The SEC’s new regulatory agenda focuses heavily on issues of crypto and capital formation, but also revives an issue that has been a thorn in the side of fund boards and advisers for half a decade.
Among the 23 items on the SEC’s most recent list of regulatory priorities is the almost detail-free indication that the agency would reconsider Rule 17a-7, which effectively drove up fund management costs by making it impossible for funds affiliated by the use of a common adviser to sell fixed-income securities to one another.
Rule 17a-7 came in as part of Rule 2a-5, the fair valuation rule passed by the SEC in 2020 to add guidelines addressing the potential conflicts of interest when one fund sold assets to another in the same fund complex.
“Prior to approval of rule 2a-5 funds did have the ability to sell a security from one fund to another in the same complex, which would otherwise be prohibited because they have a common investment adviser,” Carolyn McPhillips, president of MFDF (formerly the Mutual Fund Directors Forum) told Fund Directions.
After the valuation rule went into effect, however, affiliated funds could only sell one another securities for which market prices were readily available, which left out many bonds and other fixed-income assets whose value was determined by third-party service providers rather than by trading on the open market, McPhillips said.
“It creates a lot of extra brokerage expenses and transaction costs for funds that could otherwise easily be avoided – brokerage commissions and other sorts of transfer fees that can be attached to these because there’s a potential conflict of interest,” McPhillips said.
“That really reduced the type of asset classes and types of transactions that would be eligible for cross-trades,” according to Thomas Kim, managing director of the Independent Directors Council (IDC).
“Before the SEC 2020 rule, cross trades were permitted for a broader set of asset classes, and boards had been overseeing cross-trades among different funds effectively, which saved costs for shareholders,” Kim said.
“After passage of that rule there were a lot of conversations in which the SEC appeared to be inclined to provide more flexibility, but that has not happened,” Kim said.
Some funds operated under no-action letters from the SEC that gave them very specific guidelines on what assets they could cross-trade and which they couldn’t, but most fund advisers had to extrapolate that kind of information based on relatively informal conversations with members of the SEC staff, McPhillips said.
The industry was simply caught short when Biden became president and the SEC got a new set of regulators who failed to connect the dots on cross-trades the way the industry expected
“The SEC knew at the time 2a-5 was passed that this could potentially become an issue, and the industry expected the SEC to do something about it, but that became a non-starter after the change in administration,” McPhillips said.
It is important for both shareholders and fund advisers that the SEC address cross-trading in a less rigid way than it currently does, but the solution wouldn’t necessarily require that it replace the current cross-trading rule with a new one, Kim said.
IDC and its parent organization the Investment Company Institute (ICI) recommended in the March 2025 analysis titled “Reimagining the 1940 Act” that the SEC give funds back the option to cross-trade fixed-income securities to save money for shareholders, as long as the rule required proper guardrails to avoid conflicts and included responsible supervision from fund boards.
“The ’40 Act was designed to have flexibility, which is why there is a no-action letter process, so exemptive applications can be considered by the SEC,” Kim said. “And this is sort of a classic case where there can be safeguards, guardrails, and certainly board oversight that can be put in place in order to effectuate savings or shareholders while at the same time ensuring that their interests are protected.”
The guardrails would have to include clear guidelines on who should handle valuation of fixed-income assets, and emphasize the role of fund boards and CCOs in providing due diligence and oversight to make sure cross-trades are handled correctly, Kim said.
“We believe that with appropriate safeguards and board oversight, that cross trades of fixed income securities should be permitted,” Kim said. “It is in the shareholders’ interest that they be allowed to do this, with the appropriate protections and policies in place, because of the costs involved.”
The 17a-7 item on the SEC’s regulatory agenda gives few details about when or how the agency might address the issue. The brief description of intent – to “modernize the conditions for and expand the availability of the exemption of certain purchase or sale transactions between an investment company and certain affiliated persons” – uses language that echoes the same goals as the “modernization” goals listed in the ICI analysis.
The SEC gave no indication of when it might address the issue other than the boiler-plate target-date listing of 4/00/2026 on the agenda item – a format that rarely indicates a firm deadline for resolution.
“I imagine it would probably require a rule-making for the change, but it’s hard to know when that might come,” McPhillips said. “It would certainly save expenses for the funds, though, so even when a light touch on regulation is a priority, I think the industry could point to the millions or billions we’re paying in transaction fees to show the change would make sense, even given some cost to compliance.”
