HFMCompliance Quotes Michael Asaro on Risks to Engaging in Principal Trades

December 11, 2019

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Jacinta O'Shea-Ramdeholl

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Sarah Richmond

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HFMCompliance has quoted Akin Gump litigation partner Michael Asaro in the article “Engaging in principal trades,” which reports on an SEC risk alert pertaining to principal trades—whereby a fund manager trades between one of its proprietary accounts and an advisory account.

According to the article, the SEC has found several examination deficiencies relating to principal trades, including managers failing to properly disclose the trades to investors or get required consent to make such trades. Asaro commented on some ways to complete these transactions without violating SEC rules.

The article notes that principal trades—i.e., trades where an investment adviser is transacting with a client as principal for the adviser or its control persons’ own account—are unlawful unless the adviser obtains informed client consent before the trade settles. SEC guidance notes that pooled investment vehicles are presumed to be subject to the principal trade rule if an adviser’s control persons, in aggregate, have an ownership interest of over 25 percent.  Asaro said, this is “basically a strict liability rule, so you have to really monitor that threshold and make sure if you’re going to do a principal transaction that you’re not running afoul.”

If a manager is going to engage in principal trades, the article says the firm should have proper disclosures. Asaro agrees, pointing out that the fund’s governing documents should include disclosures that the manager may conduct principal trades. Trades, he said, should be reviewed to determine if a principal transaction has occurred and, if so, that the firm’s policies and procedures are being followed, and make sure consent is obtained.

Should one find themselves having made a trade without consent, Asaro suggested that managers contact outside counsel and then determine whether investors were harmed and to what degree.

“Managers also have to consider whether to reimburse harmed investors,” Asaro added. “A manager could potentially consider a fee offset or they could give money back.”

As for self-reporting the issue to the SEC, Asaro said it is always a difficult question and that there is no right or wrong answer. “Firms will often consider the likelihood of the SEC finding out about the issue, the scope, and what the firm did to remediate the issue.”

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