Understanding Agency Cross Transactions
An agency cross refers to a scenario where an investment advisor acts as a broker for both their client and the opposing party in a transaction involving a security. This typically occurs when conflicting orders for the same asset are received by a broker. Advisors need client approval for agency cross transactions to ensure transparency and avoid conflicts of interest.
Agency cross transactions involve investment advisors serving as brokers for both their clients and the opposing party. In the usual process of buying or selling securities, individuals rely on their investment advisors or broker-dealers to facilitate transactions. The broker seeks a counterparty in the market willing to engage in the transaction at the desired price. If the investment advisor assumes the role of broker for both parties, the transaction is labeled an agency cross.
To maintain fairness, investment advisors must secure the best possible price in agency cross transactions, similar to their approach in other transactions. This means that even if the advisor has potential buyers or sellers, including other clients, they must explore the market to ensure the best deal. Only when a suitable time passes without better offers can the advisor proceed with the agency cross.
These transactions are subject to regulation under Rule 206(3)-2 of the Investment Advisers Act of 1940—a federal law governing advisors' roles and responsibilities. To ensure clients' best interests are prioritized, advisors must obtain written consent from clients to conduct agency transactions. Notably, affiliates of the advisor, such as associates from the same investment company, can also conduct agency crosses.
Scrutiny and Compliance
Due to the potential for self-dealing and conflicts of interest, regulators vigilantly monitor advisors' adherence to Rule 206(3)-2 in agency cross transactions. Unethical advisors could exploit agency crosses to increase compensation by acting as brokers for both parties. This approach doubles their earnings, prevents bias towards one party, and ensures impartiality.
Compliance with Rule 206(3)-2 entails the following:
- Clients must give written consent, following full disclosure from the advisor regarding the broker's role, commissions, and potential conflicts of interest.
- Advisors must provide written transaction notifications, including transaction details and remuneration information, to clients before or upon transaction completion.
- Annual statements detailing the number of agency cross transactions and the received or anticipated remuneration must be sent to clients. The statements also emphasize the revocable nature of consent.
Agency Cross vs. Principal Transaction
Agency cross transactions involve advisory clients, while principal transactions take place when advisors trade securities from their firm's account with or for a client. Principal transactions are listed on exchanges, mitigating the risk of insider trading.
Agency Cross Example
Imagine a client who wishes to offload 100 shares of Enterprise A at $45 per share. Seeking assistance, the client approaches their financial advisor, who then heads to the trading floor. Upon identifying a potential buyer, or if the advisor had already identified one, willing to acquire the same quantity of shares at the designated price, the advisor can orchestrate the transaction, acting as the intermediary for both the buyer and the seller. It's essential, however, to highlight that maintaining legal and ethical standards requires the advisor to secure written approval from the client before executing the trade.
In the realm of investment, agency cross transactions epitomize the dual role of investment advisors. As intermediaries between clients and opposing parties, advisors must navigate the complexities of balancing interests, transparency, and compliance. Regulatory guidelines such as Rule 206(3)-2 ensure that agency cross transactions are conducted in the best interests of clients, safeguarding the integrity of the financial market.