Enforcement Action Targets Adviser for Lack of Policies on Cross-Trades
An adviser agreed to pay $450,000 in SEC penalties to settle violations of the 1940 Act and Advisers Act when the adviser cross traded securities between client accounts that it advised. According to the SEC’s order, Palmer Square Capital Management prearranged buys and sells of the same security in the same amount from one client account to another 351 times from at least July 2014 through September 2016. When effecting almost all of these trades, Palmer Square failed to comply with the statutory provisions regarding unlawful cross trades with registered investment companies. In addition, certain trades were principal transactions made without the required disclosures and consent. The SEC noted that while internal cross trades can benefit clients by saving on transaction and market costs that would otherwise be paid to executing broker-dealers, these transactions also pose substantial risks to investors due to the inherent conflict of interest for the adviser, which has a fiduciary duty of loyalty to its clients and also must seek to obtain best execution for both its buying and selling clients. The 1940 Act generally prohibits sales and purchases of securities between certain affiliated persons without an exemptive order from the SEC, which Palmer Square had not obtained. The SEC’s order found that Palmer Square did not adopt and implement policies and procedures that were reasonably designed to prevent violations of the federal securities laws and Commission rules governing cross trading and Palmer Square personnel did not receive training on cross trades or Rule 17a-7 under the 1940 Act. While the compliance policies applicable to the Palmer Square Funds allowed cross trades as long as the requirements of 17a-7 were followed and the trades were reported to, and approved by, the fund board, Palmer Square failed to adequately implement these policies. Further, Palmer Square inaccurately informed the board each quarter that it had not engaged in any cross trades. Palmer Square also did not ensure that the trades complied with other requirements of Rule 17a-7. In 2018, the Division of Investment Management issued no-action relief for fund boards on affiliated transactions, including cross trades, establishing that directors may rely on the written representation of the fund’s CCO rather than reviewing these transactions and making their own determinations on compliance with fund policies and procedures, reasoning that such tasks were more appropriately CCO functions and consistent with the SEC’s policy underlying Rule 38a-1 of the 1940 Act.