Sunday, November 1, 2009

Agency Cross Transactions

One of my Series 65 customers just asked me to explain "agency cross transactions," which are potentially "conflicts of interest" for investment advisers. I repsonded this way:

Hi, Kevin
If I'm your adviser, I'm supposed to be buying and selling securities only because it benefits you. If my advisory firm has an affiliated broker-dealer, and I start buying securities for your account or selling them from your account to our brokerage customers and pocketing commissions, that would be a major violation unless the "agency cross transactions" were disclosed to you. The fact that we get commissions when managing your portfolio could be making our buying and selling activities less than objective. So, we disclose the agency cross transactions to our advisory clients and once a year send itemized lists of all the agency cross transactions that we did while managing those accounts. We can never advise both sides of a transaction any more than a divorce attorney can represent both the husband and the wife in a divorce case. Here is the actual rule:

On a related note, the affiliated broker-dealer can act as a "principal" on a transaction and instead of getting a commission, the firm charges a markup-markdown. That also requires disclosure and client consent because the firm benefits suddenly beyond just the advisory fees being charged. Remember that whenever an adviser gets compensated beyond the advisory fee, this needs to be disclosed to the advisory client. If I put you into a mutual fund and receive 12b-1 fees or sales charges (with my Series 6 or 7 license) that definitely needs to be disclosed. Is my advice totally objective? If not, I must disclose anything that could make it less than objective.

These potential conflicts of interest are laid out in ADV Part 2 (disclosure brochure) and are also disclosed on a per-transaction basis to the advisory client.

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