Executive Summary
- What’s new: On October 9, 2026, the SEC proposed amendments to Rule 17a-7 under the Investment Company Act of 1940, which permits cross trading by registered funds and business development companies (BDCs) under certain conditions. The proposal seeks to expand the scope of permitted cross trading, modernize the conditions of Rule 17a-7 and enhance investor protection.
- Why it matters: This proposal would allow registered funds and BDCs to cross trade certain fixed-income securities, effectively reversing the result of the SEC’s adoption of Rule 2a-5, which defined “readily available market quotations” (a term used in Rule 17a-7) to exclude most fixed-income securities. Many funds had previously cross traded prior to the adoption of Rule 2a-5 in 2020. The proposed amendments would permit registered funds and BDCs to trade securities with valuations based on observable inputs, including most fixed-income securities.
- What to do next: Market participants should consider offering comments on the proposal, with the comment period open for 60 days after publication in the Federal Register.
__________
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 (1940 Act), which governs cross trading by registered investment companies and business development companies (BDCs) — collectively, “regulated funds.” The proposed amendments are designed to modernize and expand the cross trading rule to allow cross trades that will benefit regulated funds and their shareholders, subject to enhanced investor protections. The comment period will remain open for 60 days after publication in the Federal Register. According to a statement from SEC Chairman Paul S. Atkins, the proposed amendments are intended as another step toward modernizing the SEC’s regulatory frameworks to meet the realities of today’s markets.
Overview
Section 17(a) of the 1940 Act generally prohibits principal transactions between a fund and its affiliated persons. Rule 17a-7 exempts certain cross trades with eligible affiliates from Section 17(a) if specified conditions are satisfied. Cross trades are permissible under Rule 17a-7 if, among other conditions, (i) the security has “readily available market quotations” and (ii) the trade is executed at the “independent current market price.”
Rule 2a-5, which was adopted by the SEC in 2020 to govern fund valuation practices, defined “readily available market quotations” consistent with Level 1 inputs under the U.S. GAAP fair value hierarchy, meaning unadjusted quoted prices in active markets for identical assets. Since most fixed-income securities are valued based on observable inputs that do not meet Level 1 criteria, the cross trading of fixed-income securities, which many funds previously cross traded in reliance on prior SEC no-action relief, was effectively prohibited. The SEC proposal would amend Rule 17a-7 to restore the ability for regulated funds to cross trade most fixed-income securities.
Key Elements of the Proposed Rule
Expansion of Scope of Cross Trading
The proposed amendments expand the scope of securities eligible for cross trading to include many fixed-income securities.
- Funds would be able to 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.” The inclusion of securities valued on observable inputs is consistent with the current definition of Level 2 inputs under the U.S. GAAP fair value hierarchy.
- The valuations of most fixed-income securities fall within Level 2, as they are valued based on observable inputs. However, they are often traded too infrequently to have an active market, excluding them from Level 1 classification. The proposed amendment would allow regulated funds to cross trade most fixed-income securities.
Securities valued based on unobservable inputs that are significant to the fair value measurement in its entirety (i.e., Level 3 inputs under U.S. GAAP) or that are nonleveled under U.S. GAAP (e.g., private fund investments valued at the underlying fund’s net asset value as practical expedient) would not be eligible for cross trading under the amended rule. The SEC noted that this limitation was based on conflicts of interest implicated by cross trades and the importance of the transaction price to ensure that a cross trade is fair and reasonable to each participating fund. However, the SEC requested comment on whether the proposed eligible securities should be expanded beyond Level 2 securities and, if so, whether additional conditions should be imposed.
Pricing Mechanism
Under Rule 17a-7, cross trades must be “effected at the independent current market price of the security.” The proposed amendments would modernize the methods for funds to obtain an independent current market price, recognizing market developments that have led to more verifiable and transparent pricing. If adopted, the proposed amendments would permit funds to effect cross trades using one of two pricing methods, and a fund could switch between pricing methods for different cross trades.
- NAV pricing: The value the fund assigns to the security in its net asset value (NAV) calculation on the business day of the cross trade. A fund that does not compute its NAVs on a daily basis would be permitted to cross trade using NAV pricing only on days that its NAVs are computed. If a cross trade involves two regulated funds, the funds must share the same valuation processes so that each would apply the same price using the NAV pricing method.
- Current market pricing: A price determined by the fund’s adviser using one or more unaffiliated pricing sources, provided that the adviser periodically reviews the reasonableness of such prices. Current market pricing could be used at any time, including intraday.
Transaction Fees
The proposal would keep the existing conditions that no consideration be paid other than cash against prompt delivery, and that no remuneration be paid in connection with the cross trade. It would, however, permit de minimis payments to unaffiliated parties for clearing, settlement, custody, recording and reporting services
Affiliated Persons Eligible to Rely on Rule 17a-7
The proposal would not alter the scope of affiliates that are eligible to engage in cross trading with a regulated fund. To clarify the scope, the proposed amendments would define a new term, “eligible affiliate,” to cover (i) another regulated fund (including a separate series of the same or another regulated 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 and/or common officers.
Best-Interest Determination
Under the proposed amendments, a fund’s investment adviser would need to determine that a cross trade is in the best interest of the fund in advance of the transaction. The SEC noted that this requirement is consistent with the adviser’s fiduciary duty to each client. If a cross trade involves two regulated funds, this determination must be made for each fund involved, without regard to the benefits to the other side.
The SEC noted examples of appropriate factors for an adviser to consider in making a best-interest determination, including:
- The investment rationale for the cross trade and the expected effect of the cross trade on the fund’s performance.
- The characteristics of the cross traded security, including its liquidity.
- The method of pricing the cross trade, whether more favorable pricing appears to be available in the open market, and any cost savings associated with conducting a cross trade.
- The execution method, quality and speed, and any associated costs.
- The timing and urgency of the transaction.
- The size of the trade and expected effect on the price of the security if purchased or sold on the open market.
- The characteristics of the eligible affiliate, including its expense and fee structure.
- Current market conditions, especially if the markets are stressed.
CCO Oversight and Compliance Testing
The responsibility to conduct routine compliance reviews would shift from the fund’s board to the chief compliance officer (CCO), while the fund’s board would maintain oversight. The proposal would eliminate the current requirement of Rule 17a-7 that fund boards adopt and approve changes to the fund’s Rule 17a-7 procedures and determine at least quarterly that cross trades were done in compliance with such procedures. Instead, the amended rule would require a fund’s CCO to review compliance with Rule 17a-7 quarterly. Additionally, the CCO would be required to annually back-test trades and patterns of trades to determine whether any cross trade may have disadvantaged the fund relative to eligible affiliates. CCOs would be required to report the results of these quarterly and annual reviews to the fund’s board.
Record-Keeping Requirements
The proposed amendments would impose record-keeping requirements for cross trades, and for materials related to CCO reviews, compliance determinations and board reports.
Reporting
The proposed amendments would also require funds engaging in cross trading to report the aggregate value of portfolio securities cross traded and total and comparative volume of cross trades by asset class on Forms N-PORT and N-MFP to increase market transparency.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.