SEC Staff Issues No-Action Letter Regarding Cross Traders Where the Adviser and/or Its Controlling Persons Own 25% or Less of an Account
In a recent no-action letter provided to Gardner Russo & Gardner (GRG), the SEC staff provided no-action relief from Section 206(3) of the Advisers Act for cross transactions between a client account and an account of which the investment adviser and/or a controlling person, in the aggregate, owns 25% or less. Importantly, the SEC staff confirmed that Section 206(3) would apply to cross transactions between a client account and an account over which an investment adviser and/or a controlling person, in the aggregate, owns more than 25%. The SEC staff also reaffirmed the SEC’s view that ownership interests of an adviser’s controlling person(s) are deemed to be ownership interests of the adviser for purposes of Section 206(3). The no-action letter expresses no view on whether Section 206(3) applies to cross trades between client accounts when non-controlling personnel of an adviser have ownership interests in the accounts.
GRG serves as the investment adviser to various client accounts (Accounts), including two private funds, Semper Vic Partners, L.P. (Semper Vic) and Semper Vic Partners (QP), L.P. (Semper Vic QP)(collectively, the Private Funds). A general partner and controlling person of GRG (the Partner) is the sole general partner and portfolio manager of each Private Fund. The Partner has a 6.237% ownership interest in Semper Vic and a 1.4405% ownership interest in Semper Vic QP. Due to the timing of capital flows into and out of the Accounts, GRG frequently will be in the process of disposing of a security for one Account that it is acquiring for another. GRG requested no-action relief in order to cross the trades of a Private Fund with another Account and/or Private Fund (Proposed Transactions) without having such transactions be subject to the requirements of Section 206(3) of the Advisers Act. GRG was concerned that the Proposed Transactions could be deemed to be principal transactions because of the Partner’s ownership interest in the Private Funds.
While agreeing with GRG that Section 206(3) does not apply to the Proposed Transactions, the SEC staff noted that ownership interests of an investment adviser and/or its controlling persons of 25% or less of an account may present the opportunity for significant conflicts of interest between an investment adviser and its clients, creating incentives to overreach and treat unfairly the clients with which the account engages in transactions. The SEC staff observed that cross transactions involving such an account may implicate Sections 206(1) and (2) of the Advisers Act, which were designed to address such conflicts of interest and impose a federal fiduciary duty on an investment adviser with respect to its clients and a duty of full and fair disclosure of all material facts. The SEC staff noted that those provisions may require an investment adviser to disclose information about transactions effected by the adviser involving any account in which the adviser and/or its controlling persons have an ownership interest, regardless of whether Section 206(3) also applies. According to the SEC staff, an investment adviser, therefore, should consider monitoring the ownership interests of the adviser, and/or its controlling persons, in accounts advised by the adviser, and the terms of the transactions involving those accounts.
Investment Management FYI is a service of the Investment Management Practice of Morgan Lewis. If you have any questions concerning these important legal developments reflected herein, please contact the following Morgan Lewis attorney:
Washington, D.C.
Karen A. Aspinall
202.739.5355
kaspinall@morganlewis.com