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SEC Penalizes Former PM, Putnam for Improper Cross Trades

The SEC recently announced that Putnam Investment Management and one of its former portfolio managers facilitated dozens of prearranged cross-trades between advisory client accounts in a manner that disadvantaged some of the adviser’s clients. According to the SEC’s order, the former portfolio manager prearranged trades with brokerage firms in violation of the rules governing cross-trades. The 1940 Act generally prohibits sales and purchases of securities between certain affiliated persons without an exemptive order from the SEC. According to the order Rule 17a-7, among other things, requires that cross trades be executed at an independent current market price, which is the average of the highest current independent bid and lowest current independent offer, determined on the basis of reasonable inquiry.  If the adviser pays a brokerage commission, fee, or other remuneration in connection with the cross trade, the cross trade is impermissible. In the Putnam case, the SEC found that the former portfolio manager prearranged with broker-dealers to temporarily sell residential mortgage-backed securities and repurchase them at a small mark-up, usually the next business day. By executing the trades at the securities’ bid price, instead of the midpoint between the bid and the ask price as required by SEC rules, the portfolio manager’s trading effectively benefited the client who purchased the crossed bond, to the detriment of the client selling the bond. The SEC also found that Putnam’s training and monitoring procedures related to cross-trading were inadequate, and that it failed reasonably to supervise the portfolio manager. The order noted that Putnam’s Compliance Department had determined to schedule a training session on impermissible trades after an enforcement action against Western Asset Management Co. in 2014, however, no such training occurred during the relevant period. Without admitting or denying the findings, Putnam agreed to reimburse approximately $1,095,000 to clients and to pay a $1 million penalty, and the former portfolio manager agreed to pay a $50,000 penalty and to a nine-month suspension from the securities industry.

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