Principal Transactions by Investment Advisers
Where an agency cross transaction involves the investment adviser (IA) acting as broker for two other parties, a principal transaction puts the IA on one side of the trade itself: a more direct conflict of interest.
Definition
- 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 IA has a direct financial interest in the transaction; it is on one side of the trade and the client is on the other
Requirements
Before completion of each principal transaction, the IA must:
- Disclose in writing the capacity in which the IA is acting (as principal)
- Obtain the client's consent to the transaction
Both must occur before the 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 per-transaction written disclosure and consent before completion. Agency cross transactions allow prospective (blanket) written consent.
- Blanket advance consent is not sufficient for principal transactions. The exam frequently tests this distinction.
Agency Cross vs. Principal: Consent Comparison
| Agency Cross Transaction | Principal Transaction | |
|---|---|---|
| IA's role | Broker for both parties | Buyer or seller (trading from own account) |
| Type of consent | Prospective (blanket, given once in advance) | Per-transaction (required before each trade) |
| Written disclosure | Before initial consent + confirmation per transaction | Before completion of each transaction |
| Annual reporting | Required (transaction count + commissions) | Not specifically required |
| Dual recommendation | Prohibited (cannot advise both sides) | N/A (IA is one side) |
Exceptions
The principal transaction prohibition does not apply when:
- The broker-dealer (BD) is not acting as an investment adviser in relation to the transaction
- The BD acts as an investment adviser solely through:
- Publicly distributed written materials (to 35+ paying recipients)
- Publicly made oral statements (to 35+ paying listeners)
- Statistical information without opinions
- Any combination of the above
Exam Tip: Gotchas
- A dually registered BD/IA still triggers principal-transaction rules when acting as IA. If the firm recommended the security in an advisory capacity and then sells it to the client from its own inventory, per-transaction written disclosure and consent are required, even though the firm is also a BD.