Long Awaited SEC Proposal Would Restore Fixed-Income Cross Trading for Registered Funds
- Amy Doberman, Timothy Silva, Reid Carroll
- 10.14.2026
I. Introduction
On October 9, 2026, the Securities and Exchange Commission (“SEC” or “Commission”) at long last proposed amendments to Rule 17a-7 under the Investment Company Act of 1940 (the “1940 Act”) that would once again permit registered funds to cross trade most fixed-income securities with their affiliates.1 The proposal is a welcome development that would, if adopted, provide clarity and appropriate controls around cross-trading requirements along with substantial cost savings for fund shareholders.
While permitted through no-action letter since 1995, the ability to cross trade fixed-income securities has been effectively foreclosed since the adoption of Rule 2a-5 under the 1940 Act (the valuation rule) in 2021,2 and fund shareholders have paid the price ever since, as trades that could have been matched internally at a fair price between two affiliated funds (or other advisory clients) now have to be routed to dealers instead, incurring bid-ask spreads and other transaction expenses. The proposal would extend Rule 17a-7 to GAAP “Level 2” securities and introduce a more practical pricing framework for securities based on inputs that are observable—directly or indirectly—in addition to using “readily available market quotations” as required under the existing rule.3 By allowing cross-trade pricing to consider observable inputs, the Commission looks to expand the industry’s prior practice of cross trading based on valuations used to determine the fund’s net asset value (“NAV”). If adopted, the proposal would provide meaningful and long-overdue relief that ultimately benefits fund shareholders, while imposing appropriate controls and oversight necessary to prevent potential abuses.
Statutory and Regulatory Background
Section 17(a) of the 1940 Act generally prohibits an affiliated person of a registered fund, or an affiliated person of that person, from knowingly buying securities from or selling securities to the fund as principal.4 Funds that share an adviser and board are generally treated as being under common control (and thus are first-tier affiliates of one another),5 so a cross trade between them falls squarely within the Section 17(a) prohibition. Section 17(b) authorizes the Commission to exempt such a transaction where its terms are reasonable and fair, it does not involve overreaching, and it is consistent with each fund’s policies and the purposes of the 1940 Act.6 Rule 17a-7 codifies that standard by providing a self-executing exemption for transactions that satisfy the rule’s conditions.7
Under the current rule, only securities that have readily available market quotations are eligible to be cross traded. A cross trade between a registered fund and its affiliated fund must be for cash at the independent current market price, as defined in the rule.8 For over-the-counter securities, this means the average of the highest independent bid and lowest independent offer obtained through reasonable inquiry.9 No fee may be paid beyond customary transfer fees, and the trade must be consistent with each fund’s investment policies. The fund’s board must also adopt procedures and determine each quarter that all cross trades complied with such procedures.10
For decades, “readily available market quotation” went undefined. In 1995, the SEC Staff granted no-action relief to United Municipal Bond Funds to permit those funds to cross trade municipal bonds using the vendor price—developed through a matrix or evaluated pricing process—already used to calculate the fund’s daily NAV, subject to independent testing safeguards.11 The premise was sensible: use of a price reliable enough to value fund shares should be a sound basis on which to price an internal cross trade. The Staff reaffirmed that view in a letter issued to Federated over a decade later.12 Moreover, Commission releases adopting money market fund reform in 2014 and liquidity risk management in 2016 supported these practices, suggesting that evaluated prices could, in appropriate circumstances, qualify as readily available market quotations.13 The Rule 2a-5 proposing release preserved that possibility.14 The adopting release, however, did not.15
Rule 2a-5 provides that market quotations are readily available with respect to a security only when that “quotation is a quoted price (unadjusted) in active markets for identical investments that the fund can access at the measurement date, provided that a quotation will not be readily available if it is not reliable.”16 This definition applies throughout the 1940 Act, including in Rule 17a-7.17 Rule 2a-5 established categories of assets by incorporating the GAAP fair-value hierarchy: “Level 1” inputs are quoted prices in active markets for identical assets, “Level 2” inputs are other observable inputs, and “Level 3” inputs are unobservable inputs. Because most fixed-income securities are valued using Level 2 inputs, bonds that funds had crossed for years generally became ineligible with the adoption of Rule 2a-5.18
II. Cross-Trading Proposal
The proposal retains Rule 17a-7’s core framework. A registered fund would still have to effect cross trades for cash against prompt delivery, and the trade would still have to be consistent with the fund’s policies and investment strategies. Acknowledging the massive improvement in fixed-income price reporting and transparency, the proposal introduces more flexible conditions, including: (i) broadening eligibility beyond securities with readily available market quotations to include Level 2 securities; (ii) replacing asset-specific pricing with two alternative methods for determining current market price; (iii) requiring the funds’ investment adviser to determine before each cross trade that the transaction is in the best interest of each fund (formalizing the standard articulated in the Federated no-action letter); and (iv) requiring the fund’s CCO—not the fund’s board of directors—to perform quarterly and annual oversight of all cross-trading transactions to determine whether any such transaction, or pattern of transactions, may have disadvantaged the fund relative to the eligible affiliate.19
Expanded Eligible Securities
The proposal rests on a simple principle—a security may be cross traded if there is an independent, observable basis for pricing it.20 Funds may continue to cross trade Level 1 securities, although the pricing methodology proposed is more flexible (see below). As noted, the proposal would expand eligible securities to any security that the fund could value based on directly or indirectly observable inputs, adopting the accounting standards articulated in the Rule 2a-5 release. Because almost all fixed-income securities are “Level 2” securities under such GAAP standards, most fixed-income securities would be eligible, even though they do not have “readily available market quotations.”21 Level 3 securities and non-leveled investments would not be eligible to be cross traded under the proposed rule.22
Affiliated Persons Eligible to Rely on the Rule
The proposal would not change which affiliates may cross trade with a fund. For convenience of reference, the Commission proposes a new defined term, “eligible affiliate,” to cover (i) another registered fund that is a first- or second-tier affiliate and (ii) a person affiliated with the fund solely because of a common adviser (or affiliated advisers), common directors, or common officers.23
Pricing Mechanism
The proposal would provide two alternative methods for pricing cross trades: (1) the cross trade could be effected at the value the fund assigns to the security as part of its NAV computation on the trade date of the cross trade (“NAV Pricing”); or (2) the registered fund’s adviser would determine a price that reasonably represents the current market price of the security using one or more unaffiliated pricing sources, and the adviser would periodically review the reasonableness of such prices (“Current Market Pricing”).24 The NAV Pricing methodology allows funds to leverage existing valuation processes (i.e., NAV computation under section 2(a)(41) of the 1940 Act, Rule 2a-4, and Rule 2a-5), which are subject to robust controls and oversight, and provides a cost-effective pricing method that limits the potential for abuses.25 The Current Market Pricing methodology allows funds to account for multiple inputs and sources of data, including evaluated prices, firm quotes, and electronic trading platforms.26 It also provides flexibility to price intraday, and to retain a third-party vendor specifically for this purpose. The vendor must be independent, meaning it may not be a first- or second-tier affiliated person of the fund.27 In substance, the proposal would reinstate the pricing framework that permitted fixed-income securities to be cross traded with affiliates prior to the adoption of Rule 2a-5.28
Role of the CCO Rather Than the Board
Notably, the Commission proposes to shift cross-trading oversight to a fund’s CCO rather than its board of directors as required today. Under the proposal, the CCO would review all cross trades at least quarterly for compliance with the rule. At least annually, the CCO would conduct a broader look-back, including the timing and price of later sales of securities acquired in cross trades, to assess whether any trade or pattern of trades disadvantaged the fund relative to its affiliate.29 The Commission requests comment on whether the CCO is the appropriate person to conduct this review acknowledges the possibility that the CCO may not be best suited to conduct this review, and invites comments to permit fund accounting personnel or other professionals to assist in the review.30 Boards would receive the CCO’s quarterly and annual reports, but the board would no longer adopt Rule 17a-7-specific procedures or make quarterly compliance determinations, consistent with the Staff’s 2018 no-action position allowing the board to delegate this responsibility to the CCO.31
Fees and Reporting
The proposal would also replace the undefined “customary transfer fee” exception, which has created considerable uncertainty over the years, with an express allowance for de minimis payments to unaffiliated service providers for clearing, settlement, custody, recording, or reporting of cross trades.32 The proposal would further establish new reporting requirements for certain registered funds. Registered funds that cross traded in reliance on Rule 17a-7 during the prior 12 months would report on Form N-PORT or Form N-MFP, by asset type, the aggregate value of their cross-trade purchases and sales alongside their total purchases and sales.33
Recordkeeping
Funds would continue to keep a record of each cross trade, identifying the security, the eligible affiliate, and the terms of the transaction for six years from the end of the fiscal year in which a cross trade occurred; with the first two years in an easily accessible place.34 Consistent with the proposed shift in oversight obligations, registered funds would also be required to retain for the same period the information or materials used in the quarterly review to determine that each condition of the proposed rule was satisfied for each cross trade as part of the quarterly review, as well as the information or materials used in the annual review to determine whether a single cross trade, or pattern of cross trades, may have disadvantaged the fund.35 Records of the CCO’s reports to the fund’s board would also be required to be maintained for such periods.36
III. Conclusion
The Commission’s proposal is a measured and well-designed response to a problem that has cost fund shareholders dearly. It would restore fixed-income cross trading, anchored in objective, valuation-based methodologies, fair to both sides of the transaction, and would place oversight with the CCO (or presumably will extend to his or her delegate best positioned to perform it). As part of the proposal, the Commission has requested comment on nearly 80 questions, including the scope of eligible securities, the two pricing methods, and CCO oversight. Comments are due 60 days after publication in the Federal Register. This is a long-overdue, welcome development for registered funds and their shareholders, and constructive engagement with the Commission and its Staff should help refine the operational details and support the proposal’s adoption.
