What is the difference between cross trades and principal trades? The differences can be hard to spot, but they make a huge difference to the SEC. Investors should understand the difference and know what information their financial advisers should disclose before executing either a cross trade or a principal trade.

  • What is a Principal Trade?

In a principal trade, a broker is buying or selling trades from their own account. The adviser must disclose their role in the transaction and must ensure that they receive the client’s permission before they execute the transaction.

  • What is a Cross Trade?

Agency cross trades take place between brokerage accounts within the same agency. These trades may occur when a broker receives buy and sell orders for the same asset. The SEC has concerns about cross trades because the security in the cross trade might fetch a better price on a public exchange.  

Requirements for Cross Trades vs. Principal Trades?

Principal trades and cross trades are subject to different regulatory rules. Rules concerning both principal and cross trades appear in Section 206 (3) of the Investment Advisers Act of 1940. The SEC requires that firms who handle principle and cross trade transactions maintain reasonable policies for ensuring compliance with SEC rules.

Cross Trades:

  • For cross trades, agencies must keep careful records and submit the information about their trades to a clearing corporation.
  • Cross trades are allowed because they can allow an investor to get a better price than they would on the market, but they are not supposed to be purely a money-making scheme for a broker.

Principal Trades:

  • The SEC requires that principal trades execute trades according to market prices. Principal trades are designed to help brokerage firms make money but are only SEC compliant if they do so by charging fair prices.

Principal Trades, Cross Trades, and Transparency

Both types of trades occur within an agency. They both require transparency from the adviser regarding their role in the transaction, along with the written permission from the client. Cross trades and principal trades should come with disclosures about how much money brokers are making from the transactions. Disclosures are required because these types of transactions create a window for brokers to machinate transactions that work to their advantage, and not the client’s.

When a Cross Trade Becomes a Principal Trade

Things get more complicated when a broker owns part of the firm that offers financial advisory services. The SEC enforces this rule when the adviser owns 25% or more of the company. Once an advisor has a significant enough percentage of the company, the trades they execute among accounts in their own firm would fall under the definition of a principal trade.

SEC Risk Alert for Cross Trades and Principal Trades

Cross trades and principal trades can confuse even experienced investment advisers. In fact, the SEC published a Risk Alert that identified some of the most common compliance issues related to principal trading and agency cross trading. These issues included transactions in which the advisers effected trades between clients and their own pooled investment vehicles, without disclosing their interest in the investment vehicle to their client.

Did Your Broker Leave Out Important Information?

If your broker failed to reveal information about their role in a principal trade or a cross trade, you should review your investments to determine if there were unnecessary losses. For a free case review with experienced securities attorneys, call (877) 238-4175 or email info@fkesq.com.

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