The Securities and Exchange Commission (SEC) has proposed rule changes that would allow registered investment funds to cross trade securities valued using observable inputs – a category aligned with Level 2 inputs under U.S. GAAP – potentially restoring eligibility for many fixed-income securities.
The proposal would amend Rule 17a-7 of the Investment Company Act of 1940, which permits certain securities transactions between a registered fund and affiliated parties, subject to specified conditions. Under the rule today, a security generally must have “readily available market quotations” to be eligible for a cross trade.
The SEC said Rule 2a-5, adopted in 2020, defines readily available market quotations as unadjusted quoted prices in active markets for identical investments. That definition corresponds to Level 1 inputs in the fair value hierarchy set out in the FASB ASC Topic 820, Fair Value Measurement, and thus, in practice, has excluded most fixed-income securities from Rule 17a-7 cross trading since the rule’s compliance date in September 2022.
“Most fixed-income securities that registered funds seek to trade do not have readily available market quotations because, among other reasons, they are not frequently traded in the secondary market and therefore are not valued solely by reference to level 1 inputs,” the SEC said in Release No. IC-36358, Investment Company Cross Trading, published on October 9, 2026.
When the SEC adopted the 2020 rule, the commission noted potential revisions in the future. In March 2021, the staff issued a statement saying it was assessing amendments to Rule 17a-7 in light of developments arising from the adoption of Rule 2a-5 and the evolution of registered funds’ cross-trading practices over the last several decades preceding several decades, according to the proposing release.
Under the proposal, securities would be eligible if they either have readily available market quotations or are valued by the fund using inputs observable directly or indirectly. The SEC said the latter standard is intended to align with the Level 2 input definition under the fair value hierarchy in Topic 820.
Level 2 inputs can include quoted prices for similar securities, quoted prices in inactive markets, and observable interest rates, yield curves, and credit spreads.
The SEC would treat a security as eligible “only to the extent that level 2 inputs are the lowest level of inputs that are significant to the entire measurement.”
Securities whose valuations depend on significant unobservable inputs—generally Level 3 securities—would remain ineligible under the proposal.
“The proposed approach is designed to focus on securities that have an independent basis for pricing, including those with readily available market quotations and observable inputs, thus reducing the risk of subjectivity, bias, or error in determining the price of the cross trade,” the SEC said in Release No. IC-36358.
In a statement, SEC Chairman Paul Atkins said: “When executed appropriately, cross trades allow registered funds to avoid costs associated with open market trades and to then pass those savings on to investors. The amendments we are proposing today would modernize and expand the cross-trading rule, helping to deliver additional cost savings to those investors.”
2 alternative methods
The SEC also proposed two alternative methods for determining a cross trade’s independent current market price.
A fund could use the value assigned to the security in its next net asset value computation for the day of the trade, using the fund’s valuation processes under Rules 2a-4 and 2a-5.
Alternatively, the fund’s adviser could determine a price that reasonably represents the current market price using one or more unaffiliated pricing sources. Advisers using the latter approach would be required to periodically review the reasonableness of the prices used.
The proposed rule would require an investment adviser to determine before a cross trade that the transaction is in the best interest of each participating registered fund. Trades also would have to be consistent with the fund’s disclosed policies and investment strategies.
For oversight, the proposal would shift certain responsibilities from fund boards to chief compliance officers (CCOs).
A CCO would review cross trades at least quarterly for compliance with the rule and report the results to the board. The CCO also would conduct an annual review designed to identify whether a trade or pattern of trades may have disadvantaged a fund relative to an affiliate, including an analysis of the timing and price of subsequent sales of securities acquired through cross trades.
Funds would be required to retain cross-trade records for at least six years, including transaction details, materials supporting the CCO’s quarterly and annual reviews, and reports provided to the board.
The SEC also proposed changes to Forms N-PORT and N-MFP. Funds that conducted Rule 17a-7 cross trades during the preceding 12 months would report, by asset class or investment category, aggregate gross purchases and sales, as well as aggregate purchases and sales completed through cross trades.
The commission estimated annual monetized transaction-cost savings of approximately $173 million from the proposed framework, compared with estimated aggregate initial compliance costs of about $15.9 million and aggregate annual compliance costs of about $13.7 million.
If adopted, larger fund groups – those with at least $10 billion in net assets across their fund families – would have 12 months to comply. Smaller fund groups would have 18 months.
Comments on the proposals are due 60 days after publication in the Federal Register.
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