SEC Risk Alert Issued on Prohibited Transactions

The SEC’s Division of Examinations (formerly known as OCIE) has issued a new Risk Alert (the “Alert”) on principal and cross trades for fixed income managers. More than 20 fixed income managers were examined as part of a special study on prohibited transactions (FIX Initiative) that began more than two years ago. The investment advisers included in the study were mostly larger firms with various account types including mutual funds. The Alert focuses on Advisers Act Rule 206(3)-2 requirements and does not include any observations from mutual fund entities. Both positive and negative findings are addressed in the new Alert.

Generally, the examinations focused on disclosures, conflicts of interest, and written policies of compliance programs in relation to principal and cross trades. Both agency cross trades and client crosses were included in the cross-trade reviews. ERISA accounts were also part of the study. About two-thirds of the examined advisers received deficiency letters with most deficiencies citing compliance related issues.

Deficiencies observed by Staff included:

  • Written policies not following actual practice regarding the treatment of principal or cross trades
  • Written policies lacking sufficient direction or detail for staff to accurately follow the guidelines
  • Handling ERISA account transactions outside of contractual arrangements
  • Not testing the written compliance program via a review of trade blotters and actual trading activity
  • Conflicts of interest that were not addressed such as best execution or fees and markups
  • Omission of or poor disclosures in Form ADV Part 2A

Effective measures implemented at firms as noted by Staff included:

  • Well defined covered activities that set standards of how to address principal and cross trades so that employees were aware of compliance expectations
  • Documented testing of firm policies to uncover issues such as missing trade evaluation backup, lack of client consent, inter-positioning by brokers, or including ERISA accounts in prohibited trades
  • Written disclosure documents that provided full and fair disclosure of the transactions’ material facts
  • Multiple documents that provided the same, clear disclosures on prohibited transactions such as Form ADV Part 2A, advisory agreements, client communications, or private fund documents

The Alert provides two summary charts on findings that gives very clear information on what the Staff expects regarding compliance for both cross trades and principal trades. One chart covers standards observed and the other chart shows required disclosures.

View Risk Alert, “Observations Regarding Fixed Income Principal and Cross Trades by Investment Advisers from An Examination Initiative,” July 21, 2021