Sharing Trades with Other Firms

Okay only if all the benefits are passed on to your investors

Who owns the trades an investment adviser executes for its clients? Obviously, your clients own the profits and losses from the trades, but what if a third-party offers to pay you for combining its trades with yours so that it can take advantage of your favorable commission rates?

The SEC recently settled a case against a Washington state investment adviser who was paid by a proprietary trading firm to combine its futures trades with those of a private fund managed by the adviser so that the trading firm could enjoy the fund’s advantageous commission rates. In this case, the adviser neither passed on the payments it received to its fund investors or disclosed such payments to them in either its Form ADV or the fund’s private placement memorandum.

Under the law, a fund’s trades belong to the fund’s investors, and not to the fund manager. According to the SEC, the manager’s use of the trades for its own benefit without at least disclosing the practice to its investors operated as a fraud upon the fund. The fund manager in this case had to give up all the payments it received, the firm principals were each fined and the firm and its principals were all censured by the SEC.

The lesson investment advisers should draw from this case is that the SEC is closely examining circumstances in which they fail to discharge their fiduciary duty to clients by putting their own interests ahead of those of their clients in managing client assets.