SEC Proposes Changes to Rule 17a-7: What Investment Funds Should Know

On October 9, the SEC proposed amendments to Rule 17a-7 that would restore cross trading for most fixed-income securities (Release No. IC-36358, 91 FR 65622). Comments are due December 14.

The eligibility test is the change. The current rule reaches only securities with readily available market quotations, which in practice has meant listed equities. The proposal extends it to securities valued on observable inputs — Level 2 under GAAP — and leaves Level 3 out. The adviser would make a best-interest determination before each trade, and the CCO would review quarterly in place of the board’s current determination.

First real opening for fixed-income managers since the 1980s. The question is whether adviser-reviewed Level 2 pricing holds without the board in that seat.

What Is Cross Trading Under Rule 17a-7?

Cross trading allows registered investment funds to buy or sell securities directly with certain affiliated parties under specified conditions. Rather than executing transactions through the open market, eligible funds can transfer securities between affiliated portfolios, potentially reducing transaction costs. Rule 17a-7 provides an exemption from certain restrictions on affiliated transactions under the Investment Company Act.

What the SEC Is Proposing

The SEC proposes expanding the securities eligible for cross trading, particularly fixed-income securities that became difficult to cross trade following the adoption of the fund valuation rule in 2020. The amendments would modernize Rule 17a-7 to reflect developments in securities pricing and trading practices.

Fixed-Income Securities Could Become Eligible Again

The proposal would restore the ability to cross trade most fixed-income securities, potentially allowing registered funds to execute more transactions between affiliated portfolios without incurring the costs associated with open-market trading.

New Pricing, Oversight and Reporting Requirements

The proposed amendments would update the conditions governing cross trades, including pricing and oversight requirements intended to protect fund investors. The SEC also proposes aggregated reporting of trading activity and cross trades by participating registered funds, providing additional transparency into how these transactions are conducted.

What Fund Managers Should Consider

Investment advisers and fund compliance teams should evaluate how expanded cross-trading eligibility could affect portfolio management, transaction costs, valuation practices, and existing compliance procedures. Firms may also need to assess their pricing methodologies, oversight processes, and reporting capabilities if the amendments are adopted. Existing Rule 17a-7 requirements remain applicable while the proposal is under consideration.

Balancing Cost Savings With Investor Protection

Although cross trading can reduce transaction expenses, transactions between affiliated funds require safeguards against conflicts of interest and unfair pricing. Fund managers should consider whether their existing controls adequately address these risks.

How SJKP Can Help

SJKP can assist investment advisers, registered funds, and financial institutions with investment management regulations, securities compliance, affiliated transactions, and fund governance. Firms evaluating the proposed Rule 17a-7 amendments can work with counsel to review cross-trading policies, assess regulatory risks, and prepare for potential changes to SEC requirements.