(Article from Registered Funds Regulatory Update, January 2023)
For more information, please visit the Registered Funds Resource Center.
On November 21, 2022, the SEC settled charges against Legal & General Investment Management America, Inc. (“LGIMA”), a registered investment adviser, for violating restrictions on principal account transactions and cross trades and related policy and procedure violations. From August 2017 through December 2020, LGIMA arranged 44,125 principal account transactions and 126,249 equity cross trades, the vast majority of which were effected through an automated trade matching program implemented in May 2019. LGIMA internally matched buy and sell orders across its advisory client accounts and advisory client accounts of affiliates and sent them to a third-party broker to execute at a reduced or no commission rate.
Principal Trades
According to the settlement order, LGIMA violated the anti-fraud provision of the Advisers Act by conducting principal trades with client accounts without written disclosure to, and consent from, the affected clients. Throughout the relevant period, LGIMA’s Cross Trading Policy specifically stated that LGIMA did not engage in principal trades. As a result, LGIMA also failed to implement written policies and procedures reasonably designed to prevent these violations, did not offer adequate training on the regulatory requirements of principal transactions, and did not take steps to ensure personnel did not engage in principal transactions.
Cross Trades
The settlement order also found that LGIMA caused certain of its investment company clients to violate Section 17(a) of the 1940 Act, which prohibits any affiliated person of a registered investment company, or any affiliated person of such person, to knowingly purchase a security from the investment company when acting as principal. However, Rule 17a-7 exempts certain cross trades where the affiliation between parties is solely by reason of having a common investment adviser, provided that the transaction meets certain requirements. Among the protective conditions, Rule 17a-7 generally requires that cross trades: (i) involve a security for which market quotations are readily available; and (ii) be effected at the independent current market price of the security. Rule 17a-7 contains a number of other requirements, including that the transaction be consistent with the policy of each fund; that no commission, fee or other remuneration be paid in connection with the transaction; that the board (including a majority of independent directors) take certain actions; and that the fund maintain certain records.
Of the more than 126,000 cross trades that LGIMA arranged, 547 involved an LGIMA registered investment company client account and an affiliated person of those registered investment companies or an affiliated person of such persons. LGIMA did not identify or monitor cross trading involving its registered investment company client accounts, and it failed to implement its own stated cross trading policy requiring email documentation and compliance approval of cross trades. Moreover, because LGIMA failed to disclose such cross trades to the registered investment company’s board, the board could not determine whether the cross trades complied with its procedures and with Rule 17a-7.
Without admitting or denying the SEC’s findings, LGIMA agreed to a cease and desist order, censure, and civil monetary penalty of $500,000. In determining to accept LGIMA’s settlement offer, the SEC took into consideration LGIMA’s remedial acts, self-reporting, and cooperation. Specifically, LGIMA self-reported the potential violations to the SEC staff and provided detailed responses to staff questions. LGIMA stopped all cross trading and implemented new procedures to prevent any cross trades until it could relaunch its cross-trading program with hard-coding to prevent any impermissible principal trades or cross trades. LGIMA also hired outside counsel and an economic consultant to conduct a review of its trading practices. In addition, LGIMA disclosed the violations to its advisory clients and implemented mandatory compliance training on cross trading and principal trades for all trading, legal, compliance, and operational employees.
In the Matter of Legal & General Investment Management America, Inc., SEC Admin. Proc. File No. 3-21244 (Nov. 21, 2022), available at: https://www.sec.gov/litigation/admin/2022/ia-6188.pdf