SEC Issues No-Action Letter

Relating to Principal Transactions

The SEC’s Division of Investment Management recently provided no-action relief from the disclosure and consent requirements of Section 206(3) of the Advisers Act.  Section 206(3) prohibits an investment adviser, acting as a principal for its own account, from selling securities to or purchasing securities from a client without making a written disclosure to the client of the capacity in which it is acting and obtaining such client’s consent prior to completing each such transaction.

The adviser requesting no-action relief from the SEC is an investment manager to various client accounts including two private investment funds (hedge funds).  The general partner of the adviser is the sole general partner and portfolio manager to the private funds and its ownership interest in the funds is 6.2% and 1.4%.  The manager wanted to occasionally cross trades between retail advisory client accounts and private fund accounts to reduce transaction costs.

The SEC staff stated that in this situation, the disclosure and consent requirements of Section 206(3) would not apply to a transaction between a client account and a private fund account in which the ownership of the adviser is 25% or less.  However, the SEC went on to specify that the disclosure and consent requirements of Section 206(3) would certainly apply if the owner interest of the adviser exceeded 25%. 

The SEC staff noted that advisers to hedge funds with ownership interests of 25% or less may still present the opportunity for significant conflicts of interests between the adviser and its clients, which will invite detailed scrutiny of these situations by the regulator.  They also noted that such transactions are still subject to Section 206(1) and 206(2) of the Advisers Act, which impose a fiduciary duty on the adviser with respect to full and fair disclosure of all material facts to clients.  Accordingly, an investment adviser may be required to disclose information about transactions between such accounts regardless of whether Section 206(3) applies depending on the facts and circumstances present.

The no-action letter provided little guidance regarding how the 25% ownership level should be determined and future interpretive guidance is expected on this topic.

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