The Securities and Exchange Commission’s exam division is warning advisors in a just-released Risk Alert to watch their principal trading activities, as the agency has noted numerous compliance infractions.
The SEC’s Office of Compliance Inspections and Examinations highlights in the Risk Alert the most common compliance issues identified in advisor exams related to principal trading and agency cross transactions under Section 206(3) of the Advisers Act.
Section 206(3), the agency explains, makes it unlawful for any investment advisor, directly or indirectly, acting as principal for his own account knowingly to sell any security to a client or purchase any security from a client (“principal trades”), without disclosing to such client in writing before the completion of such transaction the capacity in which the advisor is acting and obtaining the consent of the client to such transaction.
For instance, OCIE staff observed advisors 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,” the alert states.
Examiners also found advisors that had recognized that they engaged in principal trades with a client, but did not meet all of the requirements of the rule — for example, they failed to get appropriate prior client consent for each principal trade, or failed to provide sufficient disclosure regarding the potential conflicts of interest and terms of the transaction.
As to principal trade issues related to pooled investment vehicles, examiners found that advisors that engaged in certain transactions involving pooled investment vehicle clients also didn’t comply with Section 206(3).
For instance, OCIE staff observed advisors that effected trades between advisory clients and an affiliated pooled investment vehicle, but failed to recognize that the advisors’ significant ownership interests in the pooled investment vehicle would cause the transaction to be subject to Section 206(3).
The examiners also found that some advisors disclosed to clients that they would not engage in agency cross transactions, but in fact engaged in numerous agency cross transactions.
Nicolas Morgan, a partner at the global defense firm Paul Hastings in Los Angeles, told ThinkAdvisor in a Wednesday email message that “some of the more subtle issues noted by the [alert] are noteworthy — particularly trades between advisory clients and pooled investment vehicles — because apparently OCIE is encountering advisors who are not even aware of possible violations.”
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