Legal and General Investment Management Americas (LGIMA) has accepted a fine of US$500,000 for failing to comply with Securities and Exchange Commission (SEC) rules on the internal crossing of trades for US clients.
Between August 2017 and December 2020 placed 44,125 principal trades between clients and LGIMA principal accounts without making the required client disclosures or obtaining the required client consents, and made 547 cross trades between registered investment company (RIC) clients and other LGIMA clients affiliated with RICs or affiliated with RICS affiliates, again without complying with the statutory provisions governing cross trades involving RICs.
The SEC reports that LGIMA’s violations were caused in part by its failure to adopt and implement reasonably designed policies and procedures to prevent unlawful principal and cross trading effected, initially, by its trading personnel and, later, through an automated trade matching program.
That violated Sections 206(3) and 206(4) of the Advisers Act and Rule 206(4)-7, plus violations of Sections 17(a)(1) and 17(a)(2) of the Investment Company Act and Rule 38a-1.
LGIMA sent some matched orders to a third-party broker with instructions to execute the trades against each other in exchange for reduced or no commissions, and later developed the ‘Efficient Netting Program’ (ENP), an automated trade matching program that identified, matched, and aggregated buy and sell orders for the same equity security across advisory client accounts and advisory client accounts of affiliates. LGIMA clients did not pay commissions for matched trades effected through the ENP and according to LGIMA personnel, these commission savings were the sole purpose of the ENP.
Exemption from the rules can exist where trades are authorised by clients and / or they are traded at the most recent market price. Paying any commission prevents exemption. Although the SEC found no commission was paid on any of the trades, they were executed at market close price and many of the trades were not authorised.
It also found that 126,000 equity cross trades were not reported as cross trades, as per the LGIMA policy, to a monitored email address.
The SEC concluded that LGIMA did not seek an exemptive order for any cross transaction, and the transactions were not exempt from the prohibition by virtue of Rule 17a-7 because, among other things, LGIMA did not disclose the cross transactions to the RICs and, therefore, the respective boards of directors of the affected RICs were unable to determine whether the transactions had been effected in compliance with Rule 17a-7.
The rules for crossing trades in the US are controversial, as they lower costs for investors as they bypass dealer commissions and trading platform fees.
In 2020, Lance Dial, then counsel at Wellington Management (now at Morgan, Lewis & Bockius LLP), speaking to an fixed income committee of the SEC said, “In March [2020] we saw spreads blow out to around three times normal, volumes up 55% and many times we were in the market on both sides as clients were moving and repositioning in portfolios as a response to the market. The conservative estimates from our trading desk were that the cost savings [from crossing] could have been more than US$10-15 million in trading spreads, that could have been recaptured.”
However, after consultation the SEC declined to change the rules to the dismay of buy-side firms.
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