On September 4, 2019, the Securities and Exchange Commission's Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert to encourage advisers to review their written policies and procedures and the implementation of those policies and procedures to ensure that they are compliant with the principal trading and agency cross transaction provisions under Section 206(3) of the Advisers Act and the rules thereunder.
Under Section 206(3), advisers are required to give a client
written disclosure of the capacity in which the adviser is acting
and to obtain the client's consent prior to effecting any
principal or agency trade. In addition, to ensure that a
client's consent to a principal trade or agency cross
transaction is informed, the adviser is required to disclose facts
necessary to alert the client to the adviser's potential
conflicts of interest in a principal trade or agency cross
transaction. Section 206(3)-2 notes that certain agency cross
transactions are permitted without disclosure and consent prior to
each transaction provided specific criteria is met. OCIE noted that
the most common deficiencies or weaknesses were in connection to
Section 206(3) and Rule 206(3)-2.
OCIE observed instances where advisers engaged in principal trades
but either failed to obtain appropriate client consent for each
principal trade or failed to provide sufficient disclosures
regarding the potential conflicts of interest and terms of the
transactions or both. These failures were observed in connection
with advisers who recognized they were acting in a principal
capacity as well as advisers who did not realize that the
transactions would be subject to Rule 206(3) (e.g., advisers that
effected trades between advisory clients and an affiliated pooled
investment vehicle where the advisers' significant ownership
interests in the pooled investment vehicle would cause the
transaction to be subject to the rule).
Issues regarding agency cross transactions involved advisers
relying on Rule 206(3)-2 where they either failed to disclose that
they would engage in agency cross transactions or where the adviser
was unable to produce any documentation demonstrating it complied
with the written consent, confirmation or disclosure requirements
of the rule.
A number of advisers did not adopt or implement written policies
and procedures relating to Section 206(3) even though the advisers
engaged in trades and agency cross transactions. Lastly, OCIE noted
instances where advisers maintained policies and procedures
surrounding principal trades and agency cross transaction but
failed to follow and enforce the advisers policies and
procedures.
For further information, read the entire report here.
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