SEC Proposes to Modernize and Expand Cross Trading Under Rule 17a-7

Proposed Amendments to Rule 17a-7

On October 9, 2026, the SEC proposed highly anticipated amendments to Rule 17a-7 under the Investment Company Act of 1940 (the “Investment Company Act”), which exempts certain cross trades between a registered investment company (a “registered fund”) and its affiliates from the Investment Company Act’s general prohibition on affiliated principal transactions.¹ The Release states that the proposed amendments “are designed to expand the scope of securities that are eligible for cross trading, modernize the rule’s conditions, and enhance investor protection.” The proposal would also require aggregated reporting of trading activity and cross trades on Form N-PORT and Form N-MFP.

SEC Chairman Paul S. Atkins framed the proposal as part of the SEC’s broader modernization agenda, stating that, “[w]hen executed appropriately, cross trades allow registered funds to avoid costs associated with open market trades and to then pass those savings on to investors,” and that the proposed amendments “would modernize and expand the cross-trading rule, helping to deliver additional cost savings to those investors.”

Background

The Investment Company Act generally prohibits an affiliated person of a registered fund, or an affiliated person of such a person, acting as a principal, from knowingly selling securities to, or purchasing securities from, the fund.² The primary policy rationale underlying this prohibition is to protect registered funds from overreaching or self-dealing by affiliates. Despite this prohibition, cross trades can benefit funds and their shareholders by avoiding costs associated with open market transactions (e.g., brokerage commissions, bid-ask spreads, and other transaction expenses) and from counterparty risks. Cross trades can also help funds avoid market impact and price uncertainty, provide execution speed and certainty relative to open market transactions, and provide an alternative source of liquidity where selling and purchasing funds seek to trade in the same security.³

In 1966, the SEC adopted Rule 17a-7 to permit cross trades between a registered fund and certain affiliates without the need for individual exemptive applications, subject to certain conditions. Rule 17a-7 initially was limited to cross trades of equity securities traded on a national securities exchange. In 1981, the SEC expanded the rule’s scope to cover trades involving securities with “readily available market quotations” (a term the SEC did not define at the time); registered funds relied on this language in Rule 17a-7 to cross trade both equity and fixed income securities for several decades. However, in December 2020, the SEC adopted Rule 2a-5 under the Investment Company Act, which addresses fund valuation practices and defines “readily available market quotations” by reference only to Level 1 inputs under the fair value hierarchy in U.S. generally accepted accounting principles (“U.S. GAAP”). In practice, this definition excluded most fixed income securities and certain other securities that were previously cross traded under Rule 17a-7, and fund managers generally have not engaged in cross trading of such securities since September 8, 2022, the compliance date of Rule 2a-5.⁴

Key Proposed Changes⁵

• Expansion of eligible securities to include Level 2 securities. The proposal would expand the scope of securities eligible for cross trading by registered funds to include securities that a registered fund values based on directly or indirectly observable inputs, consistent with the current definition of a Level 1 or Level 2 input in the GAAP fair value hierarchy. This change is designed to permit cross trading of most fixed income securities while continuing to exclude securities valued using unobservable (Level 3) or non-leveled inputs. The SEC explained that limiting the universe of securities eligible for cross trading to those with an independent basis for pricing (in contrast to Level 3 fair values, which rely on unobservable inputs and adviser‑specific modeling rather than market‑generated price signals) would reduce the risk of subjectivity, bias or error in determining the price. 
• Two alternative pricing methods. The proposal would replace the rule’s current long-established prescriptive pricing conditions with a choice between the following two methods for determining the “independent current market price” of a security involved in a cross trade. Funds may use either method and may switch between the two methods for different cross trades. Under either method, advisers could utilize “evaluated prices, intraday vendor data, electronic-platform indications, and other observable inputs that reflect contemporaneous market conditions” and would not be limited to broker-dealer quotes.⁶
  • NAV pricing: The value of the security determined in the fund’s next computation of net asset value on the business day of the cross trade, whether the computation is at close of business or intra-day. If a cross trade involves two registered funds, the funds must share the same valuation processes in order to arrive at the same price using the NAV pricing method.
  • Current market pricing: A price that the fund’s investment adviser determines reasonably represents the current market price using one or more unaffiliated pricing sources. Current market pricing could be used at any time, including intra-day. To use this method, an adviser must also periodically review the reasonableness of the prices used.
• Adviser best-interest determinations. In a departure from the current rule, the proposal would explicitly require the fund’s investment adviser to determine, prior to each cross trade, that the transaction is in the best interest of each participating fund. The SEC in the Release identified certain factors for an investment adviser to consider in making this best interest determination, including investment rationale, characteristics of the cross-traded security (specifically including liquidity), pricing considerations (including pricing method, potentially more favorable pricing in the open market, and cost savings), execution quality and costs, timing, trade size and market impact, the characteristics of the affiliate involved in the cross trade (including its expense and fee structure) and current market conditions.⁷ If the cross trade involves two registered funds, separate determinations must be made for each fund.
• Consistency with investment policies. The proposal would continue to require that the transaction be consistent with the fund’s policies and investment strategies as recited in its registration statement and reports.
• Oversight conditions. Under the proposal, in a meaningful departure from the current rule, the CCO would perform quarterly reviews of all cross trades to determine compliance with the rule’s conditions and report results to the board,⁸ replacing the board’s current quarterly compliance determination.
  • The CCO would also need to perform back-testing and related reviews at least annually to identify patterns that may have disadvantaged the fund relative to its cross trade counterparties, and report the results of this review to the fund’s board. The proposed amendments include a prescriptive obligation to include a review of the timing and price of any subsequent sale of a security purchased in a cross trade within the scope of this review.
  • The fund’s board, including a majority of independent directors, would continue to be required to satisfy the fund governance standards under Rule 0-1(a)(7), but the current express requirement within Rule 17a-7 that the board adopt and approve changes to cross trading procedures would be eliminated under the proposal in an effort to remove duplication with Rule 38a-1.
• New aggregated reporting on Form N-PORT and Form N-MFP. Registered funds that engage in cross trades under Rule 17a-7 would be required to disclose, for each asset type (or category of investment for Form N-MFP) and in U.S. dollars, the aggregate value (on a gross basis) of portfolio investments purchased and sold in reliance on Rule 17a-7, as well as the aggregate value of all portfolio investments purchased and sold during the reporting period, as applicable. This aggregate reporting requirement is intended to provide transparency into cross-trading activity relative to a fund’s overall trading activity.
• Modernized transaction fee condition. The proposal would retain the general prohibition on remuneration in connection with a cross trade (other than cash payment against prompt delivery of the security) but would add an explicit exception permitting de minimis payments to unaffiliated parties for clearing, settlement, custody, recording or reporting services. This amendment would address interpretive questions regarding the current rule’s “customary” transfer fees exception.

Practical Considerations

The SEC frames the proposal as restoring and expanding a long-relied-upon cost-saving mechanism for registered funds, particularly for funds with fixed income strategies that lost cross-trading eligibility following the 2020 adoption of the fund valuation rule. The proposal is thoughtfully structured and appears to achieve these goals. It would reopen cross trading of most fixed income holdings, provide greater flexibility in pricing methodology, and codify relief that allows the board to focus on oversight rather than compliance tasks.

However, the proposal also introduces several new obligations that appear to impose significant burdens on funds seeking to benefit from the proposed amendments. For example:

• The requirement that the fund’s investment adviser determine, prior to each cross trade, that the transaction is in the best interest of each fund could be seen as redundant with the adviser’s existing fiduciary duties. The SEC already has the ability to enforce an adviser’s failure to adhere to those duties, and the provision appears to be more of a documentation exercise and a costly compliance burden. It is also unclear that these requirements would provide an actual enhancement to investor protection.
• Fund managers and boards should also consider what steps would be needed to satisfy the prescriptive requirement to review the timing and price of any subsequent sale of a security purchased in a cross trade. The requirement is not limited by time and may impose a significant burden on funds to track positions over periods of months or years. The SEC did not cite a reason that this specific test is prescribed by rule, while the fund’s CCO is otherwise empowered to review for patterns that may have disadvantaged the fund based on the fund’s specific trading activities and cross trading risks.

With a 60-day comment period that will run concurrently with several other major SEC rule proposals, advisers and fund compliance teams should not delay assessing what new pricing, best-interest determination, back-testing, and CCO review processes will be needed to cross trade in reliance on an amended Rule 17a-7, including whether existing valuation and pricing infrastructure (including unaffiliated pricing sources) can support the proposal’s current market pricing option. Funds should also consider the operational and systems impact of the new Form N-PORT and Form N-MFP cross-trading reporting items, which would require tracking aggregate cross trade and total trading activity by asset class for a full twelve-month period following any cross trade.

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