The SEC censured and fined an investment adviser $900,000 for effecting client cross-trades at the bid price, rather than the bid-ask midpoint, thereby favoring its buying clients over its selling clients. According to the SEC, the adviser had an interest in maintaining higher prices for the subject thinly-traded municipal bonds because the adviser often had a controlling, institutional position. By using the bid price, the adviser generally favored his current clients over terminating clients. The SEC also accuses the adviser of challenging bids upward to inflate the bonds’ valuation. Although the adviser did not benefit directly, the SEC faults the firm for favoring certain clients over others and for failing to adopt policies and procedures that obtained independent broker quotes, supervised the portfolio manager, subjected prices to review by a valuation committee, and retained records.
OUR TAKE: It is very difficult to implement sufficient procedures or provide enough disclosure to sanitize the significant conflicts of interest that arise when cross-trading securities between client accounts. Our compliance advice is to avoid cross-trades and liquidate securities through an independent third party.