In SEC Rulemaking, Agency Appears Open to Broad Expansion of Cross Trading by Registered Funds

On October 9, 2026, the U.S. Securities and Exchange Commission (SEC) proposed amendments to Rule 17a-7 under the Investment Company Act of 1940, the rule that permits a registered fund to buy and sell securities with certain affiliated funds (cross trades). The proposal permits funds to cross trade securities valued based on inputs that are observable (designed to extend cross trading to “level 2” securities valued using observable inputs) and generally shifts the responsibilities for review of cross trades from fund boards to advisers and chief compliance officers (CCOs). The proposal replaces old pricing conditions and adds new conditions, including a pretrade best-interest determination by the adviser, quarterly reporting and annual back-testing by the CCO, and aggregate public reporting of cross trading activity on Forms N-PORT and N-MFP to enhance market transparency. Business development companies (BDCs) may currently rely on Rule 17a-7 and would be able to rely on the amended rule if adopted.

Our Take

• A welcome fix. The proposal’s observable-inputs standard would restore the ability of registered funds to cross trade most fixed-income securities and potentially other types of level 2 securities, using modernized pricing sources and allowing for de minimis third-party transaction costs.
• Enhanced and more prescriptive compliance. The new conditions would require more compliance infrastructure than the current rule, particularly around back-testing, and more documentation of pricing service due diligence, reasonableness reviews, information underlying quarterly and annual reviews, and best-interest determinations. It also prescribes that the fund policies and procedures should address how the fund and adviser will effect cross trades and how the CCO would conduct its reviews, including relevant factors and testing. The SEC acknowledges that documentation costs may lead advisers to forgo cross trades in circumstances where savings are modest.
• Board relief, CCO involvement. Boards would no longer make quarterly compliance determinations or adopt Rule 17a-7 procedures, but CCOs would take on new quarterly and annual review obligations (while boards are expected to remain actively engaged in the process). A fund’s CCO will also need to coordinate with the CCO for the adviser to the registered fund as the Advisers Act obligations for client cross trades are not superseded and would not be satisfied solely by compliance with the proposed version of Rule 17a-7.

Background: Current Rule and the Impact of Rule 2a-5

Section 17(a) of the Investment Company Act generally prohibits an affiliated person of a registered fund, or an affiliated person of such a person, from selling securities to or buying securities from the fund. Rule 17a-7 exempts cross trades with eligible affiliates (generally other registered funds with a common or affiliated adviser) if, among other conditions, the security has readily available market quotations; the trade is executed at the “independent current market price” under a prescriptive pricing hierarchy; only customary transfer fees are paid; and the board adopts procedures and determines at least quarterly that cross trades complied with them.

Adopted in 2020, Rule 2a-5 defines “readily available market quotations” as a “quoted price (unadjusted) in active markets for identical investments” (level 1 securities under U.S. generally accepted accounting principles or GAAP). This definition in practice excludes most fixed-income securities (as most fixed-income securities trade infrequently and thus usually do not have active markets) and has effectively prevented funds from cross trading fixed-income securities since the implementation of Rule 2a-5.

Overview of the Proposal

Expanded eligibility. Eligible funds could cross trade securities “for which market quotations are readily available or that would be valued by the fund based on inputs that are observable, either directly or indirectly” (level 2 securities). A security would qualify only if level 2 inputs are the lowest level of inputs significant to its measurement. Level 3 investments would remain ineligible, which affects investments in the loan, preferred equity, and real estate asset classes as those investments are more commonly reported as level 3. The proposal does not expand the types of funds or accounts eligible to effect cross trades under the rule.

Two pricing methods. The “independent current market price” would be either (1) the value the fund ascribes to the security in its next net asset value (NAV) computation on the trade date (i.e., NAV pricing) or (2) a price the adviser determines reasonably represents the current market price using one or more unaffiliated pricing sources, subject to the adviser’s periodic review (i.e., current market pricing). A fund could use either method on a trade-by-trade basis. NAV pricing would be available for trades between two registered funds only if they share the same valuation processes. The proposed rule would not permit funds to use the amortized cost values of securities. The SEC’s economic analysis discussion confirms that funds that value a security at the bid could cross trade at the bid under NAV pricing, a departure from the current rule’s midpoint requirement.

Permitted payments. The general prohibition on remuneration would be retained, but de minimis payments to unaffiliated parties for clearing, settlement, custody, recording, or reporting would be permitted, including stamp duties, transaction taxes, asset-based transaction fees, custodial fees, and settlement fees. The Proposal does not define de minimis but states the amounts would be small relative to the size of the transaction and what a fund would pay in brokerage commissions, bid-ask spreads, markups, and markdowns or otherwise if the fund were to purchase or sell the security in the market. This standard may open the door to second guessing.

Best-interest determination. Before each cross trade, the adviser would have to determine that the trade is in the best interest of the fund. Under the Proposal, the determination must be made for each registered fund involved, without regard to benefits to the other side. A cross trade would not be in a fund’s best interest if a better outcome is available in the open market, through a different security, or by not trading. Each trade also would have to be consistent with the fund’s policies and investment strategies. The fund’s policies and procedures should address how a registered fund’s adviser would make the best-interest determination, including the process and factors that lead to the determination.

CCO-centered oversight. The board’s quarterly compliance determination and its obligation to adopt and approve Rule 17a-7 procedures would be eliminated. Rather, boards would approve cross trading policies under Rule 38a-1 and receive CCO reporting developed fund by fund rather than mandated by the rules. The CCO would review all cross trades at least quarterly to determine compliance with the rule, and at least annually to determine whether any trade or pattern of trades may have disadvantaged the fund, including by reviewing the timing and price of any subsequent sale of a security purchased in a cross trade.

Reporting and recordkeeping. Funds that cross traded during the preceding 12 months would report monthly gross purchases and sales by asset type, both through cross trades and in total, on Form N-PORT (in a new Item B.12) or Form N-MFP (in a new Item A.23). “Asset type,” for this purpose, is already defined in the relevant forms, but the SEC acknowledges that mapping of asset types across internal reporting structures may be inconsistent and require effort to implement. The SEC also acknowledges that any increase in public reporting metrics will affect different funds differently and that some funds may view the new reporting as revealing proprietary information. BDCs and small business investment companies would not be subject to this reporting. Records of each trade, the CCO’s review materials, and board reports would be retained for six years, while the requirement to retain cross trading procedures indefinitely would be eliminated. The new reporting requirements reflect, in part, that the SEC is interested in having data about the overall volume of cross trading so that it can better track and understand how internal trading affects market functioning.

Reporting and recordkeeping. Funds that cross traded during the preceding 12 months would report monthly gross purchases and sales by asset type, both through cross trades and in total, on Form N-PORT (in a new Item B.12) or Form N-MFP (in a new Item A.23). “Asset type,” for this purpose, is already defined in the relevant forms, but the SEC acknowledges that mapping of asset types across internal reporting structures may be inconsistent and require effort to implement. The SEC also acknowledges that any increase in public reporting metrics will affect different funds differently and that some funds may view the new reporting as revealing proprietary information. BDCs and small business investment companies would not be subject to this reporting. Records of each trade, the CCO’s review materials, and board reports would be retained for six years, while the requirement to retain cross trading procedures indefinitely would be eliminated. The new reporting requirements reflect, in part, that the SEC is interested in having data about the overall volume of cross trading so that it can better track and understand how internal trading affects market functioning.

Staff letters and transition. Upon adoption, inconsistent SEC staff views would be superseded; the SEC’s list of letters addressing the same topics includes the municipal securities letters and the 2018 Independent Directors Council letter. Fund families with $10 billion or more in net assets would have 12 months to comply and smaller families 18 months.

Cross trades with private funds and separately managed accounts. These kinds of trades continue to warrant care. Many private funds do not satisfy the “solely” condition for eligible affiliates permitted to cross trade with a registered fund, and the proposal does not change this. Additionally, the rule provides no relief under the Investment Advisers Act of 1940 or the Employee Retirement Income Security Act of 1974, and the proposal cites enforcement actions involving trades that allegedly favored selling accounts over purchasing funds.

What’s Next: Issues to Watch During the Comment Process

Among the proposal’s 79 requests for comment, firms may wish to address whether cross trading eligibility should extend to some or all level 3 securities with added conditions; the unintended consequences of tying eligibility to GAAP concepts; whether bid-side NAV pricing is fair to selling funds; the various prescribed compliance and ongoing findings and testing terms, including whether CCO review should be annual only, quarterly only, or scaled to a fund’s activity; and the pros and cons of the proposed public reporting elements. Regarding the prospect of cross trading level 3 securities, the SEC observes that less than 1% of all securities (by value) held by registered funds are level 3 securities. It is likely, however, that some commenters will focus on the growth of funds holding these kinds of assets and argue that there can be reasonable approaches to their cross trading that mitigate the related risk and conflicts. The comment period on the proposal will be 60 days from publication in the Federal Register.

Jillian Leavey contributed to this Sidley Update.