What Is an Agency Cross?

The term "agency cross" refers to a transaction in which an investment advisor acts as the broker for their client as well as the other party. Agency cross transactions tend to occur when a broker receives opposing orders for the same asset. Investment advisors must obtain their clients' approval to engage in these kinds of transactions. Agency cross transactions are regulated to make sure there is no conflict of interest on the part of the advisor.

Key Takeaways

  • An agency cross is a transaction in which an investment advisor acts as the broker for both their client and the other party.
  • These transactions are governed by the Investment Advisers Act of 1940 to ensure advisors act in their clients' best interests rather than their own.
  • Advisors are required to get their clients' written approval before conducting agency cross transactions.
  • Affiliates of an advisory may also be able to execute agency cross transactions.
  • Because they can be used by unscrupulous advisors, authorities keep close tabs on advisors to ensure they comply with the regulations that govern agency cross transactions.

How Agency Crosses Work

When an individual wants to buy or sell a security, they normally go through their investment advisor or broker-dealer to execute the transaction. The professional goes to the market seeking a party who is willing to act as the opposing party for the same quantity of the security at the desired price. If the advisor acts as the broker-dealer for both parties, the transaction is called an agency cross.

Advisors are required to obtain the best possible price in agency cross transactions, just as they would with any other sale or purchase they execute. This means that even if an advisor has a buyer or seller for their client's securities, including another client, they must still go to the market and announce the trade in case another entity makes a better offer. If the required time passes and no one else comes forward, the advisor may go ahead with the agency cross.

Agency cross transactions are governed by Rule 206(3)-2 of the Investment Advisers Act of 1940. This is a federal law that oversees the role of advisors and defines their responsibilities. The law ensures that advisors act in the best interests of their clients rather than for their own. In order to do so, advisors are required to get their clients' consent to be able to conduct agency transactions in writing.

A client's advisor isn't the only one who can conduct an agency cross. If an affiliate of the advisor, such as an associate at the same investment company or brokerage, brokers this kind of transaction, it is still considered an agency cross transaction, just as if the advisor had brokered it themselves.

Written consent means they only have to obtain permission once—not each time an agency cross is executed.

Special Considerations

Regulators keep close tabs on advisors to make sure they comply with Rule 206(3)-2 in all agency transactions. That's because these transactions create the potential for advisors to engage in self-dealing. Put simply, agency crosses can be used by unscrupulous financial advisors to earn additional compensation.

Since they earn fees and commissions on any and all trades, acting as the broker-dealer for both parties effectively doubles their earnings. It also ensures advisors don't show a preference for one party over another.

According to the Securities and Exchange Commission (SEC), compliance with Rule 206(3)-1 requires the following:

  • A client must give written consent to authorize agency cross transactions before they happen. Consent must come after the advisor provides the client with full written disclosure that they or another person will act as a broker for, get commissions from, and have a potential conflict of interest when it comes to both parties involved in the transaction.
  • The advisor must notify each client in writing at or before the completion of any transaction that includes a statement about the nature of the transaction, the date it happened, an offer to provide the time of the transaction, and how much they received or will receive in any remuneration, as well as its source.
  • The advisor must send each client an annual statement that includes the number of agency cross transactions since the last statement, as well as the total sum they received or expected to receive in remuneration. Each statement must clearly state that the client's consent may be revoked at any time.

Agency Cross vs. Principal Transaction

When an advisor executes agency cross transactions, they do so between different advisory clients. But the type of transaction changes when the parties involved change. A principal transaction or order takes place when an advisor acts on their own behalf to buy and sell securities to or from a client's account from or to their firm's own account. These transactions are done at the professional's own risk and are listed on exchanges. This provides investors with protection against the potential for insider trading.

Example of Agency Cross

Here's a hypothetical example to show how agency cross transactions work. Let's say a client approaches their advisor because they want to sell 100 shares in Company X at $45 per share. The advisor goes to the trading floor to make the offer.

If the advisor finds a buyer or already has one in mind who is willing to purchase the same number of shares at that exact price, the advisor can act as the broker in the deal for both the buyer and the seller. But remember, in order for the trade to be legal and ethical, the advisor must first get their client's approval in writing.