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A Committee of Fund Manager Personnel May Not Be Able to Provide the Requisite Consent on Behalf of the Fund for a Principal Transaction

Fund managers may wish from time to time to conduct, or for their principals or affiliates to conduct, securities transactions opposite the fund.  The Advisers Act prohibits such transactions – called “principal transactions” – where the fund manager or its principals or affiliates transact with the fund for their own account without full disclosure to, and prior consent of, the fund.  This prohibition also extends to “agency cross” trades that do not meet the requirements for exemption set forth in Rule 206(3)-2.  Agency cross trades occur when the fund adviser’s affiliate acts as broker or adviser to the counterparty to the fund rather than as the counterparty to the fund itself.  One of the conditions of the blanket consent exemption for agency cross trades is that the fund manager or its affiliate not recommend the trade to the advisory client’s counterparty.  Many agency cross trades fail to qualify for the blanket consent exemption for this reason. These prohibitions on principal transactions and agency cross trades apply regardless of whether the adviser of the fund is registered with the SEC pursuant to the Advisers Act, registered with a state, or not registered (e.g., pursuant to federal and state registration exemptions).

So what constitutes sufficient consent for a principal transaction or an agency cross trade that does not meet the blanket consent exemption?  Generally speaking, fund managers may, depending on the circumstances, rely upon a committee of underlying investors or independent third-parties to consent to principal transactions.  For registered funds, the advisers typically have the fund board periodically review and approve agency cross trades that do not qualify for the blanket consent exemption on a quarterly basis under applicable SEC no-action guidance.  Managers that do not follow these kinds of general practices, however, may be at risk.  The SEC recently settled an enforcement actionagainst a hedge fund adviser because the fund adviser’s committee that approved the trades between the hedge fund and a broker-dealer affiliated with the fund adviser was “conflicted.”  Notably, in settling the action, the SEC noted that the trades occurred at “the prevailing market price,” and the broker-dealer did not charge a mark-up. 

This settlement calls into question whether a fund manager, or committee of fund manager personnel, can provide the necessary consent for a fund in a principal transaction or agency cross trade.

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About this Author

Steve Ganis, Mintz Levin, Derivatives Litigation Attorney, AML Sanctions Lawyer
Member

Steve has over 15 years of experience as a government and private-sector lawyer practicing financial services law, specializing in the federal banking, securities, and derivatives laws. He is globally recognized for his knowledge of anti-money laundering (AML) and sanctions regulations.

He handles a wide range of matters for institutions and high-level financial services executives involving regulation of clearing and introducing broker-dealers, mutual funds, hedge funds, transfer agents, private equity funds, institutional investors, banks,...

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