The SEC’s Office of Compliance Inspections and Examinations (OCIE) has issued a Risk Alert describing failures by investment advisers to comply with regulatory requirements when engaging in principal and agency-cross transactions. OCIE found that many advisers did not even recognize that they were engaging in principal (direct transaction with client) or agency cross (receiving compensation on behalf of third party) transactions. For example, many advisers faltered by not recognizing that a significant ownership interest in a private fund made them principals. Also, advisers with broker-dealer affiliates often ran afoul of the agency-cross rules. The OCIE staff also criticized advisers for failing to observe the significant notice and transaction-by-transaction consent requirements. In response to this Risk Alert, OCIE “encourages advisers to review their written policies and procedures and the implementation of those policies and procedures.”
Very often, these Risk Alerts immediately precede a specialized sweep exam or a focus during regular exams. We would recommend that all advisers and compli-pros take a hard look at their principal and agency-cross transaction practices and policies.
A private fund manager agreed to pay a $500,000 fine for failing to disclose, and obtain consent for, transactions for which it acted as a broker and principal. The SEC maintains that the fund manager received compensation for two transactions whereby one advisory client purchased assets from another client. The SEC also asserts that the fund manager engaged in a principal transaction when it caused a subsidiary to purchase assets from one client and then subsequently sell them to another client. The SEC charges the firm with violating Section 206(3) of the Advisers Act for failing to provide written disclosure and obtain consent for the transactions.
OUR TAKE: Moving assets around among client funds may have been common practice before Dodd-Frank required private fund managers to register. However, Section 206(3) specifically limits such transactions by requiring notice and consent.
The Managing Director of an IA/BD was censured and order to pay disgorgement and a fine for trading with his advisory clients out of a proprietary account without advance notice and consent. The respondent arranged over 2,700 principal trades between his clients and a proprietary account over which he had trading authority. The SEC asserts that he knowingly failed to provide the required disclosure about the mark-ups received as well as obtain the advance consent to engage in principal transactions. FINRA previously barred his former firm from the industry in connection with churning allegations.
OUR TAKE: Although the regulators barred his firm, they did not stop there. The SEC will hold individuals accountable for their firms’ legal violations especially if they participated and benefited.