Let’s say Investor A and Investor B work with the same advisory firm. If Investor A wants to sell an asset and Investor B wants to buy it, a broker could conceivably complete the trade without the trade being executed through the stock exchange – the swapped assets cancel each other out. Brokers are supposed to report each trade they execute, but cross trades make it possible for a transaction to escape a regulator’s notice.

It raises suspicion with the SEC when brokers don’t report their cross trades, because these types of transactions might allow a broker to hide their sale of risky stocks to a potentially unsuitable investor. Cross trading is not allowed on most major exchanges, partly because investors might not get the best price for their security. Brokers can also charge markups for cross trades, which might motivate an unscrupulous broker to facilitate the transaction without suggesting that their client execute the sale on the exchange, where they might find a better price.

Often, cross trading occurs with penny stocks. These are issued by more obscure companies, and an investor might worry that they will not have a market on a major exchange.

Cross Trades: Benefiting Unscrupulous Advisers

Cross trading makes it more difficult for advisory firms and regulators to evaluate the legitimacy of a trade. The SEC recently fined and suspended a broker when they discovered that the broker had executed a cross trade of an unlisted Real Estate Investment Trust. These types of investments are illiquid – meaning it is difficult to withdraw money from them before their maturity date. In this case, the REITs were too over-concentrated in one of the buyer’s portfolios, given her net worth.

By cross-trading these securities, the firm’s complex products supervision group did not get to evaluate the transaction. The broker also falsified documents to make it seem as though the buyer and seller of the REIT were friends, and that the transfer of sales was a gift. This deception further underlines that the broker did not want to have this trade reviewed by his firm.  

Do Cross Trades Ever Benefit the Client?

The SEC highlights that these transactions might create a conflict of interest for the adviser, and therefore requires advisers to disclose their role in the cross trade to the client. Brokers must also disclose any markups that they charge for a cross trade.

The SEC acknowledges that there are some situations in which a cross trade could work out favorably for investors. For instance, an adviser might be able to get a better price for a security when arranging a transaction between their firm’s clients. It is possible for a client to authorize cross trades in writing, as long as the advisor provides an annual statement summarizing the cross trades that have taken place during that period, along with disclosures regarding any payment the broker has received.

Did Your Broker Tell You Everything You Need to Know?

If brokers execute a cross trade, they must disclose their role to the client before the completion of the sale of the security. They must also receive their client’s consent before completing the transaction. If you believe that your broker left out information about their role in a cross trade, you may be able to recover your losses. Contact a securities attorney at Fitapelli Kurta for a free case evaluation. Call (877) 238-4175 or email info@fkesq.com.

Leave a Comment