RIA Guidance Trade Capacity
It is recommended that if a principal transaction would be the only option for a purchase for an advisory client that a brokerage account should be utilized instead of the advisory account for the transaction. Otherwise, if the transaction occurs in a principal capacity in an advisory account then additional duties and responsibilities are required as described below to satisfy an advisor’s fiduciary responsibilities to an advisory client. Additionally, the advisor must contact Compliance prior to placing a principal transaction in an advisory account to ensure you have met the requirements of the Act as this would be an exception to the firm’s policies and procedures.
Requirements for Principal or Agency Cross Transactions for RIA Accounts
If an advisor places a transaction for either a (1) principal or (2) agency cross transaction for an advisory client, then per Section 206(3) of the Act the advisor must obtain prior written consent from a client in advance of any buys or sells completed on a principal capacity. (Throughout the rest of this piece, we will only refer to both of these types of trades (principal and agency cross) as principal for simplicity sake, but know that agency crosses are also included in this description and requirement).
The reason for the written consent requirement from the client is that there could be potential conflicts of loyalties and responsibilities when an advisor is acting in a principal capacity. Simply, the regulators view principal trades as going against a fiduciary standard and not being in the client’s best interest. This requires additional documentation when performing principal trades to assist in mitigating any apparent conflicts of interest for advisory clients.
First, prior to placing the principal transaction and per the Act, the advisor must provide written disclosure to the client regarding the conflicts that could arise from conducting principal trades in the client’s account. Such conflicts may include: price manipulation and receiving both commissions and advisory fees for the principal transaction. The advisor’s written disclosure must also include a statement that the client may revoke any written consent provided to the advisor without penalty at any time with written notice to the advisor. The written disclosure is required regardless if the account is managed with discretion.
Second, prior to placing the principal transaction and per the Act, the advisor must obtain the client’s written consent to principal trading in the client’s advisory account. The consent letter must authorize the advisor to directly or indirectly act as principal for the advisor’s own account in selling any security to or purchasing any security from an advisory client. This written consent is revocable and is required regardless if the account is managed with discretion.
Prior to executing each principal transaction, the advisor must explain either in writing or orally to the advisory client the following:
(1) The capacity in which the trade will be placed (principal or agency cross) and
(2) Obtain consent from the advisory client assenting to the advisor acting as principal for its own account with respect to the transaction.
(3) If this explanation is sent in writing, there must be a disclosure that states that the client may revoke the written consent without penalty at any time with written notice to the advisor.
Finally, on an annual basis the advisor must send the advisory client a written statement which includes the date, price and other relevant specifics of all principal trades (investment, buy/sell, quantity, dollar amount involved) that occurred during the year for the advisory account.
Please also keep in mind the following:
(1) Remember - before a principal transaction is placed for an advisory account, please contact either Julie or Renee to discuss the requirements to ensure you have met the obligations of the Act and will be in compliance with IPI Wealth’s policies and the Act.
(2) A copy of your written disclosure to the client as well as a copy of the client’s revocable written consent must be sent to Compliance and/or uploaded into Compliance Review in Docupace upon receipt.
(3) Even though an advisor may have discretionary authority over the account in question, consent is still required from the client prior to the transaction as you may not have discretion over the placement of principal transactions in a client’s advisory account.
(4) Additionally, if you are doing a block trade for both advisory and brokerage accounts and will allocate between the two types of accounts then the entire trade must be performed as an agency capacity only.
We know this is a complex issue. Hopefully, this information has been informative and helpful in explaining IPI Wealth’s policy and the required steps needed if an advisor is seeking an exception to our policy. If you have any questions on this issue, please reach out to Compliance.