advice or to create an attorney-client relationship. Readers should not act upon this information without seeking advice from professional advisers.


1The SEC interprets “completion” of a transaction to be when a transaction settles.  Commission Interpretation of Section 206(3) of the Investment Advisers Act of 1940, Investment Advisers Act Rel. No. 1732 (July 17, 1998), 63 Fed, Reg. 39505, 39507 (July 23, 1998) (“[A]n adviser may comply with Section 206(3) either by obtaining client consent prior to execution of a principal or agency transaction, or after execution but prior to settlement of the transaction.”). 

Practus, LLP provides this information as a service to clients and others for educational purposes only. It should not be construed or relied on as legal advice or to create an attorney-client relationship. Readers should not act upon this information without seeking advice from professional advisers.

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