The most recent Risk Alert distributed by the Securities and Exchange Commission (“SEC”) focused on many compliance issues that have been identified relating to principal trading and cross agency transactions. The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) provided the information.
The OCIE conducts the SEC’s National Exam Program. Its mission is to protect investors, ensure market integrity, and support responsible capital formation through risk-focused strategies that improve compliance, prevent fraud, monitor risk, and inform policy. OCIE staff members promote compliance of federal securities laws through exams, outreach, and education.
In its September 4 Risk Alert OCIE disclosed findings identified from examinations of investment advisers as they relate to Section 206(3) of the Investment Advisers Act of 1940. The SEC’s interpretation of Section 206(3) imposes a prior consent requirement on any adviser that acts as principal in a transaction with a client, or that acts as broker or agent in connection with a transaction for, or on behalf of, a client.
The key takeaway? OCIE encourages advisors to review their written policies and procedures and the implementation of said policies and procedures to ensure they are compliant with principal trading and agency cross transaction provisions of the Advisers Act.
Here are some of the most common deficiencies OCIE staff members identified:
- Advisers do not appear to consistently follow the specific requirements set forth in Section 206(3). Advisers who act as principal for their own accounts had purchased securities from and sold securities to individual clients without recognizing such trades were subject to Section 206(3). As an unintended consequence, these advisers did not make the required written disclosures to their clients or obtain required client consents.
- OCIE staff members observed advisers that engaged in certain transactions involving pooled investment vehicle clients where such advisers did not appear to follow the requirements of Section 206(3). It was found that some advisers 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 and failing to provide sufficient disclosure regarding the potential conflicts of interest and terms of the transaction.
- Members of the OCIE staff observed advisers’ practices that gave rise to compliance issues in connection with agency cross transactions. Advisers 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.
- OCIE staff members observed advisers that did not have policies and procedures relating to Section 206(3) even though the advisers engaged in principal trades and agency cross transactions. OCIE staff also observed advisers that established—but failed to follow—policies and procedures regarding principal trades and agency cross transactions.
All investment advisors would be wise to review, modify, and implement their written policies procedures and practices to address the issues identified by OCIE staff. Core Compliance Legal Services can help. Contact us here or at (619) 278-0020.