Proposed Rule2026-21037
Investment Company Cross Trading
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
October 15, 2026
Effective
October 15, 2026
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission (the "Commission") is proposing to amend the rule under the Investment Company Act of 1940 (the "Investment Company Act") that permits securities transactions between a registered investment company and certain affiliates (referred to as "cross trades"), subject to conditions. The proposed amendments are designed to expand the scope of securities that are eligible for cross trading, modernize the rule's conditions, and enhance investor protection. The Commission also proposes to require aggregated reporting of trading activity and cross trades in Form N- PORT and Form N-MFP.
Full Text
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<title>Federal Register, Volume 91 Issue 198 (Thursday, October 15, 2026)</title>
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[Federal Register Volume 91, Number 198 (Thursday, October 15, 2026)]
[Proposed Rules]
[Pages 65622-65677]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2026-21037]
[[Page 65621]]
Vol. 91
Thursday,
No. 198
October 15, 2026
Part II
Securities and Exchange Commission
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17 CFR Parts 270 and 274
Investment Company Cross Trading; Proposed Rule
Federal Register / Vol. 91, No. 198 / Thursday, October 15, 2026 /
Proposed Rules
[[Page 65622]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 270 and 274
[Release No. IC-36358; File No. S7-2026-36]
RIN 3235-AN45
Investment Company Cross Trading
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
proposing to amend the rule under the Investment Company Act of 1940
(the ``Investment Company Act'') that permits securities transactions
between a registered investment company and certain affiliates
(referred to as ``cross trades''), subject to conditions. The proposed
amendments are designed to expand the scope of securities that are
eligible for cross trading, modernize the rule's conditions, and
enhance investor protection. The Commission also proposes to require
aggregated reporting of trading activity and cross trades in Form N-
PORT and Form N-MFP.
DATES: This proposal was published in the Federal Register on October
15, 2026. Comments should be received on or before December 14, 2026.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/comments/s7-2026-36/investment-company-cross-trading">https://www.sec.gov/comments/s7-2026-36/investment-company-cross-trading</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#3b494e575e16585456565e554f487b485e58155c544d"><span class="__cf_email__" data-cfemail="2654534a430b45494b4b434852556655434508414950">[email protected]</span></a>. Please include
File Number S7-2026-36 on the subject line.
Paper Comments
<bullet> Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-2026-36. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method of submission. The Commission will post all
comments on the Commission's website (<a href="https://www.sec.gov/rules-regulations/public-comments/s7-2026-36">https://www.sec.gov/rules-regulations/public-comments/s7-2026-36</a>). Do not include personally
identifiable information in submissions; you should submit only
information that you wish to make publicly available. We may redact in
part or withhold entirely from publication submitted material that is
obscene or subject to copyright protection.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
A summary of the proposal of not more than 100 words is posted on
the Commission's website (<a href="https://www.sec.gov/rules-regulations/2026/10/s7-2026-36">https://www.sec.gov/rules-regulations/2026/10/s7-2026-36</a>).
FOR FURTHER INFORMATION CONTACT: Alexis Hassell, Senior Counsel; Angela
Mokodean, Senior Special Counsel; or Brian M. Johnson, Assistant
Director at (202) 551-6792, Investment Company Regulation Office,
Division of Investment Management, Securities and Exchange Commission,
100 F Street NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment amendments to 17 CFR 270.17a-7 (``rule 17a-7''), Form N-PORT
(referenced in 17 CFR 274.150), and Form N-MFP (referenced in 17 CFR
274.201) under the Investment Company Act.
Table of Contents
I. Introduction
A. Overview
B. Evolution of Funds' Cross-Trading Activities and Developments
Underlying the Commission's Consideration of the Proposed Amendments
C. Current Cross Trading Considerations
D. Overview of Proposal
II. Discussion
A. Eligible Securities Expansion
B. Pricing of Cross Trades
1. NAV Pricing
2. Current Market Pricing
C. Transaction Fees
D. Best Interest Determination and Consistency With Fund
Policies and Strategies
E. Oversight
1. Responsible Parties
2. Quarterly and Annual Reviews and Reports
3. Policies and Procedures
F. Reporting
G. Recordkeeping
H. Other Amendments
I. Existing Staff No-Action Letters and Other Staff Statements
J. Transition Period
III. Economic Analysis
A. Introduction
B. Baseline
1. Regulatory Framework
2. Affected Entities
3. Market Practices
C. Benefits and Costs
1. Expansion of Eligible Securities To Include Level 2
Securities
2. Pricing of Cross Trades
3. Transaction Costs and Fees
4. Best Interest Determination and Consistency With Fund
Policies and Strategies
5. Oversight Requirements
6. Reporting
7. Recordkeeping
D. Aggregate Monetized Benefits and Costs
1. Aggregate Monetized Benefits and Costs Across Affected
Entities
2. Present Values and Annualized Values of Aggregate Monetized
Benefits and Costs
E. Efficiency, Competition, and Capital Formation
1. Efficiency
2. Competition
3. Capital Formation
F. Reasonable Alternatives
1. Allowing Cross Trades in Any Security
2. Alternative Approaches To Pricing Cross Trades
3. Trade-Level Reporting Alternatives for Cross Trades
G. Request for Comment
IV. Paperwork Reduction Act
A. Introduction
B. Rule 17a-7
C. Form N-PORT
D. Form N-MFP
E. Request for Comment
V. Initial Regulatory Flexibility Analysis
A. Reason for and Objectives of the Rule and Form Amendments
B. Legal Basis
C. Small Entities Subject to Rule and Form Amendments
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. Reporting
2. Recordkeeping
3. Oversight Requirements
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
G. Request for Comment
VI. Congressional Review Act
VII. Other Matters
Statutory Authority
I. Introduction
A. Overview
Section 17 of the Investment Company Act prohibits certain
transactions with a registered investment company (a ``registered
fund'') by its ``affiliated persons'' and their ``affiliated persons.''
\1\ Under
[[Page 65623]]
section 17(a), an affiliated person of a registered fund, or an
affiliated person of such a person, is generally prohibited from
knowingly selling any security or other property to, or purchasing any
security or other property from, the registered fund when acting as a
principal. This prohibition protects registered funds and their
investors against overreaching or self-dealing by the registered fund's
adviser, directors, and other affiliated persons by prohibiting
affiliated transactions where one of the parties has both the ability
and the pecuniary incentive to influence the actions of the investment
company.\2\
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\1\ See 15 U.S.C. 80a-17. Under section 2(a)(3) of the
Investment Company Act, an ``affiliated person'' of a registered
fund is generally defined to include: (1) directors, officers,
employees, and the investment adviser; (2) any person owning 5% or
more of the registered fund's voting securities; (3) any person in
which the registered fund owns 5% or more of the voting securities;
and (4) any person directly or indirectly controlling, controlled
by, or under common control with the registered fund. See 15 U.S.C.
80a-2(a)(3).
\2\ See, e.g., Investment Trusts and Investment Companies:
Hearings on S. 3580 Before a Subcomm. of the Senate Comm. on Banking
and Currency, 76th Cong., 3d Sess., at 256-59 (1940).
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These provisions, among other things, prohibit cross trades, that
is, where a registered fund sells a portfolio investment to, or
purchases a portfolio investment from, another fund or other person
that is an affiliated person of the registered fund (or an affiliated
person of such affiliated person).
In cases where there is no overreach, however, cross trades may
benefit registered funds in several ways. For example, cross trades
allow affiliated registered funds to avoid some of the costs associated
with open market trades, such as brokerage commissions, bid-ask
spreads, and other transaction expenses, when buying and selling
securities with affiliated parties. Thus, section 17(b) of the
Investment Company Act provides that the Commission shall issue
exemptive orders to permit principal transactions with affiliates,
including cross trades, when evidence establishes that certain criteria
are satisfied. These criteria are:
(1) The terms of the transaction, including the consideration paid
and received, are reasonable and fair and do not involve overreaching;
(2) The transaction is consistent with each concerned registered
fund's disclosed policies; and
(3) The transaction is consistent with the general purposes of the
Investment Company Act.\3\
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\3\ See 15 U.S.C. 80a-17(b).
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To eliminate the need to file and process exemptive applications in
situations where it appears likely that these statutory protections
would be satisfied, the Commission adopted rule 17a-7 to permit cross
trades of certain securities, subject to protective conditions that are
based upon the requirements of section 17(b).\4\
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\4\ See Exemption of Certain Purchase or Sale Transactions
Between Affiliated Registered Investment Companies, Investment
Company Act Release No. 4697 (Sept. 8, 1966) [31 FR 12092 (Sept. 16,
1966)] (``1966 Adopting Release'').
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Rule 17a-7 allows cross trades between a registered fund and
certain of its affiliates (including affiliated registered funds and
others who share a common investment adviser) (``eligible
affiliates''), subject to the following conditions: \5\
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\5\ Eligible affiliates include an affiliated person of the
registered fund, or an affiliated person of an affiliated person of
the fund, that is: (1) another registered fund (including separate
series); (2) another series of the same registered fund; or (3)
another person whose affiliation is solely by reason of having a
common investment adviser (or affiliated investment advisers),
common directors, and/or common officers.
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<bullet> The security that is cross traded has readily available
market quotations;
<bullet> There is no brokerage commission, fee (except customary
transfer fees), or other remuneration paid in connection with the cross
trade, and no consideration involved other than cash payment against
prompt delivery of the security; and
<bullet> The cross trade is consistent with the policy of each
registered fund participating in the trade.
Further, the rule places certain responsibilities upon a registered
fund's board of directors (a ``board'') to adopt cross-trading
procedures, oversee the registered fund's cross trades, and monitor
potential conflicts. Specifically, the registered fund's board
(including a majority of directors who are not interested persons of
the registered fund) must adopt procedures reasonably designed to
ensure that cross trades comply with rule 17a-7 and must approve
changes to those procedures as the board deems necessary. The
registered fund's board must also determine, no less frequently than
quarterly, that all cross trades made during the preceding quarter
complied with the procedures. The rule also requires the board to
satisfy certain registered fund governance standards.\6\ Additionally,
each participating registered fund must maintain certain records
relating to its cross-trading procedures and transactions.
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\6\ See 17 CFR 270.0-1(a)(7).
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Separate from section 17(a) of the Investment Company Act, cross
trading also involves considerations under the Investment Advisers Act
of 1940 (the ``Advisers Act''). Investment advisers have fiduciary
duties to their clients, including registered funds, under the Advisers
Act to serve the best interests of their clients and to seek best
execution of a client's transactions.\7\ In addition, section 206(3) of
the Advisers Act prohibits an investment adviser, directly or
indirectly, from knowingly selling any security to or purchasing any
security from a client without disclosing to the client the capacity in
which the adviser is acting and obtaining the client's consent to the
transaction.\8\ Rule 17a-7 currently does not provide exemptive relief
from any provisions of the Advisers Act, and the proposed amendments
likewise would not provide exemptive relief from these provisions.
Compliance with rule 17a-7 also does not relieve a party engaging in a
cross trade involving an Employee Retirement Income Security Act
(``ERISA'') plan from complying with applicable ERISA provisions.
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\7\ See, e.g., Commission Interpretation Regarding Standard of
Conduct for Investment Advisers, Advisers Act Release No. 5248 (June
5, 2019) [84 FR 33669 (July 12, 2019)] (``Standard of Conduct
Release'').
\8\ 15 U.S.C. 80b-6(3).
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Business development companies (``BDCs'') are also subject to
restrictions on affiliated transactions under section 57 of the
Investment Company Act. Section 57 differs in some respects from the
provisions for registered funds under section 17.\9\ Pursuant to
section 57(i) of the Investment Company Act, until the Commission
adopts rules for BDCs under section 57, BDCs are permitted to rely on
rule 17a-7 to the extent that rule 17a-7 would permit a cross trade
that section 57 would otherwise restrict. This release primarily
focuses on the restrictions of section 17 of the Investment Company Act
and therefore refers to registered funds throughout, but BDCs may rely
on rule 17a-7 unless the Commission adopts BDC-specific rules under
section 57 of the Investment Company Act in the future. The discussion
in this release applies equally to BDCs.
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\9\ For example, section 57 creates different categories of
affiliated transactions and permits certain types of affiliated
transactions if approved by both a majority of a BDC's directors or
general partners who have no financial interest in the transaction
and a majority of directors or general partners who are not
interested persons of the BDC. 15 U.S.C. 80a-56.
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B. Evolution of Funds' Cross-Trading Activities and Developments
Underlying the Commission's Consideration of the Proposed Amendments
In 1966, when the Commission first adopted rule 17a-7, trades in
equity securities were subject to substantial brokerage charges. The
rule served the interests of investors by permitting affiliated funds
to transact with each other, and thus avoid the payment of these
brokerage charges, in situations where the Commission was likely to
grant an exemption under section 17(b).\10\ As a result, Rule 17a-7
initially was limited to cross trades of equity securities that were
traded on a national
[[Page 65624]]
securities exchange and for which objective pricing information was
available on the exchange.\11\
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\10\ See 1966 Adopting Release, supra note 4.
\11\ The Commission later amended the rule to include securities
transactions entered into on a national inter-dealer quotation
system that met certain conditions. See Exemption for Securities
Traded in Over-the-Counter Market and Change in Annual Report Form
N-1R, Investment Company Act Release No. 8494 (Sept. 13, 1974) [39
FR 36002 (Oct. 7, 1974)].
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In the early 1980s, recognizing that funds at that time
increasingly invested in securities that traded over the counter but
had an active trading market that generated independent pricing
information, the Commission expanded the scope of rule 17a-7 to apply
to trades involving any security for which market quotations are
readily available.\12\ The Commission did not define the term ``readily
available market quotations'' at that time. Because the rule was no
longer limited to equity securities, over time, registered funds came
to rely on rule 17a-7 to cross trade fixed-income securities as well.
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\12\ See Exemption of Certain Purchase or Sale Transactions
Between a Registered Investment Company and Certain Affiliated
Persons Thereof, Investment Company Act Release No. 11676 (Mar. 10,
1981) [46 FR 17011 (Mar. 17, 1981)] (``1981 Adopting Release'').
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When expanding rule 17a-7 to permit cross trades of over-the-
counter securities, the Commission also amended the rule's pricing
provisions to require that these trades be priced at the average of the
highest current independent bid and lowest current independent offer
determined on the basis of reasonable inquiry. Historically, to meet
this ``reasonable inquiry'' standard, registered funds obtained
multiple bids and offers from broker-dealers for an over-the-counter
security. In 1981, when the reasonable inquiry standard was adopted,
quotes for fixed-income securities were generally obtained by calling
individual broker-dealers on the phone.
Since that time, markets have undergone significant technological
and structural changes, leading to pricing that is more verifiable,
accessible, and transparent. For instance, fixed-income markets have
seen developments in transparency, with Trade Reporting and Compliance
Engine (TRACE) and Real-Time Transaction Reporting System (RTRS)
reporting for many segments of the markets.\13\ In addition, there have
been improvements in price discovery with the rise of electronic
trading platforms, which can provide enhanced pre- and post-trade
transparency. This includes, for example, systems that electronically
display continuous trading interest (or ``stream axes'') in a security
or type of security on the system and ``request for quote'' (or
``RFQ'') systems that are designed to allow market participants to
obtain quotes for a particular security by sending messages to one or
multiple potential respondents on the system simultaneously. Fixed-
income exchange-traded funds (``ETFs''), which trade throughout the day
and reflect what the market believes to be the price of their
underlying portfolios, also can serve as meaningful price discovery
vehicles.\14\ Moreover, many registered funds engage third-party
pricing services to provide pricing information.\15\ In the context of
cross trading municipal securities, certain letters from the Division
of Investment Management staff (``staff'') have addressed a fund's use
in cross trades of the price provided by an independent pricing service
that values the fund's municipal securities for purposes of determining
the fund's net asset value (``NAV'').\16\
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\13\ FINRA's TRACE (introduced in 2002) is an over-the-counter
real-time price dissemination service for eligible fixed-income
securities, and MSRB's RTRS has provided real-time information about
transactions in municipal securities since 2005. See <a href="https://www.finra.org/sites/default/files/TRACE_Overview.pdf">https://www.finra.org/sites/default/files/TRACE_Overview.pdf</a> and <a href="https://www.msrb.org/Market-Transparency-Programs">https://www.msrb.org/Market-Transparency-Programs</a>.
\14\ See, e.g., M. Tucker & S. Laipply, Bond Market Price
Discovery: Clarity Through the Lens of an Exchange, 39 J. of
Portfolio Mgmt. 49 (2013).
\15\ See, e.g., Good Faith Determinations of Fair Value,
Investment Company Act Release No. 34128 (Dec. 3, 2020) [86 FR 748
(Jan. 2, 2021)] (``Valuation Rule Adopting Release''), at section
II.A.4.
\16\ See, e.g., United Municipal Bond Fund, SEC Staff No-Action
Letter (Jan. 27, 1995) (``United No-Action Letter''); Federated
Municipal Funds, SEC Staff No-Action Letter (Nov. 20, 2006)
(``Federated No-Action Letter''). The statements in these letters
and any other staff statements or guidance referenced in this
release represent the views of Commission staff. Any such staff
statements are not a rule, regulation, or statement of the
Commission. Further, the Commission has neither approved nor
disapproved their content. These statements, like all staff
statements, have no legal force or effect, do not alter or amend
applicable law, and create no new or additional obligations for any
person.
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The evolution of the registered fund industry in part drove
increased demand to cross trade fixed-income securities. In the last
twenty years, registered funds that invest primarily in fixed-income
instruments have expanded from around $1.5 trillion in assets to
approximately $7.9 trillion.\17\ Further, according to an industry
survey, registered funds engaged in more than $200 billion in cross
trades of fixed-income securities in 2020 alone, resulting in estimated
savings for those registered funds and their shareholders of over $300
million.\18\
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\17\ See 2005 Investment Company Institute Fact Book, available
at <a href="https://www.ici.org/doc-server/pdf%3A2005_factbook.pdf">https://www.ici.org/doc-server/pdf%3A2005_factbook.pdf</a>; 2026
Investment Company Factbook, available at <a href="https://www.icifactbook.org/pdf/2026-factbook.pdf">https://www.icifactbook.org/pdf/2026-factbook.pdf</a>.
\18\ See Letter of the Investment Company Institute (Apr. 9,
2021) (``ICI Letter''). The survey authors estimated that fixed
income cross trading represents approximately 3.7% of the registered
funds' total fixed income trading activity. This letter was provided
in response to a 2021 Commission staff statement on investment
company cross trading. See infra note 24. We discuss this survey and
other information about the amount of registered funds' cross-
trading activities in different markets in more detail in section
III.B.3.
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In December 2020, the Commission adopted 17 CFR 270.2a-5 (``rule
2a-5'') under the Investment Company Act, which addresses fund
valuation practices and the board's role with respect to the fair value
of a fund's investments.\19\ Among other things, rule 2a-5 defines the
term ``readily available market quotations'' because the requirement to
determine a security or other asset's fair value under the Investment
Company Act and rule 2a-5 applies to securities and assets for which
there are no readily available market quotations.
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\19\ See Valuation Rule Adopting Release, supra note 15.
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Rule 2a-5 provides that market quotations are readily available
with respect to a security only when that ``quotation is a quoted price
(unadjusted) in active markets for identical investments that the fund
can access at the measurement date, provided that a quotation will not
be readily available if it is not reliable.'' \20\ This definition is
consistent with the definition of a level 1 input in the fair value
hierarchy outlined in U.S. generally accepted accounting principles
(``GAAP'').\21\ However, this definition practically excludes most
fixed-income securities from meeting the readily available market
quotation standard because fixed-income securities trade infrequently
and thus usually do not have active markets that provide the direct
observable pricing inputs necessary to meet the standard.\22\
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\20\ See rule 2a-5(c); Valuation Rule Adopting Release, supra
note 15.
\21\ See Financial Accounting Standards Board Accounting
Standards Codification (``ASC'') Topic 820-10-20. ASC Topic 820
categorizes inputs to valuation techniques used to measure fair
value into three levels. The fair value hierarchy gives the highest
priority to quoted, observable inputs (level 1) and the lowest
priority to unobservable inputs (level 3).
\22\ We understand that most fixed-income securities are not
level 1 securities for U.S. GAAP purposes but rather are typically
classified as level 2 securities.
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Because a security must have readily available market quotations to
be eligible to be cross traded under current rule 17a-7, fixed-income
securities that previously were cross traded under the rule prior to
the adoption of rule 2a-5 generally have not been eligible for
[[Page 65625]]
cross trading since September 8, 2022, the compliance date of rule 2a-
5.\23\ The Commission acknowledged in adopting rule 2a-5 that certain
securities might become ineligible for cross trading under the new
rule. The Commission also noted that consideration of amendments to
rule 17a-7 was on its rulemaking agenda and welcomed input from the
public as it considered potential revisions to the rule.
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\23\ See Valuation Rule Adopting Release, supra note 15, at
n.359 and accompanying text (``[t]he definition of readily available
market quotations that we are adopting will apply in all contexts
under the Investment Company Act and the rules thereunder, including
rule 17a-7''). However, certain earlier letters by our staff
address, among other things, the application of rule 17a-7 in the
context of certain municipal securities transactions where there
were no readily available market quotations. See, e.g., United No-
Action Letter; Federated No-Action Letter. These letters were not
withdrawn in connection with the adoption of rule 2a-5.
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In March 2021, the staff issued a statement on investment company
cross trading (the ``Staff Statement'').\24\ The Staff Statement noted
that staff was assessing whether amendments to rule 17a-7 were
warranted in light of the developments arising from the adoption of
rule 2a-5 and the evolution of registered funds' cross-trading
practices over the last several decades, and solicited feedback on a
number of relevant issues.\25\ Response letters generally favored
amending rule 17a-7 to allow cross trading of fixed-income securities
subject to protective conditions, while expressing differing views
about the specifics of such conditions.
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\24\ See Division of Investment Management Staff Statement on
Investment Company Cross Trading (Mar. 11, 2021), available at
<a href="https://www.sec.gov/newsroom/speeches-statements/investment-management-statement-investment-company-cross-trading-031121">https://www.sec.gov/newsroom/speeches-statements/investment-management-statement-investment-company-cross-trading-031121</a>. Unless
otherwise indicated, letters cited in this release are the public
responses to the Staff Statement, which are available at <a href="https://www.sec.gov/investment/engaging-investment-company-cross-trading">https://www.sec.gov/investment/engaging-investment-company-cross-trading</a>. In
this release, we generally refer to these public responses as
``letters'' or ``response letters,'' and we generally refer to the
members of the public submitting the letters as ``respondents.''
\25\ Specifically, the Staff Statement sought feedback on: (1)
registered funds' current cross-trading practices; (2) pricing and
liquidity requirements relating to determining the eligibility of
securities to cross trade under rule 17a-7; (3) controls by
registered funds and advisers relating to cross trading; and (4)
issues relating to market transparency of cross trading.
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Members of the public have suggested other ways to improve cross
trading of fixed-income securities beyond issues relating to the
adoption of rule 2a-5. For example, some response letters suggested
that rule 17a-7's pricing conditions, which for fixed-income securities
require obtaining multiple bids and offers from broker-dealers who will
not execute the transaction, should not be the sole permissible method
of pricing such cross trades and presented challenges at times.\26\
Similarly, the Fixed Income Market Structure Advisory Committee
(``FIMSAC'') issued recommendations in 2020 related to investment
company cross trading.\27\ FIMSAC's recommendations (which discussed
cross trading prior to the changes brought about by rule 2a-5's
adoption) suggested expanding rule 17a-7's pricing conditions for cross
trades of fixed-income securities meeting the definition of a level 1
or level 2 security under GAAP to allow, for example, the use of
independent pricing sources like those used to determine a registered
fund's NAV.\28\
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\26\ See, e.g., Letter of MarketAxess (Apr. 9, 2021)
(``MarketAxess Letter''); Letter of the Securities Industry
Financial Markets Association Asset Management Group (Apr. 12, 2021)
(``SIFMA AMG Letter'') (stating that obtaining bids and offers for
certain fixed-income securities had become difficult, if not
impossible, for funds due to a reduced willingness on the part of
dealers to provide such market pricing information); Letter of T.
Rowe Price (Apr. 14, 2021) (``T. Rowe Letter'').
\27\ See FIMSAC Recommendation Regarding Modernizing Rule 17a-7
under the 1940 Act (June 1, 2020) (``FIMSAC Recommendations''),
available at <a href="https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-recommendation-internal-fund-cross.pdf">https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-recommendation-internal-fund-cross.pdf</a>.
\28\ See FIMSAC Recommendations. FIMSAC also advocated for the
use of electronic trading platforms to determine pricing, subject to
certain protective conditions.
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Respondents also suggested that rule 17a-7's requirements regarding
conflict oversight, and the role that registered fund boards play in
that oversight, deserve renewed attention.\29\ For example, the rule's
requirement that a registered fund's board review the fund's cross
trades on a quarterly basis predates the enhancements to registered
fund compliance programs mandated by 17 CFR 270.38a-1 (``rule 38a-1'')
which, among other things, placed responsibilities for administering a
registered fund's compliance policies and procedures upon the fund's
chief compliance officer (``CCO''). Consistent with rule 38a-1, in
2018, the staff stated that it would not recommend enforcement action
to the Commission if a registered fund's board receives a written
representation from the fund's CCO that transactions effected in
reliance on rule 17a-7 complied with the procedures adopted by the
board, instead of the board itself determining such compliance.\30\ A
number of respondents suggested that the Commission amend rule 17a-7 to
formally relieve boards of the responsibility for reviewing
transaction-specific cross-trading information and instead require
procedures whereby boards periodically review and analyze reports from
registered fund CCOs.\31\ Some also suggested that, if the Commission
expands the scope of securities and pricing methods for cross trades,
it could also consider requirements related to policies and procedures,
post-trade forensic testing, and board or CCO oversight as sufficiently
protective measures.\32\
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\29\ See, e.g., Letter of the Investment Adviser Association
(Apr. 11, 2021) (``IAA Letter'').
\30\ See Independent Directors Council, SEC Staff No-Action
Letter (Oct. 12, 2018) (``IDC No-Action Letter''). This no-action
position also applied to similar requirements in 17 CFR 270.10f-3
and 17 CFR 270.17e-1.
\31\ See, e.g., ICI Letter; T. Rowe Letter.
\32\ See, e.g., FIMSAC Recommendations; ICI Letter; SIFMA AMG
Letter.
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Some respondents and FIMSAC also suggested expressly allowing
registered funds to pay certain fees in connection with effecting cross
trades, such as custodial fees related to transferring securities or
fees charged by an electronic trading platform for effecting a cross
trade.\33\ In addition, market participants have expressed different
views related to the transparency and reporting of cross-trading
activity.\34\
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\33\ See, e.g., SIFMA AMG Letter; Letter of Wellington
Management Company LLP (Apr. 12, 2021) (``Wellington Letter'');
FIMSAC Recommendations.
\34\ See, e.g., SIFMA AMG Letter; FIMSAC Recommendations; Letter
of Dimensional Fund Advisors LP (Apr. 21, 2021) (``Dimensional
Letter'').
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C. Current Cross Trading Considerations
While markets have changed significantly since the Commission first
adopted rule 17a-7 in 1966, response letters to the Staff Statement
identify benefits that cross trades continue to offer to registered
funds and their investors. For example, cross trading can help a
registered fund avoid transaction costs that it would otherwise incur
in open market transactions and counterparty risks.\35\ Cross trading
also can help a registered fund avoid market impacts, including price
movement and price uncertainty, if the registered fund seeks to
increase or reduce a position that is large enough to move the price of
that security, and can provide greater execution speed and certainty
relative to open market transactions.
---------------------------------------------------------------------------
\35\ See, e.g., ICI Letter; Wellington Letter; SIFMA AMG Letter.
For example, if a bond is trading on the open market with a bid of
$100.00 and an ask of $100.50, then a selling fund would receive
$100.00 for the bond in the open market, while a buying fund would
pay $100.50 for the bond. If the funds instead cross traded the
bond, they could transact at the midpoint price of $100.25 and each
realize a benefit of $0.25.
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Apart from potential benefits in transaction costs and pricing,
cross trades can provide registered funds access to difficult to obtain
securities that an advisory client might otherwise sell into the market
due to redemption
[[Page 65626]]
activity or other portfolio management considerations. Cross trading
also can provide an alternative source of liquidity for a selling
registered fund where an affiliated fund or other account would benefit
from purchasing the security in the cross trade, which can be an
important benefit if few broker-dealers maintain an inventory of the
security. Because of these benefits, it continues to be an appropriate
use of our authority under sections 6(c) and 17(b) of the Investment
Company Act to exempt cross-trading activity, subject to appropriate
controls to prevent abuse or overreach.\36\
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\36\ Under section 6(c) of the Investment Company Act, the
Commission may by rule, regulation, or order exempt any person or
transaction or any class of persons or transactions from any
provision of the Act if and to the extent that such exemption is
necessary or appropriate in the public interest and consistent with
protection of investors and the purposes fairly intended by the
policy and provisions of the Act. See 15 U.S.C. 80a-6(c).
---------------------------------------------------------------------------
While cross trades can provide significant benefits, cross trades
also can implicate conflicts of interest in that an adviser may have
the incentive, and ability, to favor one client over another to achieve
higher advisory fees or other benefits for the adviser. These conflicts
can lead to a registered fund being disadvantaged by its adviser in
favor of higher-fee paying clients or other accounts, particularly when
a security or other instrument is thinly traded. Examples of possible
cross-trading abuses include:
<bullet> ``Parking,'' where an adviser may pre-arrange a cross
trade with the intent to purchase the securities back at prices that
disadvantage clients and evade regulatory oversight.\37\
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\37\ See, e.g., In the Matter of Morgan Stanley Investment
Management Inc. and Sheila Huang, Investment Company Act Release No.
31947 (Dec. 22, 2015) (settled enforcement action alleging that a
portfolio manager prearranged trades between affiliates at prices
that favored certain clients over others and effected such trades
through a broker-dealer to evade the firm's internal cross-trade
procedures); In the Matter of Western Asset Management Co.,
Investment Company Act Release No. 30893 (Jan. 27, 2014) (settled
enforcement action alleging engagement in dealer-interposed cross
trades at prices that favored one side over another).
---------------------------------------------------------------------------
<bullet> ``Cherry-picking,'' where more desirable investments are
cross traded to a favored or more profitable client.\38\
---------------------------------------------------------------------------
\38\ See, e.g., In the Matter of SeaCrest Wealth Management,
LLC, Advisers Act Release No. 6788 (Dec. 12, 2024) (settled
enforcement action alleging that block trades were allocated among
client accounts in a manner that favored some accounts over others).
---------------------------------------------------------------------------
<bullet> ``Dumping'' where less desirable investments are cross
traded to a less favored client.\39\
---------------------------------------------------------------------------
\39\ See, e.g., In the Matter of Macquarie Investment Management
Business Trust, Investment Company Act Release No. 35325 (Sept. 19,
2024) (settled enforcement action alleging internal and dealer-
interposed cross trades that were executed at prices that deviated
from current market prices, causing certain purchasing accounts
(primarily registered funds) to absorb trading losses that otherwise
would have been borne by the selling unregistered pooled investment
vehicles).
---------------------------------------------------------------------------
As a result, cross trading must be subject to appropriate
conditions, and registered funds must have effective and robust
oversight mechanisms to guard against these potential conflicts.
Cross trading also has the potential to negatively affect price
discovery and market integrity if large volumes of trades occur between
affiliated parties. Unlike open market transactions, information about
individual cross trades, such as the price, size, and instrument
involved in the trade, generally is not publicly reported. The lack of
transparency about the prices at which cross trades are effected may
negatively affect the market's price discovery processes. Similarly,
the lack of information about the volume of cross trades may distort
perceptions of the liquidity of a particular asset class or market. The
lack of cross-trade information may reduce the broader market's ability
to accurately assess the value of certain securities or asset classes.
As a result, some degree of transparency about funds' cross-trading
activities is necessary.
D. Overview of Proposal
We propose to modernize and expand rule 17a-7 to better allow cross
trades that are beneficial to registered funds and their shareholders,
while also updating the rule's conditions to ensure effective investor
protection: \40\
---------------------------------------------------------------------------
\40\ The exemptions proposed would be necessary and appropriate
in the public interest and consistent with the protection of
investors and the purposes fairly intended by the policy and
provisions of the Investment Company Act.
---------------------------------------------------------------------------
<bullet> Expand securities eligible to be cross traded. We propose
to expand the types of securities eligible for trading under the rule
to include securities that the registered fund values based on inputs
that are observable, either directly or indirectly. This change would
permit cross trading of most fixed-income securities under the proposed
rule because observable inputs are available for most fixed-income
securities. The proposed change would limit the universe of securities
eligible for trading under the rule to securities that have an
independent basis for pricing, including those with readily available
market quotations and observable inputs, to reduce the risk of
subjectivity, bias, or error in determining the price of the cross
trade.
<bullet> Updated pricing conditions. Recognizing the current
pricing conditions may not be well suited to modern markets, we propose
to update the pricing conditions of the rule to require the cross trade
be effected using one of two pricing methods, which would be considered
the independent current market price for purposes of the rule. The
first pricing method would use the value of the security determined in
the registered fund's next computation of NAV. Under the second method,
the cross trade would be effected at a price that the registered fund's
investment adviser determines reasonably represents the current market
price for the security using one or more unaffiliated pricing sources.
If the registered fund uses the second method, the fund's investment
adviser would be required to periodically review the reasonableness of
these prices.
<bullet> Conflict oversight and recordkeeping. In lieu of the
rule's current board oversight requirements, the proposal would make a
number of changes to the current rule designed to enhance investor
protection and allocate oversight responsibility in an effective
manner. In the first instance, the registered fund's adviser would be
required to determine prior to effecting a transaction that the
proposed cross trade is in the best interest of the fund. Additionally,
the registered fund's CCO would be required to perform quarterly
reviews of cross trades to determine compliance with the rule and
report the results to the fund's board. The CCO would also be required
to conduct at least annual back testing of cross trades, which must
include analyses of the ultimate prices realized when any security
purchased by a fund through a cross trade is ultimately sold, to look
for patterns suggesting disadvantages to the fund relative to
affiliates and report the results to the board. Funds would be required
to maintain and preserve records of each cross trade, the information
and material used by the CCO to make the required determinations
(including the information and material used to determine at least
quarterly whether the conditions of the rule were satisfied for each
cross trade and for the at least annual disposition-based and other
back-testing to identify potential abuses), and reports provided to the
board.
<bullet> Reporting. Registered funds do not currently report
information about their cross trades in a structured way. Additional
reporting about a fund's cross-trading activity in the context of its
overall trading activity would help investors, the Commission, and
other market participants better understand the scope and breadth of
cross-trading activities and how these activities relate
[[Page 65627]]
to, and affect, other reported market information. The proposal would
add requirements for registered funds that engage in cross-trading
activities to report--on Form N-PORT and Form N-MFP--aggregate
information, by asset class, about the value of securities a registered
fund traded during the preceding month and corresponding information
about cross-trading activity by asset class.
<bullet> Other modernizations. The proposed rule 17a-7 amendments
would also expressly permit de minimis payments to unaffiliated parties
for services such as clearing, settlement, and custody. In addition,
the proposed amendments would provide that a cross trade must be
consistent with the registered fund's policies and investment
strategies. For clarity, we also propose to add defined terms to the
rule related to the registered funds that may rely on the rule and the
eligible affiliates with which they may cross trade. The proposed
defined terms would not modify these aspects of the current rule.
II. Discussion
A. Eligible Securities Expansion
We propose to amend rule 17a-7 to expand the scope of securities
that are eligible to be cross traded under the rule. The proposed
amendments would permit cross trading of securities that would be
valued by a registered fund based on inputs that are observable, either
directly or indirectly, in addition to those with readily available
market quotations.\41\ By expanding the eligible securities for funds
to cross trade to include those with observable inputs, the proposal is
designed to expand the benefits of cross trading to more transactions
while protecting investors by ensuring that there is an independent
basis for determining the price of the security.
---------------------------------------------------------------------------
\41\ See proposed rule 17a-7(b)(1).
---------------------------------------------------------------------------
Rule 17a-7 currently restricts the scope of securities that are
eligible to be cross traded to securities for which market quotations
are readily available.\42\ In 1981, when the Commission amended the
rule to include this condition, the Commission stated that reliance on
readily available market quotations provides an independent basis for
determining that the terms of the transaction are fair and reasonable
to each participating registered fund and do not involve
overreaching.\43\ The Commission further stated that this condition
would limit cross trading to securities that trade in active secondary
markets, making the securities more likely to have independent pricing
information available.\44\
---------------------------------------------------------------------------
\42\ See current rule 17a-7(a).
\43\ See 1981 Adopting Release, supra note 12.
\44\ Id.
---------------------------------------------------------------------------
Rule 2a-5 under the Investment Company Act, which the Commission
adopted in 2020, defines readily available market quotations to mean
that there is a quoted price (unadjusted) in active markets for
identical investments that the fund can access at the measurement date,
provided that a quotation will not be readily available if it is not
reliable.\45\ This definition is consistent with the definition of a
``level 1'' input in the fair value hierarchy outlined in U.S.
GAAP.\46\ A security is considered to have readily available market
quotations if its value is determined solely by reference to level 1
inputs.\47\ Under the proposed rule 17a-7 amendments, funds would
continue to be allowed to cross trade securities that have readily
available market quotations as defined in rule 2a-5 (i.e., level 1
securities).
---------------------------------------------------------------------------
\45\ See rule 2a-5(c).
\46\ See Valuation Rule Adopting Release, supra note 15, at
section II.D; ASC Topic 820-10-20.
\47\ See id., at paragraph accompanying n.336.
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We understand that most fixed-income securities that registered
funds seek to trade do not have readily available market quotations
because, among other reasons, they are not frequently traded in the
secondary market and therefore are not valued solely by reference to
level 1 inputs. As discussed above, such securities generally have not
been eligible to cross trade since the compliance date for rule 2a-
5.\48\ The Commission also understands that cross trading fixed-income
securities could provide benefits to registered funds and registered
fund shareholders, including, for example, lower transaction costs and
access to difficult to obtain securities.\49\
---------------------------------------------------------------------------
\48\ See current rule 17a-7(a); supra note 23 and accompanying
text.
\49\ See, e.g., Lina Han et. al., Cross Trading in in the
Corporate Bond Market, SMU Cox Sch. of Bus., Research Paper No. 25-
15 (2025) (stating that registered funds may benefit from cross
trading due to, among other things, the funds avoiding transaction
costs and obtaining difficult to obtain bonds); ICI Letter (stating
that amending rule 17a-7 to permit registered funds to cross trade
fixed-income securities, subject to certain conditions, would
benefit funds and investors by lowering transaction costs).
---------------------------------------------------------------------------
To recognize those benefits while still protecting investors, we
propose to expand the scope of securities that are eligible to be cross
traded under the rule to include securities that are valued by
registered funds based on inputs that are observable, either directly
or indirectly (``level 2 securities''). This proposed change--that a
security valued based on direct or indirect observable inputs would be
eligible--is designed to be consistent with the current definition of a
level 2 input in the fair value hierarchy outlined in U.S. GAAP.\50\
Level 2 inputs include, for example, quoted prices for similar
securities in active markets, quoted prices for identical or similar
securities in non-active markets, and inputs other than quoted prices
that are observable for the security, such as credit spreads or
interest rates and yield curves that are observable at commonly quoted
intervals.\51\ For purposes of the proposed rule, we would consider a
security to be valued based on inputs that are observable, either
directly or indirectly, only to the extent that level 2 inputs are the
lowest level of inputs that are significant to the entire
measurement.\52\
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\50\ See ASC 820-10-20; ASC 820-10-35-47 (providing that level 2
inputs are inputs other than quoted prices included within level 1
that are observable for the asset or liability, either directly or
indirectly). Observable inputs are those that are developed using
market data, such as publicly available information about actual
events or transactions, and that reflect the assumptions that market
participants would use when pricing the security. See ASC 820-10-20
(defining ``observable inputs'').
\51\ See ASC 820-10-35-48.
\52\ See ASC 820-10-35-37A (providing that where the inputs used
to measure the fair value of an asset or liability are categorized
within different levels of the fair value hierarchy, the fair value
measurement is categorized in its entirety in the same level of the
fair value hierarchy as the lowest level of input that is
significant to the entire measurement).
---------------------------------------------------------------------------
Although level 2 securities do not have readily available market
quotations like level 1 securities, they do have other observable
inputs, such as quoted prices or prices for similar assets, that can be
independently verified and often have multiple pricing sources
available. Requiring observable pricing inputs for cross trading
eligibility reduces the potential for overreaching of the registered
fund by the adviser, and would increase the likelihood that the terms
of a cross trade are fair and reasonable to each participating
registered fund consistent with the provisions for exemptive relief
under section 17(b) of the Investment Company Act. Therefore, we
propose to expand the scope of securities that are eligible to be cross
traded to include securities that would be valued by the registered
fund based on inputs that are observable, either directly or
indirectly, which we understand would include many fixed-income
securities.\53\
---------------------------------------------------------------------------
\53\ According to an industry survey, 99.6% of the fixed-income
securities that funds that responded to the survey cross traded in
2020 were classified as level 2 securities. See ICI Letter.
---------------------------------------------------------------------------
Securities valued based on unobservable inputs that are significant
[[Page 65628]]
to the entire measurement (i.e., ``level 3'' inputs under U.S. GAAP) or
that are non-leveled under U.S. GAAP (i.e., investments that are not
categorized within the fair value hierarchy, certain private fund-
issued securities that are valued using those private fund shares' NAV
as a practical expedient) would not be eligible for cross trading under
the proposal.\54\ Given the conflicts of interest implicated by cross
trades and the importance of the transaction price to ensure that a
cross trade is fair and reasonable to each participating registered
fund and does not involve overreaching, we propose to permit cross
trading under rule 17a-7 only of securities corresponding to assets
whose fair value measurement is categorized as level 1 or level 2
within the current U.S. GAAP fair value hierarchy.\55\ The proposed
approach is designed to focus on securities that have an independent
basis for pricing, including those with readily available market
quotations and observable inputs, thus reducing the risk of
subjectivity, bias, or error in determining the price of the cross
trade.
---------------------------------------------------------------------------
\54\ See, e.g., ASC 820-10-35-51 (``An adjustment to a Level 2
input that is significant to the entire measurement might result in
a fair value measurement categorized within Level 3 of the fair
value hierarchy if the adjustment uses significant unobservable
inputs''); ASC 820-10-15-4 through 15-5; ASC 820-10-35-59 through
35-62 (permitting a security that does not have a readily
determinable fair value to be valued based on the issuer's net asset
value per share (or its equivalent) as a practical expedient under
certain circumstances).
\55\ Overall, registered funds' holdings of level 3 investments
are small in comparison to level 1 and level 2 investments. For
example, based on a review of Form N-PORT filings as of February
2026, less than 1% of the total value of all reporting funds'
investments were in level 3 investments. Of the investments that
funds reported as level 3, it was more common for investments in the
loan, equity preferred, and real estate asset classes to be reported
as level 3 than investments in other asset classes.
---------------------------------------------------------------------------
These proposed amendments are designed to allow cross trading of
securities that have an independent basis for pricing the trade as they
are less likely to raise the same concerns regarding overreaching that
rule 17a-7 was designed to address. This, in combination with the
proposal's other conditions, are designed to expand the benefits of
cross trading to more funds and shareholders while protecting investors
from the conflicts of interest implicated by cross trades.
We request comment on the proposed eligible securities
requirements.
1. Instead of expanding the rule to include level 2 securities,
should we further broaden or narrow the scope of securities that are
eligible for cross trading? If so, which securities should be eligible
for cross trading, why, and under what circumstances? Do those
securities have an independent basis for valuation and low risk of
subjectivity, bias, or error in determining the price of a cross trade,
thus making it more likely that the terms of the cross trade would be
fair and reasonable to each participating fund?
2. If we allow funds to cross trade a broader scope of securities
than proposed (e.g., all or certain types of level 3 securities),
should we include other conditions beyond those that we propose? Should
those conditions apply to cross trades of all permitted securities, or
only to certain types of securities? How would those conditions address
the potential for overreaching or conflicts of interest when securities
may lack an independent, observable basis for valuation? For example,
should we require prior trade-by-trade board or board committee
approval, including by a majority of directors who are not interested
persons of the fund, for cross trades of securities that are not level
1 or level 2 securities, or additional pricing, documentation,
escalation, and post-trade review processes to verify pricing fairness
for cross trades of such securities (e.g., the cross-trade price must
be aligned with the valuation determined for purposes of the fund's
NAV, portfolio managers must obtain advance written approval from the
fund's board or CCO to cross trade these securities, the fund must
report details of these cross trades to the Commission or the public,
or cross trades of these securities must be reviewed by the CCO and
reported to the board more frequently than the quarterly reviews the
proposal would require)?
3. Are there any types of securities that registered funds
currently cross trade under rule 17a-7 that would no longer be eligible
to cross trade under the proposed amendments to rule 17a-7?
4. Are there securities that would be included within the scope of
the proposed eligibility conditions that commenters believe should not
be eligible for cross trading? If so, which securities and why?
5. The proposed approach tracks concepts in current U.S. GAAP
related to valuation. Should we use these concepts for defining the
scope of eligible securities that registered funds can cross trade? Are
there potential unintended consequences that could arise from linking
the rule to concepts in current U.S. GAAP? Should we use a different
approach to define the scope of eligible securities and, if so, what
approach should we use for this purpose? For example, should the scope
of eligible securities be based on asset class?
6. Rather than limit the scope of securities that registered funds
can cross trade, should we permit funds to cross trade any security
provided that other conditions of the rule are met? If funds should be
permitted to cross trade any security, please explain why other
conditions in the rule would be sufficient to address overreaching and
conflicts of interest or whether there are additional conditions that
should apply to such cross trades.
B. Pricing of Cross Trades
We propose to amend rule 17a-7 to provide two alternative methods
for pricing cross trades. Under the proposal, a cross trade would be
effected at the independent current market price, which for purposes of
rule 17a-7 would be either:
(1) The value of the security determined in the registered fund's
next net asset value computation on the business day of the cross trade
(``NAV pricing''); or
(2) A price that reasonably represents the current market price, as
determined by the registered fund's adviser using one or more
unaffiliated pricing sources (``current market pricing''), provided
that the adviser periodically reviews the reasonableness of such
prices.\56\
---------------------------------------------------------------------------
\56\ See proposed rule 17a-7(b)(2).
---------------------------------------------------------------------------
The proposed pricing provisions are designed to recognize
developments since the Commission last amended this aspect of the rule,
including the availability of more verifiable, accessible, and
transparent pricing information, and the adoption of rule 2a-5, which
led to enhancements to the regulatory framework for fund valuations.
The proposal is designed to help address conflicts of interest that
could incentivize cross trading at a price that is more favorable to an
eligible affiliate than to the registered fund.
Rule 17a-7 currently prescribes different methods for determining
the price of a cross trade, depending principally on whether the
security is exchange listed or traded over the counter. For example,
for most listed equity securities other than options, the price of the
cross trade is the last sale price with respect to the security
reported in the consolidated transaction reporting system or, if there
are no reported transactions that day, the average of the highest
current independent bid and lowest current independent offer for such
security. For fixed-income securities and other securities traded over
the counter, in contrast, the price of the cross trade is the average
of the highest current independent bid and lowest current
[[Page 65629]]
independent offer determined on the basis of reasonable inquiry.\57\ As
discussed above, prior to the adoption of rule 2a-5, registered funds
cross traded some fixed-income securities. We understand that
registered funds cross trading such securities generally satisfied the
rule's pricing requirements by gathering multiple bids and offers from
broker-dealers.\58\
---------------------------------------------------------------------------
\57\ See current rule 17a-7(b).
\58\ See, e.g., United Municipal Bond Fund, SEC Staff No-Action
Letter (July 30, 1992).
---------------------------------------------------------------------------
Several letters in response to the Staff Statement and other staff
outreach addressed the rule's current pricing requirements, including
feedback that the pricing provisions should be broader and more
flexible. For example, some suggested that funds should be able to
price cross trades using multiple inputs and sources of data, including
independent evaluated prices and broker-dealer quotes.\59\ Some
supported use of independent pricing sources providing evaluated prices
that are used for valuation purposes under rule 2a-5.\60\ In light of
this feedback, the improvements in transparency and price discovery
methods available, as well as the significant diversity in how
different types of investments are priced, the pricing requirements of
the proposed rule are designed to provide funds with the ability to
price a cross trade flexibly and efficiently while maintaining investor
protections. We also recognize that price discovery methods are likely
to continue to evolve, and the proposed approach is intended to be
dynamic rather than identifying particular pricing sources that funds
must or may use.
---------------------------------------------------------------------------
\59\ See, e.g., ICI Letter; IAA Letter; Letter of Capital Group
(May 6, 2021) (``Capital Group Letter'').
\60\ See, e.g., ICI Letter; Capital Group Letter; DFA Letter.
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In addition to proposing to expand the scope of securities eligible
for cross trading by registered funds beyond those with readily
available market quotations (level 1 securities) to also include
securities valued based on directly or indirectly observable inputs
(level 2 securities), we propose that each cross trade would be
effected at the independent current market price determined using one
of two pricing methodologies, either NAV pricing or current market
pricing. A registered fund may switch between the two pricing
methodologies for different cross trades. Pricing under the proposal
would be subject to controls and oversight. If a fund uses NAV pricing
for cross trades, the price of a cross trade would be subject to
existing valuation processes and oversight procedures compliant with
rule 2a-5 designed to ensure those prices are reasonable. If a fund
uses current market pricing for cross trades, it would need to develop
processes and oversight procedures to support the determination that
the price reasonably represents the current market price and to comply
with the proposed requirement for the adviser to periodically review
the reasonableness of these prices. This approach is intended to
address concerns respondents raised about the existing pricing
provisions while promoting reasonable and fair pricing of cross trades.
These pricing-specific conditions are designed to work with other
proposed controls and oversight to promote investor protection, such as
the investment adviser's best interest determination.
1. NAV Pricing
We propose to amend rule 17a-7 to provide that a cross trade could
be effected at the price determined by using NAV pricing. The
transaction would be effected at the value the registered fund ascribes
to the security in its next computation of the registered fund's
current net asset value under section 2(a)(41) of the Investment
Company Act and 17 CFR 270.2a-4 (``rule 2a-4'') and rule 2a-5 on the
business day on which the transaction occurs. By leveraging existing
valuation processes that are already subject to robust controls and
oversight, the NAV pricing approach is designed to be a cost-effective
method of pricing cross trades that would limit the potential for
abuses.
Under this proposed approach, the cross-trade price would be
determined by the registered fund's next computation of its NAV on the
business day of the cross trade. Many registered funds make NAV
determinations at the close of business each day, and some funds--such
as some money market funds and ETFs--make NAV determinations intra-day.
Under the proposal, the registered fund would use the value determined
in the next NAV computation on that day, whether it is at close of
business or intra-day. Registered funds, such as some closed-end funds,
that do not compute their NAVs on a daily basis would be permitted to
use the NAV pricing approach only on days that their NAVs are computed.
If a cross trade involves two registered funds, the registered funds
must share the same valuation processes so that they would arrive at
the same price using the NAV pricing approach. For registered funds
that have valuation processes, such as the pricing sources used, that
could result in different valuation outcomes under the NAV pricing
approach, the cross-trade price could only be determined under the
current market pricing approach.
The NAV pricing approach would establish a standard that is
consistent with the registered fund's valuation policies and procedures
and that would apply to all types of securities that funds may cross
trade, while allowing for differences in how various types of
securities are priced. Specifically, when using NAV pricing, the cross-
trade price would be either the current market value (in the case of
securities with readily available market quotations) or the fair value
(in the case of other securities and assets) based on observable inputs
determined in the registered fund's next NAV computation.\61\
---------------------------------------------------------------------------
\61\ See section 2(a)(41) under the Investment Company Act; 17
CFR 270.2a-4; 17 CFR 270.2a-5.
---------------------------------------------------------------------------
The proposed rule would not, however, permit use of the amortized
cost value of a security that some money market funds are permitted to
use for purposes of computing their NAVs under 17 CFR 270.2a-7 (``rule
2a-7''). An amortized cost method of valuation values portfolio
securities at their acquisition cost as adjusted for amortization of
premium or accretion of discount, rather than valuing securities based
on current market factors. Current rule 17a-7 requires cross trades to
be effected at the ``current market price,'' and our proposed
amendments similarly focus on market-based pricing. Money market funds
that use the amortized cost method of valuation are separately required
to calculate their NAVs using available market quotations (or an
appropriate substitute that reflects current market conditions) at
least daily, and they could use those NAV prices under the proposed NAV
pricing approach.\62\
---------------------------------------------------------------------------
\62\ See 17 CFR 270.2a-7(g)(1).
---------------------------------------------------------------------------
Registered funds relying on this approach would use the same
pricing methodologies to determine the cross-trade price as they use
for fund valuations. A fund would not be required to determine the
cross-trade price separately, which should result in an efficient and
cost-effective pricing process. This approach is designed to allow many
cross trades to leverage existing processes.
We propose the NAV pricing approach because it utilizes an existing
methodology with robust processes, subject to rule 2a-5, to determine
the price for the cross trade. These processes and controls would
decrease the likelihood of inappropriate values for cross trading
purposes and help address conflicts of interest while
[[Page 65630]]
preserving the benefits of cross trading, such as reduced execution
costs. Further, because NAV pricing is derived from a fund's own
valuation processes, which are themselves already subject to
significant board oversight and scrutiny, this pricing method benefits
from the same rigor and independence that governs the fund's broader
valuation framework.\63\ This is expected to provide an additional
layer of protection against conflicts of interest that can incentivize
pricing a cross trade to the disadvantage of the registered fund and
its shareholders relative to the eligible affiliate. In addition,
because NAV pricing relies on the fund's valuation processes, we would
expect any improvements to valuation techniques to apply to NAV
pricing, which would improve cross trade pricing over time.
---------------------------------------------------------------------------
\63\ See, e.g., Valuation Rule Adopting Release, supra note 15,
at nn.191-220 and accompanying text (outlining guidance on board
oversight of the valuation process).
---------------------------------------------------------------------------
2. Current Market Pricing
Additionally, we propose to amend rule 17a-7 to provide that a
cross trade could be effected at a price determined by the registered
fund's investment adviser to reasonably represent current market price
for the security using one or more unaffiliated pricing sources,
provided that the adviser periodically reviews the reasonableness of
such prices.\64\ Similar to the valuation process underlying NAV
pricing, current market pricing may take into account multiple inputs
and sources of data. Additionally, current market pricing may be used
at any time, including intra-day, unlike NAV pricing, which would be
determined by the registered fund's next computation of its NAV on the
business day of the cross trade. The adviser, in using any unaffiliated
pricing source, first would need to determine that the price reasonably
represents the current market price for the security and also would
need to periodically review the reasonableness of the prices used under
this provision.
---------------------------------------------------------------------------
\64\ Proposed rule 17a-7(b)(2)(ii).
---------------------------------------------------------------------------
We understand that it is not always practical or possible for
registered funds to use NAV pricing to price cross trades. For example,
a registered fund may wish to effect a cross trade intra-day, before
the fund's next NAV computation, which is often at the close of
business. Additionally, to analyze compliance with the rule's
conditions, an adviser may find it more efficient to have all
information about the potential cross trade, including pricing
information, available at the time of the trade decision, instead of
waiting for an end of day valuation process to be completed. As another
example, for registered funds that do not compute their NAVs on a daily
basis (e.g., some closed-end funds), a registered fund may wish to
effect a cross trade on a day on which the fund will not compute its
NAV. Using the current market pricing approach, the adviser might
reasonably determine that using the same valuation methodology for the
security as the fund would use if it were computing its NAV on that day
would reasonably represent the current market price for the
security.\65\ In these and other situations, allowing a registered
fund's investment adviser to determine a cross-trade price that
reasonably represents the current market price for the security using
unaffiliated pricing sources would further promote the cost-saving
benefits of cross trading while helping address conflicts of interest.
---------------------------------------------------------------------------
\65\ The registered fund, however, would not be required to
value each of the securities in the registered fund or determine NAV
for the registered fund in order to determine the price for the
particular security being cross traded.
---------------------------------------------------------------------------
Determination That a Price Reasonably Represents the Current Market
Price
Using the proposed current market pricing approach, the registered
fund's investment adviser would be required to determine the price that
reasonably represents the current market price for the security being
cross traded using one or more unaffiliated pricing sources. Consistent
with funds' valuation methodologies and the current pricing provisions
in rule 17a-7, the adviser's analysis of current market price and
sources for unaffiliated pricing information would generally vary by
asset type. A security with readily available market quotations must
have quoted prices in active markets that the registered fund can
access and that are reliable.\66\ For these securities, the adviser
should look to the prices at which a particular security is being
traded and quoted in active markets to determine a price that
reasonably represents the current market price. For example, for cross
trades of listed equity securities, it generally would be appropriate
to use either the last reported sale price or, if there are no reported
transactions on that day, the average of the highest current
independent bid and the lowest current independent offer. This would be
consistent with the current rule's asset-specific pricing requirements.
Although we propose to remove these asset-specific pricing requirements
in favor of standards that can be applied across permissible asset
types, we do not intend for the proposed amendments to change how funds
price cross trades of listed equity securities with readily available
market quotations and continue to view the current rule's requirements
as an appropriate way to comply with the proposal.
---------------------------------------------------------------------------
\66\ See rule 2a-5(c).
---------------------------------------------------------------------------
For securities that do not have readily available market
quotations, a registered fund's investment adviser would use observable
inputs from one or more unaffiliated pricing sources to determine a
price that reasonably represents the current market price for the
security. Registered funds already use various unaffiliated pricing
sources, such as pricing services that provide evaluated prices by
using matrix or model-based pricing methodologies, to support their NAV
determinations. Broker-dealer quotes may continue to provide valuable
pricing inputs. In addition, newer and developing sources, such as
electronic trading platforms, may provide observable inputs to help
determine price for some asset types, and we also understand that some
pricing services are offering intra-day evaluated prices. These
available unaffiliated pricing sources may be used by a registered
fund's investment adviser to determine a price that reasonably
represents the current market price for a cross trade. The proposal
would also allow developing technologies and new unaffiliated pricing
sources to be used.
Under the proposal, the pricing sources an investment adviser uses
would need to be unaffiliated. The proposed rule would define
``unaffiliated'' to be a person other than an affiliated person or
promoter of, or principal underwriter for, a fund (e.g., a first-tier
affiliate) or an affiliated person of such entities (e.g., a second
tier affiliate), consistent with the coverage of section 17(a).\67\
Requiring the pricing sources to be unaffiliated reduces the potential
for conflicts of interest between the registered fund and the adviser
and is designed to increase the likelihood that the terms of a cross
trade are fair and reasonable to each participant and do not involve
overreaching, consistent with section 17(b) of the Investment Company
Act. The current rule similarly provides that cross trades must be
effected at the independent current market price.\68\
---------------------------------------------------------------------------
\67\ See proposed rule 17a-7(d).
\68\ See current rule 17a-7(b).
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Regardless of the type of security or the unaffiliated pricing
source used, the proposal would require the adviser to make a
determination that the price of the cross trade reasonably represents
the current market price for the security.
[[Page 65631]]
There are different ways an adviser might make this determination
before executing a cross trade, and the approach may vary based on the
type of security or the unaffiliated pricing source used. For example,
an investment adviser considering the use of broker-dealer quotes as an
unaffiliated pricing source generally should confirm with more than one
broker-dealer that the quotes reflect current market conditions, are
timely, are binding, and are verifiable (based on real transactions or
other similar available quotes). These and any other appropriate
factors would help inform an adviser's consideration of whether an
average price based on the highest bid and lowest offer from the
broker-dealers reasonably represents the current market price for the
security. ``Indications of interest'' or ``accommodation quotes''
(i.e., non-firm expressions of interest to trade at a given price)
would not reasonably represent the current market price of a security
for purposes of cross trades under proposed rule 17a-7.\69\
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\69\ This is consistent with prior Commission statements related
to current rule 17a-7. See Investment Company Liquidity Risk
Management Programs, Investment Company Act Release No. 32315 (Oct.
13, 2016) [81 FR 82142 (Nov. 18, 2016)] (``Liquidity Rule Adopting
Release'') at nn.800-801 and accompanying text.
---------------------------------------------------------------------------
Similarly, an investment adviser considering the use of prices from
a pricing service as an unaffiliated pricing source, including for
intra-day evaluated prices for securities that do not have readily
available market quotations, should conduct due diligence on the
service and its methodologies to determine whether prices provided by
the service can be reasonably determined to represent current market
value for the security. In this due diligence, an adviser could
consider factors such as:
<bullet> The qualifications, experience, and history of the pricing
service, particularly in providing intra-day pricing;
<bullet> The pricing methods or techniques, inputs, and assumptions
the pricing service uses for different classes of holdings, how they
are affected (if at all) as market conditions change, and, if the same
pricing service is used for both NAV computation and current market
pricing, how these methods or techniques may differ;
<bullet> The quality of the pricing information the service
provides and the timing of the service's determination of pricing
information relative to the timing of the cross trade;
<bullet> The pricing service's process for considering pricing
challenges, including how the pricing service incorporates information
received from pricing challenges into its pricing information;
<bullet> The pricing service's actual and potential conflicts of
interest (e.g., potential conflicts associated with maintaining
continuing business relationships and the potential incentive to
provide higher or more aggressive prices to retain business) and the
steps the pricing service takes to mitigate such conflicts; and
<bullet> The testing processes the pricing service uses, especially
for newer technologies such as intra-day pricing information.\70\
---------------------------------------------------------------------------
\70\ See Valuation Rule Adopting Release, supra note 15, at
paragraph accompanying n.117 (discussing similar factors for
consideration when using pricing information provided by a pricing
service in determining the fair values of the fund's investments).
---------------------------------------------------------------------------
Allowing registered funds' investment advisers to determine cross-
trade prices that reasonably represent current market prices using
unaffiliated pricing sources such as pricing services and broker-dealer
quotes is consistent with allowing registered funds to use these
sources as part of a registered fund's NAV computation. In addition,
improvements to the pricing process as a result of the adviser's
evaluation of current market price could improve the NAV computation
process.\71\ Similar to registered funds' valuation considerations, a
registered fund relying on the current market pricing approach should
select and apply in a consistent manner the methodologies the adviser
uses to determine a price that reasonably represents the current market
price.\72\ To the extent a fund uses the same pricing source for both
NAV computation and current market pricing, it may combine the due
diligence on the same vendor for both purposes and would not need to
conduct a separate due diligence process.
---------------------------------------------------------------------------
\71\ The current market price may also be used as an input to a
fair value measurement if the fund has evidence that the transaction
was entered into at market terms. See Financial Accounting Standards
Board (FASB), Master Glossary: Market Participant, at <a href="https://asc.fasb.org/MasterGlossary">https://asc.fasb.org/MasterGlossary</a>.
\72\ See rule 2a-5(a)(2) (requiring that, for purposes of fair
value determinations, a registered fund select and apply in a
consistent manner an appropriate methodology or methodologies for
determining (and calculating) the fair value of fund investments,
provided that a selected methodology may be changed if a different
methodology is equally or more representative of the fair value of
fund investments, including specifying the key inputs and
assumptions specific to each asset class or portfolio holding).
---------------------------------------------------------------------------
Reviewing the Reasonableness of Prices
Under the proposed current market pricing approach, the registered
fund's investment adviser would be required to periodically review the
reasonableness of the prices. This review requirement is designed to
ensure that prices determined under the current market pricing approach
are reasonable and subject to appropriate oversight through periodic
reviews.
We are not proposing to require a particular method of reviewing
cross-trade prices determined using the current market pricing approach
or the frequency at which these reviews must occur. The investment
adviser's review of the prices determined under the current market
pricing approach for reasonableness would be established by the
investment adviser and should be specific to the circumstances of the
registered fund's cross trading, the type of security being cross
traded, and the frequency and volume of cross-trading activity.
When structuring the method and frequency of reviewing cross-trade
prices under the current market pricing approach, it would be
reasonable to consider the methods for reviewing a fund's valuations
for purposes of NAV computations and whether applying such methods (or
similar methods) would be appropriate for these purposes. For example,
under rule 2a-5, funds must periodically review the appropriateness and
accuracy of the fair value methodologies selected and make any
necessary changes or adjustments to them, test the appropriateness and
accuracy of fair value methodologies, and evaluate pricing services if
used.\73\ These types of reviews could potentially be leveraged to
review the reasonableness of prices used under the current market
pricing approach. For example, if a specific approach to determining
cross-trade prices consistently over- or under-prices securities as
compared to observed market transactions or valuations used for NAV
purposes, the adviser should investigate the reason for the difference
and consider whether use of that approach for pricing cross trades
continues to be reasonable.
---------------------------------------------------------------------------
\73\ See rule 2a-5(a)(2)(ii), (3), and (4).
---------------------------------------------------------------------------
Under the proposed rule, the registered fund's adviser would be
responsible for conducting the periodic review of the reasonableness of
prices used under the current market pricing approach. This review
requirement would be separate from CCO review requirements in the
proposal, which are more focused on reviewing cross trades for
compliance with the rule, although the periodic reviews would be within
the scope of the CCO's overall compliance assessments as well. We
[[Page 65632]]
propose to require the adviser to conduct this pricing review because
the adviser overall is better situated to review the reasonableness of
cross-trade prices than fund CCOs, as these reviews would involve
considerations about available market data, and the choice of and
reliability of different pricing sources. In addition, the adviser may
be able to react more accurately and quickly to correct pricing issues
than the CCO. This review is similar to the reviews that advisers may
conduct for purposes of fund valuations.
As discussed below, the proposed rule would require the retention
of the information or materials upon which the CCO makes certain
compliance-related determinations. This recordkeeping requirement would
include information or materials used to determine that the pricing
conditions of the proposed rule are satisfied.\74\ These records are
designed so that a CCO would have the necessary information to review
whether and how the investment adviser determined that the price
reasonably represents the current market price, as well as the periodic
review of the reasonableness of prices.
---------------------------------------------------------------------------
\74\ See proposed rule 17a-7(c)(2); see also infra section II.G
(discussing the proposed recordkeeping requirements).
---------------------------------------------------------------------------
We request comment on the proposed pricing requirements for cross
trades.
7. Are the proposed methodologies for pricing cross trades workable
in practice?
8. Would registered funds participating in cross trades receive a
fair and reasonable independent current market price for the securities
involved under the proposed pricing methodologies?
9. Should we permit registered funds to use either the NAV pricing
approach or the current market pricing approach for a cross trade, as
proposed? Should a registered fund be permitted to switch between one
pricing methodology and another for different cross trades, as
proposed? Are the proposed approaches sufficiently evergreen? Would
these approaches have any issues in an extended trading hours
environment? Are there other ongoing or reasonably anticipated market
developments that may raise issues with the proposed approach?
10. Should we alternatively require cross trades to be priced under
a single standard, or different standard(s) than those proposed? If so,
would NAV pricing, current market pricing, or some other standard be
most appropriate for a uniform approach? Should we permit more than two
approaches to pricing? How would we ensure that investors are protected
using those methods given the conflict of interest implicated by cross
trading? What are the advantages and disadvantages to each method?
11. Do the NAV pricing approach and the current market pricing
approach work for all assets that registered funds would be permitted
to cross trade under rule 17a-7? Should we have more specific pricing
provisions based on, for example: how a security is traded, like the
current rule; asset type (e.g., such as equities or fixed income, or
level 1 or level 2 securities, to recognize differences in pricing
sources); type of fund (e.g., such as closed-end or open-end); or some
other method? Commission staff no-action letters have addressed pricing
cross trades for certain types of securities, including municipal
securities and variable rate demand notes (``VRDNs'').\75\ Are the
proposed pricing provisions workable for these types of securities, or
would registered funds need different conditions or guidance to
facilitate pricing cross trades for these securities?
---------------------------------------------------------------------------
\75\ See, e.g., Federated No-Action Letter (providing that the
staff would not recommend enforcement action if cross trades of
municipal securities that lack readily available market quotations
are conducted at a price provided by an independent pricing service
that values the fund's municipal securities for purposes of
determining the fund's net asset value); Benham California Tax Free
Trust and Benham National Tax-Free Trust, SEC Staff No-Action Letter
(Aug. 6, 1986) (providing that the staff would not recommend
enforcement action if cross trades of VRDNs are priced at par plus
accrued interest).
---------------------------------------------------------------------------
12. Are there circumstances in which either NAV pricing or current
market pricing should not be permitted? For example, we understand that
some registered funds value portfolio investments at the bid price,
rather than the mid price, when computing their NAVs.\76\ Rule 17a-7
currently requires that cross trades be executed at mid prices. Should
registered funds that price at bid be permitted to cross trade at the
bid price under NAV pricing when doing so aligns with the valuation of
the security or should they use current market pricing? Is using NAV
pricing at bid fair and reasonable for the seller in the cross trade,
even though it is receiving a lower price than it would if mid prices
were used? What would be the advantages and disadvantages of allowing
cross trades to occur at bid prices under the NAV pricing approach? For
example, the seller would not avoid spread costs under these
circumstances but might avoid other costs associated with open market
transactions (e.g., market impact) and experience reduced risks (e.g.,
counterparty or liquidity risk).
---------------------------------------------------------------------------
\76\ See ASC 820-10-35-36C. GAAP provides that if an asset
measured at fair value has a bid price and an ask price (for
example, an input from a dealer market), the price within the bid-
ask spread that is most representative of fair value in the
circumstances shall be used to measure fair value, and that the use
of bid prices for asset positions is permitted but not required for
these purposes. Id.; see also ASC-820-10-35-36D (stating that use of
mid-market pricing as a practical expedient for fair value
measurements within a bid-ask spread is not precluded). Mid-market
pricing values a security at the average of its bid and ask prices.
Since a seller generally asks for a higher price for a security than
a buyer bids for that security, the mid-market price is higher than
the bid price for a security, but lower than its ask price.
---------------------------------------------------------------------------
13. Under the proposed NAV pricing approach, the execution price
for a cross trade would not be known until the registered fund's next
NAV computation on that business day, which may be at the end of the
day or during the day for funds that make multiple NAV computations
during a business day. Would this create operational or practical
impediments to using the NAV pricing approach? If so, would these
impediments occur in specific scenarios (e.g., with particular types of
cross-trade counterparties) or for particular types of registered
funds, or would the impediments be broader based for registered funds?
How would registered funds weigh any such impediments against the
efficiencies that the NAV pricing approach may present?
14. How should funds that compute their NAVs less frequently or
more frequently than daily price cross trades? Should the funds that
compute their NAV less frequently than daily be able to use NAV pricing
only on the days that they perform NAV computations, as proposed?
Should these funds be allowed to use NAV pricing by following their NAV
pricing procedures to price cross trades on days the funds do not
compute their NAVs? Are there any impediments to using the next NAV
computation for funds that make more than one NAV computation daily?
15. How should money market funds that use the amortized cost
method of valuation under rule 2a-7 implement NAV pricing to price a
cross trade? Should these funds be required to use their market-based
NAV prices, as proposed, or should they be able to use the amortized
cost value of a security for cross trades?
16. Rule 2a-4 under the Investment Company Act permits funds to
reflect changes in holdings of portfolio securities in fund NAVs on the
next business day. As a result, registered funds currently may not
value newly acquired securities on the day of acquisition. How would
this affect the use of NAV pricing for cross trades?
17. Under the current market pricing approach, should we permit the
registered fund's adviser to determine a
[[Page 65633]]
price that reasonably represents the current market price using one or
more unaffiliated pricing sources, as proposed? Do advisers need
additional requirements or guidance on how to make these
determinations? Please provide specific information on what
requirements or guidance would be helpful and how. For example, are
there circumstances when listed equity securities would not be priced
using the last reported sale price or, if there are no reported
transactions on that day, the average of the highest current
independent bid and the lowest current independent offer? If so, what
are they, and how would the adviser determine a price?
18. What unaffiliated pricing sources would an investment adviser
use to determine the price that reasonably represents the current
market price for a security under the proposed methodology? Should the
rule or Commission guidance address the use of particular pricing
sources, for example, electronic trading platforms? If so, how? How are
unaffiliated pricing sources offering intra-day information (for
example, for which asset classes, at what frequency, and using what
delivery method)?
19. Should a pricing source be required to be unaffiliated, as
proposed? Should we, as proposed, define ``unaffiliated'' as persons
other than first- or second-tier affiliates? Should a fund be permitted
to use a pricing source that is affiliated with the registered fund or
investment adviser to determine the current market price under certain
circumstances (e.g., if the pricing source is widely recognized and
used by non-affiliated parties, or if certain information barriers are
in place designed to prevent personnel involved in cross-trading
decisions from influencing the price provided by the pricing source)?
Should a fund be permitted to use quotes from a broker-dealer that is
affiliated with the registered fund or investment adviser under certain
circumstances? How have registered funds applied the current rule's
provision about effecting cross trades at the ``independent current
market price''? Would our proposal lead to different results regarding
the independence of the cross-trade price?
20. Instead of requiring an unaffiliated pricing source, should we
require that pricing sources be subject to oversight so that there is a
reasonable basis to use the pricing information as an input for cross
trades, similar to the oversight requirement in rule 2a-5? If yes,
should the adviser, CCO, board, or some other party be placed in charge
of pricing source oversight?
21. As proposed, should we require the adviser to periodically
review the reasonableness of prices used under the current market
pricing approach? Is the adviser better situated to conduct this review
or should other parties, such as an unaffiliated third-party, the
fund's CCO, or board, be involved? Should the rule prevent a fund's
portfolio manager or other personnel from being involved in, or
responsible for, the periodic review to address potential conflicts?
Should the rule specify a frequency for these reviews (e.g., annual,
quarterly, monthly)? Separate from the compliance oversight provisions
discussed below, should we require that another party, such as an
unaffiliated third party, validate the results of the adviser's review?
22. How similar or different should these reasonableness reviews be
to the review and testing of funds' fair value methodologies and
oversight of pricing service providers conducted under rule 2a-5?
Should we more directly link these processes in rule 17a-7 or in
Commission guidance?
23. How would the use of the proposed current market pricing
approach affect registered funds' valuation processes? Would cross-
trade prices using the proposed current market pricing approach help
improve valuation processes, and if so, how?
24. If a registered fund and its eligible affiliate cannot agree on
a price for the cross trade, the trade will not occur. Are there
circumstances in which a registered fund and its eligible affiliate
would arrive at different prices for a cross trade they want to engage
in under the proposed rule and, if so, what are those circumstances and
how likely are they to occur? Relative to the current rule, would the
proposed rule increase, decrease, or have no significant effect on the
likelihood that a registered fund and its eligible affiliate cannot
agree on a price for a cross trade? Are there changes we should make to
facilitate agreement on price? For example, if a registered fund and
its eligible affiliate ascribe different values to the same security in
a cross trade, should we require or permit use of the average price in
these circumstances? Should this be permitted or required only when the
parties to a cross trade are both registered funds and/or only when NAV
pricing is used? Are we correct in assuming that the differences in
value, when they do occur, would be minimal? Should we instead require
or permit some other solution, such as using the trade price at the
value that the buying or selling registered fund would ascribe to the
security?
C. Transaction Fees
We propose to condition the exemption on no consideration, other
than cash payment against prompt delivery of a security, and no
remuneration being paid in connection with the transaction, other than
de minimis payments to unaffiliated parties for services provided for
clearing, settlement, custody, recording, or reporting of the
transaction.\77\ As discussed further below, this condition retains the
current rule's focus on limiting costs associated with the transaction
to reduce the potential for conflicts and promote the cost-saving
benefits of cross trading while permitting the payment of
administrative fees where necessary to effect the transaction.
---------------------------------------------------------------------------
\77\ See proposed rule 17a-7(b)(3).
---------------------------------------------------------------------------
Current rule 17a-7 has similar conditions. One condition in the
rule prohibits the payment of consideration other than cash payment
against the prompt payment of a security, and another provides that no
brokerage commission, fee (except for customary transfer fees), or
other remuneration may be paid in connection with the transaction.\78\
The limit on remuneration allows cross trades only in those instances
where the registered fund would avoid paying traditional transaction
expenses, a key purpose of the rule. In response to the Staff
Statement, however, some suggested that the current provision lacks
clarity regarding what constitutes a customary transfer fee, including,
for example, payments related to clearing and settlement, transfer fees
to a custodian, or recordation fees to an administrative agent.\79\ To
address these issues, some recommended eliminating this condition,
allowing registered funds to pay any fee that is appropriate to the
services offered.\80\ Others suggested clarifying the scope of fees
that are permissible in connection with cross trades.\81\
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\78\ See current rule 17a-7(a) and (d).
\79\ See, e.g., Letter from Invesco Ltd. (Apr. 12, 2021)
(``Invesco Letter''); MarketAxess Letter; Letter from Jack W. Murphy
(May 6, 2021) (``Murphy Letter'').
\80\ SIFMA AMG Letter; MarketAxess Letter; FIMSAC
Recommendations (``the Committee recommends that the SEC make it
clear that custodial fees and the fees of electronic trading
platforms or dealers can be paid in connection with effecting cross
trades involving [registered] funds'').
\81\ Invesco Letter; Murphy Letter; ICI Letter.
---------------------------------------------------------------------------
Restrictions on the payments of fees in connection with cross
trades continue to be necessary and appropriate. A major benefit of
cross trades is lowered transaction costs to registered funds that
accrue to the
[[Page 65634]]
benefit of registered fund shareholders, as many observed in response
to the Staff Statement.\82\ A general restriction on remuneration for
cross trades provides appropriate safeguards so that registered fund
shareholders benefit from lower transaction costs associated with cross
trading. We are, however, proposing to modify this condition to
modernize the rule and address interpretive questions raised by members
of the public.
---------------------------------------------------------------------------
\82\ See, e.g., ICI Letter; SIFMA AMG Letter; Letter from
Pacific Investment Management Company LLC (Apr. 9, 2021) (``PIMCO
Letter'').
---------------------------------------------------------------------------
The proposed condition continues to include a general restriction
on the payment of remuneration in connection with the transaction for
the reasons discussed above. We also are proposing to amend the rule's
current prohibition on the payment of any fee (except for customary
transfer fees) or other remuneration to provide an exception for
certain de minimis payments to unaffiliated service providers.
Permitting only de minimis payments to unaffiliated service providers
is designed to: (1) limit the potential for conflicts, consistent with
the underlying purpose of section 17 and (2) safeguard against
transactions being effected for the benefit of other affiliates.\83\
The language allowing certain payments to unaffiliated service
providers would replace the current rule's language about customary
transfer fees.
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\83\ The proposed rule would define ``unaffiliated'' to be a
person other than an affiliated person or promoter of, or principal
underwriter for, a fund (e.g., a first-tier affiliate) or an
affiliated person of such entities (e.g., a second-tier affiliate),
consistent with the coverage of section 17(a).
---------------------------------------------------------------------------
The proposed condition would permit de minimis payments relating to
the clearing, settlement, custody, recording, or reporting of cross
trades.\84\ Providing a specific list of administrative services for
which payment is permitted is designed to provide greater assurance as
to which fees are permissible under the rule than the current
provision's exception for ``customary'' transfer fees. For example, we
understand that a custodian, broker-dealer, or trading platform may
help settle a cross trade and charge a service or administrative fee
for these purposes.\85\ In addition, we understand that in some non-
U.S. markets registered funds are required to make certain payments to
broker-dealers or trading platforms in order to effect cross trades,
such as stamp duties, transaction taxes, asset-based transaction fees,
custodial fees, settlement fees, or other similar fees.\86\ These
payments are customary in the relevant market and are unavoidable when
effecting a cross trade in certain jurisdictions. Because these
payments relate to the clearing, settlement, custody, recording, or
reporting of the cross trade, the proposal would expressly permit these
payments despite the general prohibition on payment of remuneration.
---------------------------------------------------------------------------
\84\ See ICI Letter; Invesco Letter. Such de minimis payments
include the equivalent payments on a blockchain or other distributed
ledger. For example, gas fees on the Ethereum blockchain are
required for processing transactions and are used to maintain and
secure the blockchain. We would consider these payments to relate to
the clearing, settlement, custody, recording, or reporting of cross
trades under the proposal.
\85\ See, e.g., FIMSAC Recommendation (discussing the treatment
of custodial fees related to the transfer of a security from one
client account to another client account or a fee charged by an
electronic trading platform for a dealer to effect a cross trade for
an asset manager client under current rule 17a-7).
\86\ See, e.g., SIFMA AMG Letter (discussing requirements in
India and Brazil, where cross trades must cross the market and
involve a broker or in Malaysia, where cross trades are subject to a
minimum brokerage commission).
---------------------------------------------------------------------------
A de minimis amount for these purposes would depend on the facts
and circumstances of the registered fund and the overall context of the
fee being paid. In general, the amounts would be small relative to the
size of the transaction--and below what a fund would pay in brokerage
commissions, bid-ask spreads, mark-ups and mark-downs or otherwise if
the fund were to purchase or sell the security in the market. In order
to satisfy its obligations under rule 38a-1 to have policies and
procedures reasonably designed to prevent violations of the Federal
securities laws, a registered fund's cross-trading policies and
procedures should address how the fund will determine whether a given
fee is de minimis and whether it is being incurred for a permissible
purpose.\87\
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\87\ See infra section II.E.
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Also consistent with the current rule, the proposed condition would
include a requirement that the transaction involve no consideration,
other than cash payment against prompt delivery of a security. This
helps to ensure that cross trades are simple, transparent, and not
complicated by non-cash considerations like in-kind exchanges or other
forms of payment. It also provides for prompt settlement of cross
trades to avoid intervening market risk.
We request comment on all aspects of proposed restrictions on
payment of fees in connection with cross trades, including the
following items:
25. Do commenters agree that the cross-trading rule should continue
to include a condition restricting the types of permissible payments in
connection with the transaction? Have there been any changes in market
practice or other reasons to change from the rule's current general
prohibition on the payment of remuneration in connection with cross
trades? Are there circumstances in which remuneration to a broker-
dealer, electronic platform provider, or other party beyond the
administrative services proposed in the rule would be appropriate? As
an alternative, should we omit the proposed condition and explicitly
require advisers to include a consideration of remuneration paid in
their determination that a transaction is in the best interest of the
registered fund? If so, should we describe what factors advisers must
or should include in their consideration of remuneration paid? Are
there other methods of safeguarding against the potential for payments
that are indirect compensation for other services the third party
provides?
26. Are there instances when an affiliated party might need to be
compensated for administrative services in connection with a cross
trade? What conditions would permit appropriate payments while
safeguarding against the potential for overreaching or self-dealing?
Conversely, should the adviser bear any costs for administrative
services provided by affiliated service providers (or should these fees
be waived by the service provider) to protect the registered fund from
the possibility of overreach or self-dealing?
27. Should we, as proposed, define ``unaffiliated'' as persons
other than first- or second-tier affiliates?
28. Does the proposed provision for ``clearing, settlement,
custody, recording, or reporting of the transaction'' include the full
scope of administrative services provided by third party providers that
may be necessary to effect a cross trade? Are there any services we
need to further clarify? Are there any types of fees that third parties
may charge in connection with facilitating a cross trade that the rule
should more clearly address? To what extent would advisers anticipate
needing to pay for data, such as data from a pricing service, to price
a cross trade where the fund is not already obtaining that data to
determine the fund's net asset value or for another purpose? Should we
modify the rule to permit this form of remuneration to be paid in
connection with a cross trade?
29. In non-U.S. jurisdictions, are there fees that are customary
fees in the relevant market and are unavoidable when effecting a cross
trade in that jurisdiction but do not relate to the clearing,
settlement, custody, recording, or reporting of a cross trade? If so,
please describe such fees and whether
[[Page 65635]]
the rule should more clearly permit these fees.
30. Do commenters agree that the provision, in combination with the
proposed oversight and best interest requirements, sufficiently limits
excessive payments? Is there any alternative condition we should
include to ensure that the amount of payment for administrative
services is appropriate? Should the CCO or adviser be required to
document the basis for concluding that any administrative fee paid in
connection with the transaction is for a necessary administrative
service and is de minimis?
31. Should we specify what specific amounts should be considered de
minimis for purposes of this provision or provide a safe harbor amount
(e.g., as a percentage of the transaction price)? How would we
establish such amount in a way that is flexible enough to not permit
excessive payments by all sizes of registered funds? Should this
specify that de minimis means an amount less than what a fund would pay
in transaction costs to purchase or sell the security in the market?
32. Should we make any changes to the current rule's requirement
that cross trades involve no consideration other than cash payment
against prompt delivery of the security? Is there any reason to permit
in-kind cross trades? If so, what limitations would be needed to
prevent overreach or self-dealing?
D. Best Interest Determination and Consistency With Fund Policies and
Strategies
The proposed amendments would require a registered fund's
investment adviser to determine prior to the cross trade that the cross
trade is in the best interest of each registered fund involved in a
transaction (which determination, for the sake of clarity, is not
dependent on any benefits enjoyed by another fund to the cross
trade).\88\ The proposed amendments would also require that a cross
trade be consistent with the registered fund's policies and investment
strategies.\89\
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\88\ See Federated No-Action Letter; Liquidity Rule Adopting
Release, supra note 69, at text accompanying n.799 (noting ``that
cross trading also implicates a fund's adviser's duty to seek best
execution for each fund or other advisory client, as well as its
duty of loyalty to each fund or other advisory client''); proposed
rule 17a-7(b)(5). Although the proposed amendments to rule 17a-7
would not require an investment adviser to make a best interest
determination as to a non-registered fund client involved in a cross
trade, the adviser still owes that client a fiduciary duty and
remains subject to the antifraud provisions of the Advisers Act and
other Federal securities laws with respect to its advice to that
client. See supra notes 7-8 and accompanying text.
\89\ See proposed rule 17a-7(b)(4).
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The best interest determination requirement is consistent with the
adviser's fiduciary duty, or its obligation to act in the best interest
of each client. We are proposing to require a best interest
determination for each cross trade to help ensure that an investment
adviser puts the interests of each fund and its shareholders above its
own and does not favor one client over another, and to address the
investment adviser's responsibilities as they relate specifically to
cross trades.\90\ Cross trades implicate heightened conflicts of
interest, which require careful consideration as to whether a
particular cross trade is in the best interest of each registered fund
involved in the transaction. If an adviser can obtain a more favorable
outcome for a fund by trading in the open market (including if more
favorable pricing is available in the open market), buying or selling a
different security, or not transacting at all, the cross trade is not
in the fund's best interest.
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\90\ See Standard of Conduct Release, supra note 7, at n.23 and
accompanying text (describing an adviser's fiduciary duty, including
the duty of loyalty and duty of care) and n.54 (noting that the duty
of loyalty requirement prohibiting an adviser from putting its own
interests above its client's also would prohibit the adviser from
favoring certain client accounts that pay higher fee rates to the
adviser over other client accounts).
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Appropriate factors for an adviser to consider when determining if
a cross trade is in the fund's best interest could include, for
example:
<bullet> The investment rationale (i.e., the investment-related
justifications) for the cross trade and the expected effect of the
cross trade on the fund's performance (e.g., is the cross trade
expected to improve, harm, or have no effect on the fund's
performance);
<bullet> The characteristics of the cross-traded security,
including its liquidity;
<bullet> The method of pricing the cross trade, whether more
favorable pricing appears to be available in the open market, and any
cost savings associated with conducting a cross trade;
<bullet> The execution method, quality, and speed, and any
associated costs;
<bullet> The timing and urgency of the transaction;
<bullet> The size of the trade and the expected effect on the price
of the security if that volume of securities were purchased or sold on
the open market;
<bullet> The characteristics of the eligible affiliate, including
its expense and fee structure; and
<bullet> Current market conditions, especially if the markets are
stressed.
The proposed best interest determination is distinct from the other
proposed conditions in rule 17a-7(b) and must be considered separately.
An adviser could not determine that a cross trade is in the best
interest of a registered fund simply because the other conditions of
the rule, including the pricing conditions, are met. Although the best
interest determination is a separate condition, other conditions of the
rule relate to topics that are relevant and may inform the adviser in
the best interest determination, such as pricing and transaction fees.
For example, with respect to pricing, an adviser should consider how
the approach to pricing the cross trade under the rule affects best
interest considerations (e.g., if current market pricing is used, the
quality of the unaffiliated pricing source(s) used for the
transaction). Further, if a trade would be in such volume as to move
the market price, conducting the trade as a cross trade may require a
heightened level of review of price before the investment adviser
determines that it is in the best interest of the fund because such
cross-trade price would not incorporate the market moving price
effects. As another example, while the proposal would permit the
payment of certain de minimis transaction fees in connection with cross
trades, an adviser should consider whether paying such fees in a cross
trade affects the best interest determination.
While the process and factors for making the best interest
determination should be tailored based on the registered fund and the
specific circumstances of the cross trade, the proposal would not
preclude an adviser from using standardized internal forms in its
process that are automatically populated with, or include dropdown
menus of, preapproved reasons that the adviser has pre-selected based
on its experience and expertise so long as this approach would
facilitate accurate documentation of the best interest determination
for purposes of the rule's CCO review and recordkeeping requirements.
In order to satisfy its obligations under rule 38a-1 to have policies
and procedures reasonably designed to prevent violations of the Federal
securities laws, a registered fund's cross-trading policies and
procedures should address how a registered fund's investment adviser
would determine whether a cross trade is in the best interest of the
fund, including the process and factors that lead to the
determination.\91\
---------------------------------------------------------------------------
\91\ See infra section II.E.
---------------------------------------------------------------------------
The proposal would require the investment adviser to make the best
interest determination, but it does not
[[Page 65636]]
specify particular investment adviser personnel who should make these
determinations. In determining which personnel would be appropriate for
making the determination, one consideration for an adviser would be the
person's role in making the investment or trading decision to cross
trade a security. For example, relying upon personnel that have a
direct role in making investment decisions for a fund involved in the
transaction, such as a portfolio manager, may prove beneficial in that
they would have the most direct knowledge of the suitability of the
trade for a fund. However, while a portfolio manager may have an
incentive to obtain positive results for each fund involved, it is also
possible that such portfolio manager would have an incentive to favor
the performance of one party to a trade over the other because, for
example, one party pays higher fees, including performance fees.\92\ In
determining which personnel are appropriate for making the best
interest determinations, the adviser should carefully consider
potential conflicts of interest between potential personnel and each of
the funds involved in the transaction. Personnel who provide oversight,
monitoring, or review may also be useful in assisting in the best
interest determination, but it is possible that they are not best
placed solely to make the determination. If the cross trade is between
two registered funds, a best interest determination must be made by
personnel representing each registered fund. Those personnel might be
the same; however, they must make separate determinations, considering
the facts and circumstances of each registered fund.
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\92\ The Commission has brought enforcement actions against
advisers that allegedly favored one party to a cross trade over
another party. See, e.g., Putnam Investment Mgmt., LLC and Zachary
Harrison, Investment Company Act Release No. 33257 (Sept. 27, 2018)
(portfolio manager prearranged contemporaneous purchases and sales
between registered funds in a manner that allegedly favored
purchasing funds and disadvantaged selling funds); Macquarie
Investment Management Business Trust, Investment Company Act Release
No. 35325 (Sept. 19, 2024) (adviser arranged contemporaneous
purchases and sales between affiliated selling accounts and
registered funds in a manner that allegedly favored the selling
accounts and disadvantaged the purchasing funds).
---------------------------------------------------------------------------
Separate from the best interest requirement, the proposed rule
would require that a cross trade be consistent with the registered
fund's policies and investment strategies, as recited in its
registration statement and reports filed under the Investment Company
Act.\93\ The investment adviser may determine whether the cross trade
is consistent with the registered fund's policies and investment
strategies in conjunction with its best interest determination or
separately.
---------------------------------------------------------------------------
\93\ Currently, one of the conditions of rule 17a-7 is that
``[t]he transaction is consistent with the policy of each registered
investment company and separate series of a registered investment
company participating in the transaction, as recited in its
registration statement and reports filed under the [Investment
Company] Act.'' The proposal would revise the language to more
clearly refer to the registered fund's investment strategies as well
as policies. The current condition, which the Commission included in
the original rule adopted in 1966, was designed to address the risk
of overreaching in cross trades. See 1966 Adopting Release, supra
note 4. Including an express reference in the rule to the fund's
investment strategies would be consistent with this purpose.
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We request comments on the proposed best interest determination:
33. Is the proposed best interest determination condition
appropriate or necessary?
34. Who should make the best interest determination? Is the
investment adviser the appropriate party? If so, are there any concerns
of a conflict of interest and could those concerns be mitigated? If
not, who should make the determination? Should we provide more detail
or guidance on which personnel are best placed to make the best
interest determination? If so, which personnel would be most qualified?
35. Should we provide more detail in the rule or guidance on how an
adviser should make a best interest determination and what it should
consider? For example, should the rule require that an adviser must
always consider certain factors in making its best interest
determination (e.g., the expected effect of the cross trade on the
registered fund's performance; the characteristics of the cross-traded
security, including its liquidity; and the cost savings of the cross
trade)? Please provide specific information on what detail or guidance
would be helpful.
36. Should the rule, as proposed, specifically provide that the
investment adviser should make the best interest determination prior to
the cross trade? Why or why not? Are there circumstances in which it
would be reasonable for an adviser to make a best interest
determination after executing a cross trade and, if so, what are those
circumstances? Should we require the best interest determination to be
made on a transaction-by-transaction basis or are there circumstances
in which an adviser could reasonably make a best interest determination
in advance for certain categories of cross trades? If so, how far in
advance and for what categories?
37. Should the proposed rule require any particular form of
documentation to be maintained under this new condition?
38. Do investment advisers have concerns that it will be difficult
to make these determinations? Could this place an undue burden on
smaller investment advisers or funds or on specific types of funds,
such as internally managed funds? Are there special concerns for
advisers and funds with automated or algorithmic trading, because, for
example, such trading is generally designed to have minimal human
involvement and the best interest determination would require at least
some human involvement or because such systems pose the risk that
programming problems could cause it to fail to prohibit affiliated
trades? Are there instances where the best intertest determinations
would be automated or done according to an algorithm with no human
oversight other than CCO and board review? What benefits and risks
would be associated with such an approach, and should this approach be
permitted under rule 17a-7?
E. Oversight
We propose to require the registered fund's CCO, instead of its
board, to review cross trades, while still requiring oversight by the
fund's board. Specifically, the CCO would be responsible for reviewing
all cross trades at least quarterly to determine their compliance with
the proposed rule (``quarterly review'') and at least annually to
determine if they may have disadvantaged the registered fund relative
to the eligible affiliate (``annual review'').\94\ As part of the
annual review, the CCO would also review other transactions by the fund
or information necessary to evaluate cross trades (including the timing
and price of any subsequent sale of a security purchased in a cross
trade). The CCO would be required to report the results of these
reviews to the registered fund's board.\95\ These reviews would replace
the current rule's requirement that the board determine at least
quarterly that the cross trades were done in compliance with the
registered fund's rule 17a-7 procedures.\96\ The proposal would also
eliminate the current requirement that the board adopt, and make and
approve changes to, the cross-trade procedures.\97\ The proposed
amendments are designed to better align oversight requirements to
business responsibilities, reduce the burden on
[[Page 65637]]
boards associated with rule 17a-7, and remove duplication with rule
38a-1.
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\94\ See proposed rule 17a-7(b)(7)(i) and (ii).
\95\ See proposed rule 17a-7(b)(7)(iii).
\96\ See current rule 17a-7(e)(3).
\97\ See current rule 17a-7(e)(1)-(2).
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1. Responsible Parties
Currently, the rule requires that the board adopt, and make and
approve changes to, the fund's cross-trade procedures, and review cross
trades quarterly. The proposal would remove the quarterly review
requirement from the board's responsibilities and place it on the CCO,
who is already responsible for administering the registered fund's
compliance policies and procedures, including those pertaining to cross
trades, while maintaining board oversight through reports of the CCO's
review of cross trades.\98\ Accordingly, the proposed rule would
provide layers of protection for investors against conflicts of
interest implicated by cross trading and better align oversight
requirements to business responsibilities.
---------------------------------------------------------------------------
\98\ See rule 38a-1(a)(4).
---------------------------------------------------------------------------
Under the proposal, the CCO would be responsible for reviewing
cross trades at least quarterly to determine whether they are compliant
with the rule and at least annually to determine whether a cross trade
or set of cross trades may have disadvantaged a registered fund
relative to its eligible affiliate. Finally, the board would receive
quarterly and annual reports from the CCO on the results of the
quarterly review and annual review, respectively.\99\ This requirement
is designed to facilitate the board's oversight of the fund's cross-
trading activities and would remove the need for the board to determine
quarterly that cross trades were made in compliance with the procedures
as is required under the current rule.\100\ The proposed amendments
would allow boards to focus on larger issues, including conflict of
interest concerns, arising out of the CCO's reports, rather than a more
granular focus on whether each cross trade complied with the fund's
cross-trading policies and procedures as currently required under rule
17a-7. Although the proposed amendments would modify the oversight
framework, boards should continue to engage actively in overseeing and
asking questions about cross-trading activity, particularly given the
conflict of interest considerations it raises. By better aligning the
responsibilities of oversight to the business responsibilities of the
CCO and the board, the proposal is designed to increase efficiencies
while providing multiple layers of protection for investors.
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\99\ Consistent with the current rule, the proposed rule would
require that the registered fund's board of directors satisfy the
fund governance standards defined in rule 0-1(a)(7). See proposed
rule 17a-7(b)(6).
\100\ See current rule 17a-7(e)(3).
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2. Quarterly and Annual Reviews and Reports
Currently, the board must determine no less frequently than
quarterly that all cross trades made during the preceding quarter were
effected in compliance with the cross-trade procedures.\101\ The
proposal would remove this requirement and replace it with the
requirement of the CCO's quarterly and annual reviews and reports to
the board, which would provide the CCO and board multiple opportunities
for review or oversight of cross trades. At a minimum, quarterly
reviews would comprise of a technical compliance check of whether
individual trades met the conditions of the rule, similar to the
current rule's requirement that the board determine quarterly that
cross trades complied with the fund's procedures. In comparison, annual
reviews would be an opportunity for the CCO to perform a holistic
review over a longer period to determine whether the registered fund
was disadvantaged, for example, by identifying indicators of parking,
dumping, or cherry-picking. The annual and quarterly reviews and
reports are designed to work together, providing snapshots of a fund's
cross-trading activity at different points in time, providing the CCO
and board with the information necessary to monitor and oversee the
investment adviser's cross-trading activities, identify any problems,
and help limit overreaching.
---------------------------------------------------------------------------
\101\ See id.
---------------------------------------------------------------------------
Quarterly reviews by the CCO would help provide opportunities to
monitor the procedures, identify any aspects of the procedures that are
not working as intended and that need adjustment, and detect any cross
trades that did not comply with the proposed rule. A quarterly review
would encompass all cross trades effected during the period and would
be required to include information to determine whether trades complied
with the conditions under the proposed rule, such as whether:
<bullet> Each cross trade occurred with an eligible affiliate;
<bullet> Each security was eligible to be cross traded;
<bullet> The price was determined in compliance with the rule;
<bullet> Any fees paid in connection with a cross trade were
consistent with the rule;
<bullet> Each cross trade was consistent with the registered fund's
policies and investment strategies; and
<bullet> The investment adviser determined that each cross trade
was in the best interest of the registered fund.
The quarterly review cadence would be consistent with the current
rule's requirement for the board to determine compliance with the
cross-trade procedures. The proposal would require the CCO to provide a
quarterly report to the board on the results of the quarterly review.
These quarterly reports would facilitate the board's oversight by
providing timely information about the fund's cross trades and the
efficacy of the fund's cross-trading policies and procedures.
The proposed amendments also would require that the CCO review
annually cross trades as well as other transactions or information
necessary to evaluate the cross trades to help the CCO determine if the
cross trade, or a pattern of cross trades, may have disadvantaged the
registered fund relative to the eligible affiliate. As part of the
annual review, the CCO would be required to review the timing and price
of subsequent sales by the registered fund of securities it purchased
in a cross trade. This requirement is designed so that the CCO reviews
not only a cross trade itself, but also any other transactions or
information necessary, to analyze whether the fund may have been
disadvantaged by the cross trade or by the cross-trading arrangements
more broadly. The CCO may conduct the annual review in a variety of
ways, including, for example, by testing a sample of cross trades,
automated monitoring and scanning of cross trades, or forensic testing
to better identify patterns and trends that may show a fund being
disadvantaged by a cross trade.
The annual review would cover more cross trades over a longer
period, which would provide better information to the CCO, especially
in identifying a pattern of transactions that may disadvantage a fund
relative to the eligible affiliate. For example, an analysis of larger
or longer datasets may help identify a pattern of favoring an eligible
affiliate that charges a higher management fee such as a performance-
based fee. These or other patterns may be more difficult for the CCO to
detect when reviewing, on an idiosyncratic basis, at or near the time
of the cross trade. An annual review is designed to balance the time
that might be needed to detect these patterns with the disadvantages
that the fund and its shareholders may suffer. The reviews also have
different, but complementary, primary focuses: the quarterly review
would focus on whether each cross trade effected during the quarter
complied with the rule's conditions,
[[Page 65638]]
while the annual review would utilize data across the entire life cycle
of a given investment holding to more holistically assess whether the
fund was disadvantaged by any given cross trade or pattern of cross
trades.
The proposal would specifically require that the CCO, as part of
the annual review, review the timing and price of subsequent sales of
securities purchased in cross trades (a ``disposition price'') to
determine if the fund was disadvantaged by cross trades. The CCO may
conduct this review using any testing method, including sampling a
selection of cross trades to analyze and compare their disposition
price to the cross-trade price. While funds would be required to
conduct this analysis regardless of the timing of the disposition, this
type of testing may be particularly helpful when the cross-traded
security is disposed of close-in-time to the cross trade as many
considerations may factor into a disposition price.
The proposed rule would also require the retention of the
information or materials upon which the CCO's determinations are made,
which would include information or materials related to other
transactions or information reviewed as part of this annual
review.\102\ These records are designed so that a CCO would have the
necessary information to review the disposition price of any security
as compared to the price of the cross trade to identify a pattern of
cross trades that may disadvantage a fund. The CCO would not need to
review any such cross trades before the adoption of the proposed
amendments for subsequent sales.
---------------------------------------------------------------------------
\102\ See proposed rule 17a-7(c)(3); see also infra section II.G
(discussing the proposed recordkeeping requirements).
---------------------------------------------------------------------------
In connection with the annual review, the CCO generally should also
consider other appropriate factors as relevant, including for example:
<bullet> The appropriateness of cross-trade prices;
<bullet> The performance of cross-traded securities;
<bullet> The cost savings of cross trades;
<bullet> The volume, frequency, and timing of cross trades;
<bullet> The characteristics of the cross-traded securities,
including the liquidity profile;
<bullet> The characteristics of eligible affiliates, including
their expense and fee structure;
<bullet> The quality of unaffiliated pricing sources;
<bullet> The execution quality of the cross trade; and
<bullet> The market conditions at the time the trades occurred,
especially if the markets were stressed.
The CCO may evaluate these factors using any appropriate testing
method. For example, to determine whether the cross-trade price is
appropriate, the CCO may review the investment adviser's determination
or process for determining that the cross-trade price reasonably
represented the current market price for the security using
unaffiliated pricing sources. The CCO may also back test or validate
the price, as appropriate, against: (1) NAV pricing, if the cross-trade
price is determined using current market pricing, (2) pre-trade quotes
or prices, or (3) other observed transactions or market information. If
the investment adviser's approach to determining cross-trade prices
consistently over- or under-prices securities as compared to observed
market transactions or valuations used for NAV purposes, the CCO should
investigate the reason for the difference and consider whether use of
that approach for pricing cross trades continues to be reasonable.
Other testing methods include, for example: comparing the performance
of the cross-traded securities against the fund as a whole; comparing
the estimated cost savings of a cross trade against the costs of a
similar arms-length transaction; monitoring relative volume and
frequency of cross trades for a fund against previous periods;
determining if the cross trades are consistent with the fund's
investment policies and strategies; examining the characteristics of
the cross-traded securities, such as if they are newly issued or their
availability in the market; analyzing execution of the cross trade,
including speed, market impact, execution quality; and monitoring the
timing of a cross trade, for example, if a cross trade is done in
stressed market conditions. These types of testing can often reveal
important information about the continuing appropriateness of the
registered fund's cross-trade policies or practices. Testing
methodologies may develop, improve, and change over time. We would
expect the CCO to be empowered to ask for any appropriate information
in the course of the quarterly or annual reviews and reports.\103\
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\103\ See also Compliance Programs of Investment Companies and
Investment Advisers, Advisers Act Release No. 2204 (Dec. 17, 2003)
[68 FR 74714 (Dec. 24, 2003)] (``Compliance Programs Release''), at
n.75 and accompanying paragraph.
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A cross-trade review may also be combined with other compliance
reviews. The cross trade annual review may be completed simultaneously
with the annual review required by rule 38a-1 of the adequacy of the
policies and procedures of the fund and the effectiveness of their
implementation. Combining reviews may increase efficiencies and improve
the quality of the review by allowing the CCO a more comprehensive view
of the fund's policies and procedures, including those involving cross
trades. As another example, a fund may experience cost savings and
efficiencies if it combines its review and due diligence of the same
vendor that is used both as an unaffiliated pricing source under rule
17a-7 and as a pricing service provider under rule 2a-5.
The timing and format of the CCO's quarterly and annual reports
would depend on the facts and circumstances. The CCO and board may
determine that summaries are sufficient for the reports.\104\ While
reviews and reports are required quarterly and annually, they could be
performed on an as needed or more frequent basis as well. For example,
a registered fund that has higher volumes of cross-trading activities
may warrant more frequent review. Fund or investment adviser personnel
other than the CCO may contribute to the report, as cross trades may
touch multiple business functions, including portfolio management and
trading. The information or materials considered as part of the CCO's
reviews and the reports to the board are required to be documented, and
should be documented in a manner that best suits the fund's cross-
trading policies and internal practices.\105\ The CCO's annual review
and report to the board may include an analysis of such matters as:
whether the cross-trading policies and procedures are working as
intended; whether the content, structure, and timing of the review and
report are appropriate; and whether any changes are needed to the
fund's cross-trading policies and procedures. The annual report may
also include a discussion of any actions taken if a cross trade is
found to disadvantage a fund. As with other policies and procedures,
the board would be able to request and review any other related
materials.\106\
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\104\ This is similar to how directors may satisfy their
obligations under rule 38a-1 by reviewing summaries of compliance
programs. See id., at text accompanying n.33.
\105\ See proposed rule 17a-7(c)(2) through (4); see also infra
section II.G (discussing the proposed recordkeeping requirements).
\106\ See, e.g., Compliance Programs Release, supra note 103, at
n.65 and accompanying text (stating, for example, that the fund's
governance related policies and procedures should be designed to
guard against the failure of the board to request and consider
information required by the Investment Company Act from the adviser
and other service providers).
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[[Page 65639]]
3. Policies and Procedures
Currently under rule 38a-1, the board is responsible for approving
registered fund written compliance policies and procedures, reviewing
their adequacy and effectiveness of implementation, and determining
that they are reasonably designed to prevent violation of the Federal
securities laws.\107\ In many respects, this is duplicative of the
current requirement under rule 17a-7 for the board to adopt, make, and
approve changes to the registered fund's cross-trade procedures, and we
propose to remove this requirement from rule 17a-7.\108\ Instead, the
board would approve policies and procedures under rule 38a-1 that are
reasonably designed to prevent violations of section 17(a) by, among
other things, conducting cross trades that would comply with proposed
rule 17a-7. At a minimum, the policies and procedures should address
how the fund and adviser will effect cross trades to satisfy the
conditions of the proposed rule. The policies and procedures generally
should describe how the CCO would conduct the quarterly review to
determine compliance with the requirements of the proposed rule, for
example, by examining any portfolio manager input in determining
whether a security is eligible for cross trading, reviewing the
adviser's best interest determination for any irregularities, and
confirming that the cross trade is consistent with the fund's other
policies and investment strategies as stated in its registration
statement. They generally should also describe how the CCO would
conduct the annual review, for example, by describing the review of
other transactions or information, the disposition price, any relevant
factors, and any appropriate testing to determine that a cross trade
did not disadvantage a fund.
---------------------------------------------------------------------------
\107\ See rule 38a-1(a)(1)-(3).
\108\ See current rule 17a-7(e)(1) and (2).
---------------------------------------------------------------------------
Rule 38a-1 provides flexibility for funds and fund complexes to
apply the requirements of the rule in a manner that best suits the
organization.\109\ In the case of cross trades, the board could
consider the fund's circumstances and use of cross trades, which may
include considerations such as the registered fund's investment
objective and strategies, risk and liquidity profile, conflicts of
interest with eligible affiliates, potential cost savings, and market
conditions. The policies and procedures should be tailored to each
registered fund.\110\ For example, a registered fund that only
occasionally cross trades exchange-traded equity securities using NAV
pricing may not require the same level of CCO review or detailed
reporting to the board as a registered fund that frequently cross
trades fixed-income securities using current market pricing.
---------------------------------------------------------------------------
\109\ See Compliance Programs Release, supra note 103, at n.30
and accompanying paragraph.
\110\ However, a board could approve a combined cross-trade
policy for multiple registered funds as long as the combined policy
meets the requirements under rule 38a-1 and proposed rule 17a-7 for
each fund.
---------------------------------------------------------------------------
The registered fund's policies and procedures may set appropriate
levels of deviation (e.g., tolerance levels) to trigger further review.
For example, registered funds may set a tolerance level for differences
between the cross-trade price and the valuation price, which may
automatically trigger additional review. As another example, the
policies and procedures may set a minimum holding period for cross-
traded securities, which may trigger additional review to address any
parking or dumping concerns.
The policies and procedures may describe specific circumstances and
conditions that bar a cross trade from occurring, prevent them through
pre-trade compliance blocks, require additional investigation, or give
a CCO or investment adviser personnel complete discretion to prevent a
cross trade. For example, pre-trade compliance testing could be
implemented for cross trades to determine if they are consistent with a
registered fund's investment policies and procedures or other
compliance requirements, and trade blocks could be implemented for
those that are not. The policies and procedures may also describe any
actions that should be taken if a cross trade is found to disadvantage
a registered fund relative to an eligible affiliate. Actions might
include, for example, depending on all the facts and circumstances,
including applicable law, reversing a trade or the adviser making the
disadvantaged registered fund whole, together with additional
monitoring in the future.
We request comments on the proposed oversight requirements:
39. Are the proposed oversight requirements appropriate? What are
the advantages and disadvantages of the proposed oversight
requirements?
40. Are the quarterly and annual review and reporting cadences
appropriate? Should we instead require only an annual review, similar
to that required under rule 38a-1, or conversely only a quarterly
review as in current rule 17a-7? Should we provide more detail or
guidance on how the quarterly or annual review should be performed and
documented? Please provide specific information on what detail or
guidance would be helpful.
41. Is the fund's CCO the appropriate party to perform the review
and report to the board? Should a fund's investment adviser instead be
able to designate the person(s) responsible for reviewing cross-trading
activity and reporting to the board, provided the fund's board,
including a majority of disinterested directors, approves such
designation? What qualifications or limitations should there be on who
those persons may be (e.g., only an officer or officers of the fund's
investment adviser, or limitations on the ability of portfolio managers
to serve in this role)? Should we provide more guidance on which
additional parties may perform or contribute to the review and report
to the board? Please provide specific information on what guidance
would be helpful.
42. Is the annual requirement to review whether a cross trade or
pattern of transactions may have disadvantaged the registered fund
relative to the eligible affiliate appropriate? Are there patterns of
transactions that may be more difficult or impossible to identify
during a quarterly review?
43. Should we provide more guidance on what the cross-trade
policies and procedures should include or consider? Please provide
specific information on what should be included or considered, and why.
44. Should we provide more guidance on how a CCO should conduct the
review quarterly and annually? Should the guidance include other
factors and considerations? Please provide specific information on what
factors and considerations should be included and why. Should those
factors and considerations be specifically listed in the rule? Should
we provide more detail or guidance on when the quarterly or annual
review should end, for example, one year after the fund's most recent
cross trade?
45. What are the advantages and disadvantages of requiring the CCO
to conduct disposition analysis by reviewing other transactions or
information necessary to evaluate transactions effected under this
section (including the timing and price of subsequent sales of
securities purchased in cross trades), in determining whether a cross
trade may have disadvantaged the fund relative to the eligible
affiliate? Should the rule require information other than the timing
and price of subsequent sales for the CCO to compare against the cross
trade, such as reasons that the disposition price is
[[Page 65640]]
different from the cross trade purchase price? Should CCOs be required
to conduct similar analyses when a fund sells a security in a cross
trade, by considering the timing and price of that cross trade sale
relative to the earlier purchase of the security by the fund? Would
that type of analysis present additional challenges, such as
identifying the time and price of the earlier purchase of the security
when the fund has engaged in multiple purchases to build its position
in the security over time?
46. Is the proposed role of the board appropriate? Should the rule
prescribe the content and format of the reports to the board and how
the board should review those reports?
47. Should the oversight requirements instead be proportionate
based on the size or characteristics of a registered fund or its cross-
trading activity? For example, should certain types of funds be
required to have fewer or less frequent reviews and reports to the
board (e.g., only annual reviews/reports)? If so, why and for what
types of funds (e.g., small funds, funds that engage in a small amount
of cross trading relative to their net assets, funds that only cross
trade securities that have readily available market quotations, or
funds that exclusively use NAV pricing of cross trades)?
48. Should the rule require certain actions if a CCO finds material
noncompliance with the proposed rule or a fund's policies and
procedures? If so, what should the actions include?
F. Reporting
The proposed amendments would establish new reporting requirements
for certain registered funds.\111\ We propose to amend Form N-PORT and
Form N-MFP (together, the ``forms'') to require certain registered
funds to provide additional information about their cross trade-related
purchase and sale activity. Specifically, we propose to amend the forms
to require registered funds that engaged in cross trades of portfolio
investments in reliance on rule 17a-7 during the preceding twelve-month
period to disclose, for each asset type (or category of investment, in
the case of Form N-MFP) during the reporting period and in U.S.
dollars: \112\
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\111\ Form N-PORT is used by registered management investment
companies, and exchange-traded funds organized as unit investment
trusts (``UITs'') but is not used by money market funds or by small
business investment companies (``SBICs'') registered on Form N-5.
Form N-MFP is used by money market funds.
\112\ For Form N-PORT filers, asset types are defined as short-
term investment vehicle (e.g., money market fund, liquidity pool, or
other cash management vehicle), repurchase agreement, equity-common,
equity-preferred, debt, derivative-commodity, derivative-credit,
derivative-equity, derivative-foreign exchange, derivative-interest
rate, derivatives-other, structured note, loan, ABS-mortgage backed
security, ABS-asset backed commercial paper, ABS-collateralized
bond/debt obligation, ABS-other, commodity, real estate, and other.
If other, the registered fund must provide a short description. See
Item C.4.a. of Form N-PORT. For Form N-MFP filers, categories of
investments include: U.S. Treasury debt; U.S. Government agency
debt; non-U.S. sovereign, sub-sovereign and supra-national debt;
certificate of deposit; non-negotiable time deposit; variable rate
demand note; other municipal security; asset backed commercial
paper; other asset backed securities; U.S. Treasury repurchase
agreement; U.S. Government Agency repurchase agreement; other
repurchase agreement; insurance company funding agreement;
investment company; financial company commercial paper; non-
financial company commercial paper; tender option bond; and other
instrument. If other instrument, the registered fund must provide a
brief description. See Item C.6. of Form N-MFP.
---------------------------------------------------------------------------
<bullet> The aggregate value of portfolio investments the
registered fund purchased under rule 17a-7; \113\
---------------------------------------------------------------------------
\113\ While the proposed amendments to Form N-MFP use the term
``portfolio securities'' rather than ``portfolio investments,''
reflecting that money market funds invest in a more limited universe
of instruments than other registered funds subject to Form N-PORT,
we use the term ``portfolio investments'' throughout this discussion
for simplicity.
---------------------------------------------------------------------------
<bullet> The aggregate value of portfolio investments the
registered fund purchased;
<bullet> The aggregate value of portfolio investments the
registered fund sold under rule 17a-7; and
<bullet> The aggregate value of portfolio investments the
registered fund sold.\114\
---------------------------------------------------------------------------
\114\ See Item B.12 of proposed Form N-PORT; Item A.23 of
proposed Form N-MFP.
---------------------------------------------------------------------------
The aggregate value would mean the value of portfolio investments
purchased or sold, calculated on a gross basis, without netting any
purchases and sales. When providing the aggregate value of portfolio
investments purchased or sold under the items mentioned in the second
and fourth bullets above, a registered fund should include all purchase
or sale transactions, including any amounts purchased or sold in cross
trades. The trading information would be reported for the preceding
month.\115\ This disclosure would follow the filing timelines,
publication frequency, and reporting period of each form.\116\
---------------------------------------------------------------------------
\115\ For example, a report providing a registered fund's
portfolio holdings as of the last business day, or last calendar
day, of the month of April would be required to include information
about aggregate trading activity and cross trades the fund effected
in the month of April.
\116\ Currently, Form N-PORT reports for each month in a
registered fund's fiscal quarter are filed with the Commission
within 60 days of the end of the fiscal quarter, and the report for
the third month of the quarter is made public upon filing. In 2024,
the Commission adopted amendments to Form N-PORT that require
registered funds to file monthly reports within 30 days of month end
and that provide for publication of monthly reports with additional
delay. These requirements have not gone into effect. See Form N-PORT
and Form N-CEN Reporting; Guidance on Open-End Fund Liquidity Risk
Management Programs; Delay of Effective and Compliance Dates,
Investment Company Act Release No. 35538 (Apr. 16, 2025) [90 FR
16812 (Apr. 22, 2025)]. In 2026, the Commission proposed changes
that, among other things, would provide registered funds with
additional time to file monthly Form N-PORT reports and restore a
quarterly publication frequency. See Form N-PORT Reporting,
Investment Company Act Release No. 35962 (Feb. 18, 2026) [91 FR 8582
(Feb. 23, 2026)] (``Form N-PORT Reporting Release''). As the
proposed cross-trading reporting requirements would follow the same
timeframes as generally required for Form N-PORT, if we were to
adopt the Form N-PORT proposal, we also expect that the proposed
cross-trading reporting items would be reported and made public at
the amended timeframes. If the 2026 amendments in the Form N-PORT
Reporting Release are adopted as proposed and the Commission adopts
the proposed amendments to rule 17a-7, we would anticipate requiring
cross-trade information for each of the preceding three months in
each Form N-PORT report to provide transparency in cross-trade
information to investors. This would also mitigate concerns that
investors might potentially believe that one month's cross trades
represent the full quarter and better conform with other information
that would be presented on Form N-PORT if the 2026 amendments are
adopted as proposed. Form N-MFP reports are filed on a monthly basis
no later than the fifth business day of the month.
---------------------------------------------------------------------------
Currently, most registered funds report on Form N-CEN whether they
relied on certain statutory and rule-based exemptions, including rule
17a-7.\117\ While this information helps identify whether a registered
fund made cross trades in the reporting period, it does not provide any
additional information, such as the volume of cross trades by
registered fund or asset class. Registered funds currently also are
subject to requirements to disclose material information about cross
trades in their financial statements.\118\ This information is often in
narrative form, which limits comparability, and may not provide a clear
picture of the frequency, type, or amount of all cross trades by the
registered fund or those that are not deemed material. As suggested by
some respondents, reporting aggregated cross-trade information on Form
N-PORT could provide additional transparency and visibility into
registered funds' cross-trading practices.\119\ The proposed reporting
on the forms would provide information about the total and comparative
volume of cross trades by asset class in a structured format that can
be efficiently analyzed by the Commission staff and market participants
across registered funds in a
[[Page 65641]]
way that is not currently available through reports on Form N-CEN or in
registered fund financial statements.
---------------------------------------------------------------------------
\117\ See Item C.7 of Form N-CEN (requiring this reporting by
management investment companies).
\118\ See 17 CFR 210.6-07 (requiring disclosure of certain
affiliated transactions as part of a registered fund's statement of
operations) and ASC 850 (requiring disclosure of material related
party transaction).
\119\ See ICI Letter; Capital Group Letter.
---------------------------------------------------------------------------
Similarly, registered funds do not currently disclose the volume of
trading activity that occurred during the reporting period,
specifically, the aggregate value of portfolio investments that were
purchased or sold. Registered funds are currently required to report
information on the forms generally on an ``as-of'' basis, which
provides information at a single point in time, but does not provide
this specific information about the volume of investments the
registered fund purchased or sold during the period.\120\
---------------------------------------------------------------------------
\120\ See, e.g., Item B.7 on Form N-MFP (requiring shareholder
flow information as of the close of business on each business day of
the month reported).
---------------------------------------------------------------------------
This reporting requirement would enable the Commission and its
staff and market participants to understand the proportion of a
registered fund's overall trading activity that consists of cross
trades, both in the aggregate and within specific asset classes, which
would provide necessary context for understanding the volume,
significance, and materiality of cross trades relative to total trading
activity as well as trends in such activity over time. To provide
better contextual information about how the volume of a registered
fund's cross trades compares to its overall trading activity, the
proposed reporting requirement would begin when a registered fund
begins cross trading and apply for a 12-month period following any
cross trades. During this period, the registered fund would be required
to report information about its aggregate trading activity by asset
class, even if it does not conduct cross trades for particular months
within that period. This approach is designed to recognize that the
volume and character of funds' trading activities can vary from month-
to-month and also provide an appropriately lengthy period for data
review. For example, if we were to instead require aggregate trading
information only for months in which a fund conducts cross trades, the
aggregate trading information for those months may not accurately
reflect how the volume of a fund's cross-trading activity compares to
its overall trading activities.\121\
---------------------------------------------------------------------------
\121\ Specifically, if we required aggregate trading information
only for months in which a fund cross trades, the reported
information may over- or under-estimate the proportion of a fund's
trading activity that consists of cross trades. For example, if a
registered fund engaged in relatively low volumes of non-cross-
trading activity in months in which the fund cross traded, but
higher volumes of non-cross-trading activity in other months, or
only reported for a shorter period than twelve months, the reported
information would suggest that cross trading represents a greater
volume of the fund's trading activity than it actually does.
---------------------------------------------------------------------------
Since the volume of cross trades can reasonably be expected to grow
under the proposed amendments, the proposed reporting requirement would
assist in understanding and monitoring the effects of that growth and
how it affects specific registered funds and asset classes. This
reporting requirement would enhance transparency and facilitate more
informed decision-making by providing information on cross-trading
activity over time for a registered fund and across similar registered
funds by asset class and reporting period.
The proposed reporting is also important because cross trades occur
outside of the public markets and do not generate publicly observable
market data, unlike transactions on registered exchanges or reported
through post-trade transparency systems such as TRACE or RTRS. The lack
of public information about specific transaction prices may negatively
impact price discovery processes. In addition, the lack of public
information about the volume of cross trades may distort perceptions of
liquidity in a particular asset class or market. While the proposal
would not provide the type of transparency available through systems
like TRACE or RTRS, the proposed reporting on the forms would provide
volume transparency by requiring reporting of the aggregate volume of
cross trades, by asset class. If the volumes of cross trades are
growing or substantial, this information may help market participants
understand the potential effects of the cross trades on the reliability
of other available information about trading in that asset class. In
addition, the proposed reporting may inform any future Commission
action about cross-trading data and whether it should be made available
through post-trade transparency systems.
As with other information on the forms, the proposed disclosure
would be filed in a structured data format. Standardized disclosure on
a registered fund's cross trading and total trading activity would
provide transparent, standardized, and comparable information regarding
the extent to which the registered fund industry, and each individual
registered fund, engages in cross trading, overall volumes, as well as
the types of assets involved in such trading activities. This allows
investors and other market participants to easily access and process
the cross-trade information reported, either by analyzing the forms
directly or through analyses prepared by third-party service providers,
which may enable more informed investment decisions and promote greater
accountability by the adviser. This reporting would also provide market
participants with information to evaluate the potential effects of
cross trades on perceptions of liquidity in a particular asset class or
market.
The information we propose to be reported is designed to balance
the burden of providing it with the Commission's and the public's need
for the information. The proposal would only require registered funds
that engaged in cross trades of portfolio investments in reliance on
rule 17a-7 during the preceding twelve-month period to provide
information about the aggregate value of cross trade-related purchases
and sales grouped by asset type or category of investments. While more
granular reporting, such as the price and volume of each trade or cross
trade, or industry-wide reporting on total trading volumes, would
provide valuable information, registered funds would then bear a more
significant reporting burden. In addition, the proposed amendments work
with existing recordkeeping obligations under the Investment Company
Act, such as the requirement to maintain records of registered funds'
portfolio transactions.\122\ The proposed reporting may help mitigate
the potential conflicts of cross trading by providing insight into such
trading to the Commission and its staff, assisting them in carrying out
their regulatory responsibilities, including any future Commission
action as to cross trading, risk monitoring during periods of market
stress, and regulatory oversight.
---------------------------------------------------------------------------
\122\ See 17 CFR 270.31a-1(b)(1) (requiring, for example,
itemized daily records in detail of all purchases and sales of
securities).
---------------------------------------------------------------------------
We request comments on the proposed reporting requirements:
49. Is the proposed reporting requirement appropriate? For example,
is the information that registered funds currently provide on the
forms, Form N-CEN, and in financial statements sufficient for the
Commission, investors, and other market participants to monitor fund
trading activity, including cross trades? What are the advantages and
disadvantages of the proposed reporting requirements? If the proposed
requirements to Form N-PORT and Form N-MFP are adopted, should we
eliminate Item C.7.e. on Form N-CEN, which asks if a fund relied on the
rule 17a-7 exemption?
[[Page 65642]]
50. Is the proposed reporting trigger for registered funds that
engaged in cross trades during the preceding twelve-month period
appropriate? Would this approach affect registered funds' ability to
automate their filing processes or introduce complexity to the
reporting process? For funds that engage in cross trading, how
frequently do cross trades occur? Does the frequency at which funds
engage in cross trading suggest that it would be unnecessary or
ineffective to require reporting over a twelve-month period since the
fund's last cross trade? Should this reporting requirement apply to
registered funds that have engaged in cross trades within a shorter or
longer period than the preceding twelve months (for example, the past
3, 6, 18, or 24 months)? Should the reporting be limited to only those
months in which a registered fund engaged in a cross trade?
51. Instead of using a reporting trigger based on when the fund
last engaged in a cross trade as proposed, should we require registered
funds to report cross trade and total trading information if a fund has
policies and procedures that permit it to cross trade regardless of
whether the fund has cross traded? Should the reporting apply to any
registered fund that has cross traded or intends to cross trade over a
specified period (for example, 1, 3, 6, 12, 18, or 24 months)? Are
there other, more effective ways to identify funds that engage in
cross-trading activity for purposes of determining which funds must
report cross trade-related information?
52. Is the proposed reporting period of the preceding month
appropriate? If the 2026 amendments in the Form N-PORT Reporting
Release are adopted as proposed, should a registered fund reporting on
Form N-PORT be required to disclose for a longer period (for example,
each of the preceding three months with the report for the third month
of the quarter being made public) to provide for public transparency of
the monthly data? \123\
---------------------------------------------------------------------------
\123\ See supra note 116.
---------------------------------------------------------------------------
53. Is the proposed requirement to report the aggregate value of
cross trading and all trading activity by asset class or category of
investment appropriate? Should the proposed amendments use the
investment groupings already established in each form for this purpose
or should they be modified to better capture trading activity
information? If yes, how? Should registered funds instead, or in
addition, report trading activity using other measurements, for
example, by level within the fair value hierarchy under U.S. GAAP?
54. Is the proposed requirement to report the aggregate value of
portfolio investments purchased and sold appropriate? Should registered
funds instead, or in addition, report the proportion of total purchases
and sales attributable to cross trades? Should registered funds
instead, or in addition, report portfolio investments that are acquired
or disposed of, or held to maturity? Should reporting of aggregate
trading activity be required only for the asset classes in which the
registered fund has conducted a cross trade during the preceding
twelve-month period, or should reporting of aggregate trading activity
be required for all asset classes in the relevant form? Are there
certain asset classes in which registered funds are unlikely to conduct
cross trades, either due to the conditions of the rule or other
considerations, and therefore registered funds should not be required
to report aggregate trading activity for those asset classes?
55. Is the term ``aggregate value'' clear and operationally
workable? If not, what additional guidance on specific portfolio
investments or how values should be reported would be helpful?
56. Is the proposed requirement to report cross trade purchases and
sales transactions separately appropriate? Should registered funds
instead, or in addition, report additional information about their
aggregate cross-trading activities, for example, the number of cross
trades effected during the reporting period or total net realized gains
or losses associated with cross-trading activities (or net change in
unrealized appreciation or depreciation)? Should registered funds
instead, or in addition, report additional information about individual
cross trades, for example, details on the timing, price, and volume of
each cross trade, the potential cost savings, and cross-trade parties?
If yes, what other information should be disclosed?
57. Should registered funds be required, instead of the proposed
reporting requirements or in addition, to publicly report cross-trading
activity, for example, through a reporting venue administered by a
self-regulatory organization or securities information processor? If
yes, why and what method should be used (e.g., reporting individual
cross trades to reporting venues such as TRACE and RTRS)? Would this
type of public reporting of cross-trading activity assist price
discovery and impose pricing discipline? If yes, how? Is some cross-
trading activity already being reported, for example by an affiliated
broker-dealer? If yes, under what circumstances and how often?
58. Should registered funds instead report the proposed information
about trading activity, including cross trades, confidentially to the
Commission? If so, why would public disclosure of information about
registered funds' trading activities be neither necessary nor
appropriate in the public interest or for the protection of investors?
\124\
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\124\ See section 45 of the Investment Company Act (providing
that information filed with the Commission shall be made available
to the public, unless the Commission finds that public disclosure is
neither necessary nor appropriate in the public interest or for the
protection of investors).
---------------------------------------------------------------------------
59. Are there any barriers to registered funds reporting trading
activity, including cross trades, on the forms? If yes, what are they
(e.g., needing to manually process information or link separate
information systems)? Would those barriers cause some registered funds
to avoid cross trading when cross trading would otherwise be beneficial
to the funds? If so, which funds and why? Should there be a de minimis
exception to reporting (e.g., cross trades that do not exceed 1%, 5%,
or 10% of net assets) or should certain funds (e.g., small funds or
funds that engage in cross trading only for level 1 securities) be
exempt from the proposed reporting requirements? \125\ If so, why and
for what types or size of funds or what amount of cross trading? Are
there other changes we should make to reduce reporting burdens, such as
requiring the proposed information about cross-trading activity but not
requiring the proposed information about aggregate trading activity?
---------------------------------------------------------------------------
\125\ See infra note 134 (discussing a pending proposal
addressing the definition under the Investment Company Act of small
organization and small business for purposes of the Regulatory
Flexibility Act).
---------------------------------------------------------------------------
60. Some types of funds that may rely on rule 17a-7, such as BDCs
and SBICs, are not required to report on Form N-PORT or Form N-MFP and
therefore would not be subject to the proposed reporting requirement.
Is the information that BDCs or SBICs currently provide on other forms
or periodic reports sufficient for the Commission, investors, and other
market participants to monitor fund cross-trading activity? Should we
amend other reporting forms to require cross-trading information for
funds that do not report on Form N-PORT or Form N-MFP? If so, where
should this disclosure be located (e.g., in Form 10-K or other periodic
reports for BDCs)?
61. Part D of Form N-MFP separately requires all prime money market
funds to disclose the gross market value of portfolio securities they
sold during the
[[Page 65643]]
reporting period by category of investment. For prime money market
funds that engage in cross trading, the proposal would require the same
information under a different item on Form N-MFP for a 12-month period
after any cross trade (in addition to the aggregate value of portfolio
securities purchased or sold in cross trades, and the aggregate value
of portfolio securities purchased). Recognizing that the proposed
reporting requirement and Part D of Form N-MFP differ in the scope of
money market funds subject to the reporting requirements, are there
ways in which we should consolidate the reporting requirements for
prime funds that engage in cross trading? Would such consolidation
reduce reporting burdens without affecting the utility of the reported
information?
G. Recordkeeping
We propose to update the recordkeeping requirements of rule 17a-7
to reflect the proposed amendments. The current recordkeeping
requirements under the rule and proposed changes are set forth in Table
1 below.
Table 1
------------------------------------------------------------------------
Record Current rule Proposal
------------------------------------------------------------------------
Written Policies and Procedures. Rule 17a-7(g)(1): Removed.
Maintain and
preserve
permanently.
Rule 38a-1: No change.
Maintain all
policies and
procedures that
are in effect or
were in effect at
any time during
the last five
years.
Transaction Records (including Six years from the Maintains current
description of security, end of the fiscal requirements.
identity of counterparty, and year in which a
terms of the transaction). rule 17a-7
transaction
occurred, the
first two years
in an easily
accessible place.
Information or Materials Related Six years from the Similar to current
to Oversight. end of the fiscal requirements, but
year a rule 17a-7 would generally
transaction relate to the
occurred, two in CCO's oversight
an easily requirements,
accessible place. specifically
Record relates to including
the board's information or
oversight. materials: (1)
used to determine
that each
condition of the
rule was
satisfied for
each cross trade
as part of
quarterly
reviews; \1\ and
(2) used to
determine whether
a cross trade, or
pattern of
trades, may have
disadvantaged the
registered fund,
including
information or
materials related
to other
transactions or
information
reviewed as part
of annual
reviews.\2\
Records of the
CCO's reports to
the fund's board
would also be
required.\3\
------------------------------------------------------------------------
Notes:
\1\ See proposed rule 17a-7(c)(2).
\2\ See proposed rule 17a-7(c)(3).
\3\ See proposed rule 17a-7(c)(4). See supra section II.E for discussion
of the CCO's oversight requirements.
The proposed amendments to the recordkeeping requirements would
remove duplication and correspond with other proposed amendments to
rule 17a-7. The amendments are designed to ensure accountability,
transparency, and verifiability for compliance and oversight purposes.
The recordkeeping amendments also would allow the Commission and its
staff to better understand cross-trading activities, identify issues,
and conduct examinations. These amendments are designed to prevent
overreaching and help address conflicts of interest that may harm
investors and should improve the Commission's ability to oversee the
industry and increase investor protection.
The proposal would remove the requirement to maintain and preserve
permanently a written copy of the registered fund's cross-trading
procedures from rule 17a-7(g)(1). This change would remove duplication
with the requirements of rule 38a-1 under the Investment Company Act,
which requires registered funds to maintain a copy of their policies
and procedures reasonably designed to prevent violation of the Federal
securities laws that are in effect or were in effect at any time during
the last five years.\126\ The requirements of rule 38a-1 apply to cross
trades under rule 17a-7, making rule 17a-7(g)(1) unnecessary. In
addition to harmonizing the recordkeeping requirements to rule 38a-1,
the proposed change would reduce recordkeeping burdens while still
providing the Commission's examination staff sufficient information to
assess whether the fund is adhering to rule 17a-7 and in identifying
weaknesses in compliance with the rule.
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\126\ Rule 38a-1(d)(1).
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Consistent with the current rule, registered funds would be
required to maintain and preserve written records of cross trades for
at least six years, starting from the end of the fiscal year when the
transaction took place, with the records stored in an easily accessible
place for the first two years. The proposed amendments would include
records on each cross trade, including a description of the security
purchased or sold, the identity of the eligible affiliate on the other
side of the transaction, and the terms of the purchase or sale
transaction.\127\
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\127\ See proposed rule 17a-7(c)(1). The proposed amendment
references the proposed newly defined term, ``eligible affiliate,''
to more clearly reference the counterparty to the cross trade rather
than ``the person'' as used in the current rule. This will also
facilitate verification that the counterparty meets the ``eligible
affiliate'' definition.
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As discussed above, the current rule requires maintaining and
preserving records the board used to determine, no less frequently than
quarterly, that all cross trade purchases or sales made during the
preceding quarter were effected in compliance with the registered
fund's cross-trade procedures.\128\ The proposed amendments would
remove this requirement and instead require maintaining and preserving
records of
[[Page 65644]]
the information or materials upon which the CCO, rather than the board,
based the determinations for the required quarterly and annual reviews.
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\128\ Current rule 17a-7(g)(2).
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With respect to quarterly reviews, the proposed amendments would
require maintaining and preserving information or materials the CCO
used to determine that each condition under the rule was satisfied with
respect to each transaction, as well as the quarterly reports provided
to the board on the results of those reviews.\129\ The proposed
recordkeeping requirement connected to the quarterly review would
require, at a minimum, documentation showing whether the cross trades
complied with each condition under proposed rule 17a-7.\130\
Accordingly, the proposed records would need to include documentation
used to determine that:
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\129\ See supra section II.E. Proposed rule 17a-7(b)(7) would
require the registered fund's CCO to review, and report to the board
the results of the review, (1) no less frequently than quarterly all
transactions during the preceding quarter that were effected under
this section to determine their compliance with rule 17a-7, and (2)
no less frequently than annually all transactions during the
preceding period that were effected under rule 17a-7, as well as
other transactions by the fund or information necessary to evaluate
transactions effected under rule 17a-7 (including the timing and
price of any subsequent sales of securities purchased in cross
trades), to determine whether any such transaction, or pattern of
transactions, may have disadvantaged the fund relative to the
eligible affiliate(s).
\130\ See proposed rule 17a-7(c)(2).
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<bullet> Each security was eligible to be cross traded, for
example, whether it was a level 1 or level 2 security;
<bullet> Each cross trade met the pricing condition under the
proposed rule, including whether NAV pricing or current market pricing
was used and, if current market pricing, how the adviser determined
that the price reasonably represented current market price for the
cross-traded security, for example, by identifying any unaffiliated
pricing source, and the results of the adviser's review of the
reasonableness of those prices;
<bullet> Any fees paid in connection with the cross trade were de
minimis and consistent with the rule;
<bullet> Each cross trade was consistent with the registered fund's
policies and investment strategies; and
<bullet> The investment adviser determined the cross trade to be in
the best interest of the fund, including the factors considered, such
as the characteristics of the securities (e.g., availability, price,
and liquidity) and expected effect of the cross trade on the fund
(e.g., cost savings and performance).
With respect to annual reviews, the registered fund also would be
required to maintain and preserve records of the information or
materials the CCO used to determine whether a cross trade, or pattern
of cross trades, may have disadvantaged the fund relative to eligible
affiliates as part of its annual review.\131\ That would include
information or materials related to other transactions or information
necessary to evaluate those cross trades, including, as is consistent
with the oversight requirement in the proposal, documentation showing
that the CCO considered the timing and price of subsequent sales of
securities purchased in cross trades. As part of this requirement to
consider the timing and price of these subsequent sales, the fund must
maintain and preserve records that detail the economic terms of each
sale of a security that was purchased by a registered fund in a cross
trade, including:
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\131\ See proposed rule 17a-7(c)(3).
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<bullet> The date of purchase,
<bullet> The purchase price,
<bullet> The date of the sale, and
<bullet> The sale price.
While registered funds are already required to maintain and
preserve these trade records under either current rule 17a-7 or rule
31a-1, the proposal would require the CCO to review these records as
part of the annual review in a manner that may not currently be done.
These records also would be required to be made available to the board
promptly upon request. Reports and other information provided to the
board should be in a format that is easy to digest to facilitate the
board's oversight.
In addition, the information or materials used in connection with
the CCO's annual review that must be maintained and preserved may
include, for example, information and reports that identify other
details of cross-traded securities (including how prices were
calculated for sales of securities acquired at different times and at
different prices (e.g., average price mechanics)), analysis of
performance of the cross-traded security, analysis of market and fund
flow conditions around the time of the cross trade, and other analyses
to determine why the timing and disposition of the cross-traded
security did not disadvantage the fund. The registered fund also would
be required to maintain and preserve the reports the CCO provided to
the board with the results of the CCO's quarterly and annual
reviews.\132\
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\132\ See proposed rule 17a-7(c)(4).
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The proposed amendments do not otherwise prescribe how a fund would
meet these recordkeeping requirements. These records, for example, may
consist of spreadsheets or logs with dropdown lists as well as longer
descriptions. The recordkeeping requirements are designed to assist the
CCO's reviews and reports, help determine and test compliance with rule
17a-7, and provide important information about cross trades to the
Commission and its staff.
We request comments on the proposed recordkeeping requirements:
62. Are the proposed recordkeeping requirements appropriate?
63. Should we provide more guidance or more detailed provisions in
the rule on what type of records are required? If so, what should the
records be required to include? Is it appropriate to require records on
the CCO's determinations that cross trades were made in compliance with
proposed rule 17a-7 and that a cross trade, or pattern of cross trades,
did not disadvantage the fund relative to the eligible affiliate(s)?
Should we provide more details in the rule or guidance on what records
would show that the CCO reviewed the cross trades and other
transactions or information necessary to evaluate transactions effected
under this section (including the timing and price of any subsequent
sales of securities purchased in cross trades)? Should the rule instead
impose independent recordkeeping requirements with respect to each
condition of the rule? What recordkeeping systems would need to be
involved?
64. Should the rule require a particular format or contents of the
documentation required to be maintained under this new requirement?
65. Are the proposed retention periods sufficient to evidence
compliance? Should we require a longer (e.g., eight years) or shorter
(e.g., four years) retention period?
66. Do registered funds have concerns that it would be difficult to
maintain and preserve these records?
H. Other Amendments
We are proposing to add definitions of the terms ``fund'' and
`
[…truncated; see source link]Indexed from Federal Register on October 15, 2026.
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