What is a 'Cross Trade'

A cross trade is a practice where buy and sell orders for the same asset are offset without recording the trade on the exchange, an activity that is not permitted on most major exchanges. A cross trade also occurs when a broker executes buy and a sell orders for the same security across different client accounts. For example, if one client wants to sell and another wants to buy, the broker could match those two orders without sending the orders to the stock exchange to be filled.

Breaking Down the 'Cross Trade'

Cross trades have inherent pitfalls due to the lack of proper reporting involved. When the trade doesn't get recorded through the exchange one or both clients may not get the current market price that is available to other (non-cross trade) market participants. Since the orders are never listed publicly, the investors may not be made aware as to whether a better price may have been available. Cross trades are typically not allowed on major exchanges. Orders need to be sent to the exchange and all trades must be recorded.

However, cross trades are permitted in select situations, such as when both the buyer and the seller are clients of the same asset manager and the price of the cross trade is considered to be competitive at the time of the trade.

Permitted Cross Trades

A portfolio manager can effectively move one client's asset to another client that wants it and eliminate the spread on the trade. The broker and manager must prove a fair market price for the transaction and record the trade as a cross for proper regulatory classification. The asset manager must be able to prove to the Securities and Exchange Commission (SEC) that the trade was beneficial to both parties.

Cross Trades and Matching Orders

While a cross trade does not require each investor to specify a price for the transaction to proceed, matching orders occur when a broker receives a buy and sell order from two different investors both listing the same price. Depending on local regulations, trades of this nature may be allowed, since each investor has expressed an interest in completing a transaction at the specified price point. This may be more relevant for investors trading highly volatile securities where the value may shift dramatically in a short period of time.

Cross trades are controversial because they may undermine trust in the market. While some cross trades are technically legal, other market participants were not given the opportunity to interact with those orders. Another market participants may have wanted to interact with one of those orders, but was not given the chance because the trade occurred off the exchange.

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