Quick Answer
A principal transaction happens when an investment adviser, trading for its own account, buys from or sells to an advisory client. Before completing each such transaction, the adviser must disclose in writing that it is acting as principal and obtain the client's consent to that specific transaction. Blanket advance consent does not satisfy this rule.
Unlike an agency cross transaction, a principal transaction puts the adviser directly on the other side of the client's trade, which is why the consent requirement is stricter.
What Is a Principal Transaction?
- A principal transaction occurs when an investment adviser, acting for its own advisory account, buys a security from or sells a security to a client
- The adviser is on one side of the trade and the client is on the other side, giving the adviser a direct financial interest in the outcome
What Must Happen Before a Principal Transaction Is Completed?
Before completion of each principal transaction, the adviser must:
- Disclose in writing the capacity in which it is acting (as principal)
- Obtain the client's consent to that transaction
Both disclosure and consent must occur before completion of each transaction, not just once at account opening. Per-transaction disclosure and consent is required; blanket advance consent is not sufficient for principal transactions.
Exam Tip: Gotchas
- Principal transactions require fresh written disclosure and consent every single time. Agency cross transactions, by contrast, allow prospective (blanket) written consent covering future transactions. A question describing a client who consented once, at account opening, to "any future principal trades" describes a violation: the adviser still needs disclosure and consent before completing each one.
Are There Exceptions to the Principal Transaction Rule?
The principal transaction disclosure-and-consent requirement does not apply when:
- The adviser is not acting as an investment adviser in relation to that particular transaction, or
- The adviser acts as an investment adviser solely through publicly distributed written materials (distributed to 35 or more paying recipients), publicly made oral statements (to 35 or more paying listeners), or statistical information without opinions, or any combination of these
What Should You Check on Exam Day?
- Disclosure of principal capacity and client consent must both happen before completion of each transaction; a single blanket consent does not cover future principal trades.
- Contrast with agency cross transactions: principal transactions need per-transaction consent, agency cross transactions need only prospective consent.
- The narrow publicly distributed materials exception applies only when the adviser's role in the transaction is limited to that kind of public, non-personalized communication.