[Federal Register Volume 75, Number 250 (Thursday, December 30, 2010)]
[Rules and Regulations]
[Pages 82236-82241]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-33077]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
[Release No. IA-3128; File No. S7-23-07]
RIN 3235-AJ96
Principal Trades with Certain Advisory Clients
AGENCY: Securities and Exchange Commission.
ACTION: Temporary final rule.
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SUMMARY: The Securities and Exchange Commission is amending rule
206(3)-3T under the Investment Advisers Act of 1940, a temporary rule
that establishes an alternative means for investment advisers who are
registered with the Commission as broker-dealers to meet the
requirements of section 206(3) of the Investment Advisers Act when they
act in a principal capacity in transactions with certain of their
advisory clients. The amendment extends the date on which rule 206(3)-
3T will sunset from December 31, 2010 to December 31, 2012.
DATES: The amendments in this document are effective December 30, 2010,
and the expiration date for 17 CFR 275.206(3)-3T is extended to
December 31, 2012.
FOR FURTHER INFORMATION CONTACT: Brian M. Johnson, Attorney-Adviser,
Devin F. Sullivan, Senior Counsel, Matthew N. Goldin, Branch Chief, or
Sarah A. Bessin, Assistant Director, at (202) 551-6787 or
[email protected], Office of Investment Adviser Regulation, Division of
Investment Management, U.S. Securities and Exchange Commission, 100 F
Street, NE., Washington, DC 20549-5041.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission is
adopting an amendment to temporary rule 206(3)-3T [17 CFR 275.206(3)-
3T] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] that
extends the date on which the rule will sunset from December 31, 2010
to December 31, 2012.
I. Background
On September 24, 2007, we adopted, on an interim final basis, rule
206(3)-3T, a temporary rule under the Investment Advisers Act of 1940
(the ``Advisers Act'') that provides an alternative means for
investment advisers who are also registered as broker-dealers to meet
the requirements of section 206(3) of the Advisers Act when they act in
a principal capacity in transactions with certain of their advisory
clients.\1\ In December 2009, we extended the rule's sunset period by
one year to December 31, 2010.\2\
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\1\ Rule 206(3)-3T [17 CFR 275.206(3)-3T]. All references to
rule 206(3)-3T and the various sections thereof in this release are
to 17 CFR 275.206(3)-3T and its corresponding sections. See also
Temporary Rule Regarding Principal Trades with Certain Advisory
Clients, Investment Advisers Act Release No. 2653 (Sep. 24, 2007)
[72 FR 55022 (Sep. 28, 2007)] (``2007 Principal Trade Rule
Release'').
\2\ See Temporary Rule Regarding Principal Trades with Certain
Advisory Clients, Investment Advisers Act Release No. 2965 (Dec. 23,
2009) [74 FR 69009 (Dec. 30, 2009)] (``2009 Extension Release'') and
Temporary Rule Regarding Principal Trades with Certain Advisory
Clients, Investment Advisers Act Release No. 2965A (Dec. 31, 2009)
[75 FR 742 (Jan. 6, 2010)] (making a technical correction to the
2009 Extension Release).
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On July 21, 2010, President Obama signed into law the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank
Act'').\3\ Under section 913 of the Dodd-Frank Act, we are required to
conduct a study, and provide a report to Congress, concerning the
obligations of broker-dealers and investment advisers, including the
standards of care applicable to those intermediaries and their
associated persons.\4\ We intend to deliver the report concerning this
study, as required by the Dodd-Frank Act, no later than January 21,
2011.\5\
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\3\ Pub. L. 111-203, 124 Stat. 1376 (2010).
\4\ See generally section 913 of the Dodd-Frank Act and Study
Regarding Obligations of Brokers, Dealers, and Investment Advisers,
Investment Advisers Act Release No. 3058 (July 27, 2010) [75 FR
44996 (July 30, 2010)].
\5\ See section 913(d)(1) of the Dodd-Frank Act (requiring us to
submit the study to Congress no later than six months after the date
of enactment of the Dodd-Frank Act).
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Section 913 of the Dodd-Frank Act also authorizes us to promulgate
rules concerning, among other things, the legal or regulatory standards
of care for broker-dealers, investment advisers, and persons associated
with these intermediaries for providing personalized investment advice
about securities to retail customers. In enacting any rules pursuant to
this authority, we are required to consider the findings, conclusions,
and recommendations of the mandated study. The study and our
consideration of the need for further rulemaking pursuant to this
authority are part of our broader consideration of the regulatory
requirements applicable to broker-dealers and investment advisers in
connection with the Dodd-Frank Act.\6\
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\6\ The study mandated by section 913 of the Dodd-Frank Act is
one of several studies and other actions relevant to the regulation
of broker-dealers and investment advisers mandated by that Act. See,
e.g., section 914 of the Dodd-Frank Act (requiring the Commission to
review and analyze the need for enhanced examination and enforcement
resources for investment advisers); section 919 of the Dodd-Frank
Act (authorizing the Commission to issue rules designating documents
or information that shall be provided by a broker or dealer to a
retail investor before the purchase of an investment product or
service by the retail investor).
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In light of these legislative developments, we proposed on December
1, 2010 to extend the date on which rule 206(3)-3T will sunset for a
limited amount of time, from December 31, 2010 to December 31, 2012.\7\
We received 10 comment letters addressing our proposal prior to the
expiration of the comment period.\8\ Six of these commenters generally
supported
[[Page 82237]]
extending rule 206(3)-3T,\9\ and two commenters opposed an
extension.\10\ Two other commenters did not address the extension
directly.\11\ The comments we received on our proposal are discussed
below. After considering each of the comments, we are extending the
rule's sunset period by two years to December 31, 2012, as proposed.
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\7\ See Temporary Rule Regarding Principal Trades with Certain
Advisory Clients, Investment Advisers Act Release No. 3118 (Dec. 1,
2010), [75 FR 75650 (Dec. 6, 2010)] (``Proposing Release'').
\8\ See Comment Letter of the Consumer Federation of America
(Dec. 20, 2010) (``CFA Letter''); Comment Letter of Bank of America
Corporation (Dec. 20, 2010) (``Bank of America Letter''); Comment
Letter of Fiduciary360 (Dec. 20, 2010) (``Fiduciary360 Letter'');
Comment Letter of Tamar Frankel, Professor of Law, Boston University
School of Law (Dec. 14, 2010) (``Frankel Letter''); Comment Letter
of the National Association of Personal Financial Advisors (Dec. 20,
2010) (``NAPFA Letter''); Comment Letter of Pickard and Djinis LLP
(Dec. 10, 2010) (``Pickard and Djinis Letter''); Comment Letter of
Public Investors Arbitration Bar Association (Dec. 20, 2010)
(``PIABA Letter''); Comment Letter of Ron A. Rhoades, JD, CFP (Dec.
20, 2010) (``Rhoades Letter''); Comment Letter of the Securities
Industry and Financial Markets Association (Dec. 20, 2010) (``SIFMA
Letter''); Comment Letter of Winslow, Evans & Crocker (Dec. 8, 2009)
(``Winslow, Evans & Crocker Letter''). The comment letters are
available at http://www.sec.gov/comments/s7-23-07/s72307.shtml.
\9\ See Bank of America Letter; CFA Letter; PIABA Letter;
Pickard and Djinis Letter; SIFMA Letter; Winslow, Evans & Crocker
Letter. We note that PIABA supported a one-year extension.
\10\ See Fiduciary360 Letter; NAPFA Letter.
\11\ See Frankel Letter; Rhoades Letter.
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II. Discussion
We are amending rule 206(3)-3T only to extend the rule's expiration
date by two years. Absent further action by the Commission, the rule
will expire on December 31, 2012. We are adopting this extension
because, as we discussed in the Proposing Release, we believe that
firms' compliance with the substantive provisions of rule 206(3)-3T
provides sufficient protection to advisory clients to warrant the
rule's continued operation for the additional two years while we
conduct the study mandated by section 913 of the Dodd-Frank Act and
consider more broadly the regulatory requirements applicable to broker-
dealers and investment advisers.\12\ As part of our broader
consideration of the regulatory requirements applicable to broker-
dealers and investment advisers, we intend to carefully consider
principal trading by advisers, including whether rule 206(3)-3T should
be substantively modified, supplanted, or permitted to expire.
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\12\ See Proposing Release, Section II.
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If we permit rule 206(3)-3T to expire on December 31, 2010, after
that date investment advisers also registered as broker-dealers who
currently rely on rule 206(3)-3T would be required to comply with
section 206(3)'s transaction-by-transaction written disclosure and
consent requirements without the benefit of the alternative means of
complying with these requirements currently provided by rule 206(3)-3T.
This could limit the access of non-discretionary advisory clients of
advisory firms that are also registered as broker-dealers to certain
securities. In addition, certain of these firms have informed us that,
if rule 206(3)-3T were to expire on December 31, 2010, it would be
disruptive to their clients, and the firms would be required to make
substantial changes to their disclosure documents, client agreements,
procedures, and systems.
We expect to revisit the relief provided in rule 206(3)-3T soon
after the completion of our study in January 2011. Although we
anticipate that will occur prior to the amended expiration date for the
temporary rule, we want to ensure that we have sufficient time to
engage in any potential rulemaking or other process that may emerge
from either the study or any broader consideration of the regulatory
requirements applicable to broker-dealers and investment advisers prior
to the rule's expiration.
As discussed above, six commenters generally supported our proposal
to amend rule 206(3)-3T to extend it,\13\ and two commenters opposed
it.\14\ Commenters who supported the extension cited the disruption to
investors that would occur if the rule expired at this time, asserting
that investors would be forced to change their accounts and would lose
access to a wider range of securities.\15\ Commenters who supported the
extension of the rule also asserted that allowing the rule to sunset
would prove disruptive to advisory firms that are registered as broker
dealers: they explained that expiration of the rule would act as an
operational barrier to their ability to engage in principal trades with
their customers.\16\ These and other commenters further explained that,
if the rule were allowed to expire, firms relying on the rule would be
required to make considerable changes to their disclosure documents,
client agreements, procedures, and technical systems at substantial
expense.\17\ These commenters agreed that extending the rule while the
Commission conducted its review of the obligations of broker-dealers
and investment advisers, as mandated by the Dodd-Frank Act, would be
the least disruptive option.
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\13\ See Bank of America Letter; CFA Letter; PIABA Letter;
Pickard and Djinis Letter; SIFMA Letter; Winslow, Evans & Crocker
Letter.
\14\ See Fiduciary360 Letter; NAPFA Letter.
\15\ See Bank of America Letter; CFA Letter; SIFMA Letter.
\16\ See Bank of America Letter; SIFMA Letter.
\17\ See Bank of America Letter; SIFMA Letter; Winslow, Evans &
Crocker Letter.
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Conversely, two commenters questioned whether the rule benefits
clients and asserted that the Commission should not further extend the
rule in light of what they view as risks posed by the compliance issues
that the staff identified.\18\ One commenter, while opposing the
extension, encouraged the Commission to take additional measures to
protect clients from the conflicts of interest raised by principal
trading if we chose to extend the rule.\19\ Another commenter
challenged the proposition that firms and investors would face
disruptions if the rule sunsets, asserting that few firms and investors
rely on the rule.\20\
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\18\ See Fiduciary360 Letter; NAPFA Letter. We also note that
one commenter who supported the extension, CFA, also expressed
concern about these compliance issues. See CFA Letter.
\19\ See NAPFA Letter. We also note that CFA, while supporting
the extension, stated that the Commission should address
``weaknesses identified in the current approach and [back] that rule
with tough enforcement focused on the larger issue of the
appropriateness of recommendations.'' CFA Letter.
\20\ See Fiduciary360 Letter.
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On balance, and after careful consideration of these comments, we
conclude that the benefits from extending this rule outweigh the
potential costs of an extension. First, we believe that permitting the
rule to sunset just before we commence a comprehensive review of the
obligations of broker-dealers and investment advisers could produce
substantial disruption for investors with accounts serviced by firms
relying on the rule. These investors might lose access to securities
available through principal transactions and be forced to convert their
accounts in the interim, only to face the possibility of future change
-- and the costs and uncertainty such additional change may entail.\21\
This disruption will be avoided if we maintain the status quo while we
engage in our broader consideration of the regulatory requirements
applicable to broker-dealers and investment advisers.\22\ We continue
to believe that the rule benefits investors because it provides
investors with access to a wider range of securities and protects
investors who hold billions of dollars in advisory accounts.
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\21\ As discussed in the 2007 Principal Trading Release and
again in the 2009 Extension Release, firms have explained that they
may refrain from engaging in principal trading with their advisory
clients in the absence of the rule given the practical difficulties
of complying with Section 206(3), and thus may not offer principal
trading through advisory accounts. See 2007 Principal Trading
Release, Section I.B; 2009 Release, Section I.
\22\ See CFA Letter (``Although CFA has been critical of the
temporary rule and has in the past urged the Commission to act
expeditiously to replace it, we believe that, at this point,
revision of the rule is best achieved in conjunction with the
Commission's broader consideration of the regulatory requirements
applicable to broker-dealers and investment advisers.'').
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In reaching this conclusion, we have paid particular attention to
our staff's observations about firms' compliance with the rule. We
emphasize that we share the commenters' concerns about the compliance
issues that the staff identified, the critical aspects of which we
summarized in the Proposing Release.\23\ Having carefully considered
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the staff's observations, we conclude that the requirements of rule
206(3)-3T, coupled with regulatory oversight informed by those
observations, will adequately protect advisory clients during the
extension. Throughout the period of the extension, the staff will
examine firms with higher risk characteristics, including firms that
engage in principal transactions in reliance on rule 206(3)-3T,\24\ and
continue to take appropriate action to help ensure that firms are
complying with the rule's conditions, including referring firms to the
Division of Enforcement for possible enforcement action if warranted.
One commenter asserted that the burdens placed on firms by rule 206(3)-
3T are too stringent.\25\ As this commenter noted, the staff did not
identify instances of ``dumping,'' a harm that section 206(3) is
designed to redress, and we believe that the conditions and limitations
in the rule serve as appropriate safeguards during the pendency of the
extension.
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\23\ Although some of the commenters suggested that the
discussion of the staff's observations in the Proposing Release was
not robust enough, we believe the summary contained in the release
outlined the critical aspects of the issues observed by the staff
with respect to compliance with the rule. See NAPFA Letter;
Fiduciary360 Letter; CFA Letter.
\24\ One commenter suggested that the Commission's Office of
Compliance Inspections and Examinations should conduct additional
examinations to determine if firms are complying with rule 206(3)-
3T, among other requirements. See NAPFA Letter.
\25\ See Pickard and Djinis Letter.
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We note that one commenter asserted that even if principal trading
relief may have been appropriate when we originally adopted rule
206(3)-3T in 2007, it no longer is.\26\ In particular, the commenter
contended that the valuation of certain securities--such as municipal
bonds--has become much more difficult, such that ``a much greater
amount of due diligence is required of the investment adviser who
engages in advising clients on purchases of individual municipal
bonds.'' But extension of the rule does not have any bearing on an
adviser's due diligence obligations. The standard of care to which
advisers are subject and the duties they owe clients are in no way
diminished by their reliance on rule 206(3)-3T.\27\
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\26\ See NAPFA Letter.
\27\ See rule 206(3)-3T(b) (``This section shall not be
construed as relieving in any way an investment adviser from acting
in the best interests of an advisory client, including fulfilling
the duty with respect to the best price and execution for the
particular transaction for the advisory client; nor shall it relieve
such person or persons from any obligation that may be imposed by
section 206(1) or (2) of the Advisers Act or by other applicable
provisions of the federal securities laws.'').
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Second, we further conclude that the extension of the rule's sunset
date is warranted to avoid the disruption to firms relying on the rule
that will occur if the rule expires. The letters submitted by three
commenters demonstrated that some firms in fact do rely on the rule,
and that those firms will be faced with uncertainty and disruption of
operations should the rule expire just as the Commission is about to
begin a comprehensive review process that may ultimately produce a
different regulatory standard.\28\ One commenter that represents
securities firms described that large and small firms have relied upon
the rule, and provided data showing that a substantial number of
accounts and volume of trades would be affected by a change in the
rule.\29\
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\28\ See Bank of America Letter; SIFMA Letter; Winslow, Evans &
Crocker Letter.
\29\ See SIFMA Letter.
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We received four comment letters specifically addressing the
duration of our proposed extension of rule 206(3)-3T.\30\ Three
expressed support for extending the rule for an additional two years,
but argued that the rule should be made permanent.\31\ One of these
commenters cited uncertainty and its attendant costs as a reason to
make the rule permanent.\32\ Other commenters supported a shorter
extension of the rule. For example, one commenter supported a one-year
extension.\33\ This commenter stated that a one-year extension of the
rule strikes the proper balance between the concerns of investor
protection and the burden of potential revised regulations applying to
investment advisers and broker-dealers.\34\ Two commenters generally
opposed the extension and supported allowing the rule to expire: One
commenter stated alternatively that the Commission should adopt a one-
year extension with the imposition of other measures to ensure firms'
compliance with the rule and with their fiduciary obligations
generally, and the other indicated that it would support an extension
of six months if the Commission provided ``further explanation and
supporting evidence.'' \35\
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\30\ See Bank of America Letter; Fiduciary360 Letter; Winslow,
Evans & Crocker Letter; PIABA Letter.
\31\ See Bank of America Letter; Winslow, Evans & Crocker
Letter; Pickard and Djinis Letter.
\32\ See Winslow, Evans & Crocker Letter.
\33\ See PIABA Letter.
\34\ See id.
\35\ See NAPFA Letter; Fiduciary360 Letter.
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As we noted in the Proposing Release, we believe that the rule
should be extended only for a limited amount of time.\36\ That period
of time, however, must be long enough to permit the Commission to
engage in any rulemaking prompted by our study under section 913 of the
Dodd-Frank Act and our broader review of regulatory requirements
applicable to investment advisers and broker-dealers. Having considered
the comments regarding the duration of the extension, and taking into
account the importance of the issues that this process will address,
the Commission believes on balance that a two-year extension is
necessary to give the Commission adequate time to complete any such
rulemaking. Because that process cannot begin until the completion of
the study required by the Dodd-Frank Act, adopting a six-month or one-
year extension, as certain commenters recommended, most likely would
not provide sufficient time for such rulemaking, and thus could result
in greater uncertainty (along with its attendant costs) for investors
and firms that rely on the rule. We believe that certainty in this area
is important, and we will complete any relevant rulemaking as soon as
is feasible consistent with administrative procedure.
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\36\ See Proposing Release, Section II. The statements in the
Proposing Release should not be read as limiting the scope of the
alternatives we will consider in conducting the study mandated by
section 913 of the Dodd-Frank Act and considering more broadly the
regulatory requirements applicable to broker-dealers and investment
advisers.
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A number of commenters also raised issues that were beyond the
scope of our proposal to extend rule 206(3)-3T, including the broader
legal and policy questions related to the meaning, scope, and
application of a fiduciary standard and the appropriate considerations
related to principal trading.\37\ These comments pertain to our broader
consideration of the regulatory requirements applicable to broker-
dealers and investment advisers, and we will consider these comments in
conducting this broader review.
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\37\ See CFA Letter; Fiduciary360 Letter; Frankel Letter; NAPFA
Letter; Pickard and Djinis Letter; Rhoades Letter; SIFMA Letter.
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III. Certain Administrative Law Matters
The amendment to rule 206(3)-3T is effective on December 30, 2010.
The Administrative Procedure Act generally requires that an agency
publish a final rule in the Federal Register not less than 30 days
before its effective date.\38\ However, this requirement does not apply
if the rule is a substantive rule which grants or recognizes an
exemption or relieves a restriction, or if the rule is
interpretive.\39\ Rule 206(3)-3T is a rule that recognizes an
[[Page 82239]]
exemption and relieves a restriction and in part has interpretive
aspects.
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\38\ 5 U.S.C. 553(d).
\39\ Id.
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IV. Paperwork Reduction Act
Rule 206(3)-3T contains ``collection of information'' requirements
within the meaning of the Paperwork Reduction Act of 1995.\40\ The
Office of Management and Budget (``OMB'') approved the burden estimates
presented in the 2007 Principal Trade Rule Release,\41\ first on an
emergency basis and subsequently on a regular basis. OMB approved the
collection of information with an expiration date of March 31, 2011. An
agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid OMB control number. The title for the collection of information
is: ``Temporary rule for principal trades with certain advisory
clients, rule 206(3)-3T'' and the OMB control number for the collection
of information is 3235-0630. The 2007 Principal Trade Rule Release and
the Proposing Release solicited comments on our PRA estimates, but we
did not receive comment on them.\42\
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\40\ 44 U.S.C. 3501 et seq.
\41\ See 2007 Principal Trade Rule Release, Section V.B&C.
\42\ See 2009 Extension Release, Section IV; Proposing Release,
Section IV.
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The amendment to the rule we are adopting today--to extend rule
206(3)-3T for two years--does not affect the burden estimates contained
in the 2007 Principal Trade Rule Release. Therefore, as was the case
when we extended rule 206(3)-3T in December 2009, we are not revising
our Paperwork Reduction Act burden and cost estimates submitted to OMB
as a result of this amendment. We will submit burden and cost estimates
as part of our routine renewal of OMB's approval of the rule's
collection of information.
V. Cost-Benefit Analysis
Other than extending rule 206(3)-3T's sunset period for two years,
we are not otherwise modifying the rule from the form in which we
initially adopted it on an interim final basis in September 2007 or as
final in December 2009. We discussed the benefits provided by rule
206(3)-3T in both the 2007 Principal Trade Rule Release and the 2009
Extension Release.
In summary, as explained in the 2007 Principal Trade Rule Release,
the 2009 Extension Release, and the Proposing Release,\43\ we believe
the principal benefit of rule 206(3)-3T is that it maintains investor
choice and protects the interests of investors who formerly held an
estimated $300 billion in fee-based brokerage accounts. A resulting
second benefit of the rule is that non-discretionary advisory clients
of advisory firms that are also registered as broker-dealers have
easier access to a wider range of securities which, in turn, should
continue to lead to increased liquidity in the markets for these
securities and promote capital formation in these areas. A third
benefit of the rule is that it provides the protections of the sales
practice rules of the Securities Exchange Act of 1934 (``Exchange
Act'') \44\ and the relevant self-regulatory organizations because an
adviser relying on the rule must also be a registered broker-dealer.
Another benefit of rule 206(3)-3T is that it provides a lower cost
alternative for an adviser to engage in principal transactions.
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\43\ See 2007 Principal Trade Rule Release, Section VI.C; 2009
Extension Release, Section V; Proposing Release, Section V.
\44\ 15 U.S.C. 78 et seq.
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One commenter disputed a number of the benefits of rule 206(3)-3T
we have described above. The commenter did not provide any specific
data, analysis, or other information in support of its comment.\45\ No
commenter provided any substantive or specific evidence to contradict
the Commission's previous conclusion that the rule benefits investors,
and the Commission continues to believe that the rule provides those
benefits.\46\
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\45\ See NAPFA Letter (questioning the benefits of the rule in:
(1) Providing protections of the sales practice rules of the
Exchange Act and the relevant self-regulatory organizations; (2)
allowing non-discretionary advisory clients of advisory firms that
are also registered as broker-dealers to have easier access to a
wider range of securities which, in turn, should continue to lead to
increased liquidity in the markets for these securities and promote
capital formation in these areas; and (3) maintaining investor
choice).
\46\ See 2007 Principal Trade Rule Release, Section VI.C; 2009
Extension Release, Section V; Proposing Release, Section V.
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In addition to the general benefits described above, there also are
benefits to extending the rule for an additional two years. By
extending the rule for two years, non-discretionary advisory clients
who have had access to certain securities because of their advisers'
reliance on the rule to trade on a principal basis will continue to
have access to those securities without disruption. If we chose not to
extend the rule in its current form, firms currently relying on the
rule would be required to restructure their operations and client
relationships on or before the rule's current expiration date--
potentially only to have to do so again shortly thereafter (first when
the rule expires or is modified, and again if we adopt a new approach
after the study mandated by the Dodd-Frank Act, discussed above, is
complete). Firms relying on the rule will continue to be able to offer
clients and prospective clients access to certain securities on a
principal basis as well and will not need during this two-year period
to incur the cost of adjusting to a new set of rules or abandoning the
systems established to comply with the current rule. In other words,
extension will avoid disruption to clients and firms during the period
while we complete the study mandated by section 913 of the Dodd-Frank
Act and our broader consideration of the regulatory requirements
applicable to broker-dealers and investment advisers.
We also discussed the costs associated with rule 206(3)-3T in the
2007 Principal Trade Rule Release, the 2009 Extension Release, and the
Proposing Release.\47\ In the 2007 Principal Trade Rule Release, we
presented estimates of the costs of each of the rule's disclosure
elements, including: Prospective disclosure and consent; transaction-
by-transaction disclosure and consent; transaction-by-transaction
confirmations; and the annual report of principal transactions. We also
provided estimates for the following related costs of compliance with
rule 206(3)-3T: (i) The initial distribution of prospective disclosure
and collection of consents; (ii) systems programming costs to ensure
that trade confirmations contain all of the information required by the
rule; and (iii) systems programming costs to aggregate already-
collected information to generate compliant principal transactions
reports. We did not receive comments directly addressing with
supporting data the cost-benefit analysis we presented in the 2007
Principal Trade Rule Release.\48\ We do not believe that a two-year
extension of rule 206(3)-3T would materially affect those costs.\49\
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\47\ See 2007 Principal Trade Rule Release, Section VI.D; 2009
Extension Release, Section V; Proposing Release, Section V.
\48\ In the 2007 Principal Trade Rule Release, we estimated the
total overall costs, including estimated costs for all eligible
advisers and eligible accounts, relating to compliance with rule
206(3)-3T to be $37,205,569. See 2007 Principal Trade Rule Release,
Section VI.D.
\49\ See Proposing Release, Section V.
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We recognize that, as a result of our amendment, firms relying on
the rule will incur the costs associated with complying with the rule
for two additional years. We also recognize that a temporary rule, by
nature, creates uncertainty, which in turn, may generate costs and
inefficiency.\50\
[[Page 82240]]
However, we believe that a temporary extension of the rule is the most
appropriate action that we can take at this time while we conduct the
study mandated by section 913 of the Dodd-Frank Act and consider more
broadly the regulatory requirements applicable to broker-dealers and
investment advisers.\51\
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\50\ See Winslow, Evans & Crocker Letter (``We do, however, feel
that extending the temporary rule is in the best interest of
investors but think that doing so on a temporary basis is short
sighted and leads to certain inefficiencies, particularly to smaller
firms * * * We believe the Commission should adopt the rule on a
permanent basis thus eliminating uncertainty with respect to
compliance in this area.''). See also Bank of America Letter (urging
the Commission to consider a permanent rule that would allow firms
to continue acting in a principal capacity in transactions with
certain of their clients).
\51\ See CFA Letter (``If, as we hope, more extensive revisions
to the principal trading requirements are just around the corner, it
would be unduly disruptive to abandon the existing system now absent
evidence of significant harm to investors.'').
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VI. Promotion of Efficiency, Competition, and Capital Formation
Section 202(c) of the Advisers Act mandates that the Commission,
when engaging in rulemaking that requires it to consider or determine
whether an action is necessary or appropriate in the public interest,
consider, in addition to the protection of investors, whether the
action will promote efficiency, competition, and capital formation.\52\
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\52\ 15 U.S.C. 80b-2(c).
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We explained in the 2007 Principal Trade Rule Release, the 2009
Extension Release, and the Proposing Release, the manner in which rule
206(3)-3T, in general, would promote these aims.\53\ We continue to
believe that this analysis generally applies today.
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\53\ See 2007 Principal Trade Rule Release, Section VII; 2009
Extension Release, Section VI; Proposing Release, Section VI.
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As noted in the 2009 Extension Release and Proposing Release, we
received comments on the 2007 Principal Trade Rule Release from
commenters who opposed the limitation of the temporary rule to
investment advisers that are also registered as broker-dealers, as well
as to accounts that are subject to both the Advisers Act and Exchange
Act as providing a competitive advantage to investment advisers that
are also registered broker-dealers.\54\ Based on our experience with
the rule to date, just as we noted in the 2009 Extension Release and
Proposing Release, we have no reason to believe that broker-dealers (or
affiliated but separate investment advisers and broker-dealers) are put
at a competitive disadvantage to advisers that are themselves also
registered as broker-dealers; \55\ however we intend to continue to
evaluate these effects in connection with our broader consideration of
the regulatory requirements applicable to broker-dealers and investment
advisers.
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\54\ See 2009 Extension Release, Section VI; Proposing Release,
Section VI; Comment Letter of the Financial Planning Association
(Nov. 30, 2007).
\55\ See 2009 Extension Release, Section VI; Proposing Release,
Section VI.
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We received one comment letter arguing that rule 206(3)-3T would
impede capital formation because it would lead to ``more numerous and
more severe violations * * * of the trust placed by individual
investors in their trusted investment adviser.'' \56\ While we share
the view that numerous and severe violations of trust could
theoretically impede capital formation, we have not seen any evidence
that rule 206(3)-3T has caused this result. We also reiterate that, in
addition to conducting a broader review, we will continue to consider
any potential violations of the rule and take appropriate action as
necessary.
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\56\ See NAPFA Letter.
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VII. Final Regulatory Flexibility Analysis
The Commission has prepared the following Final Regulatory
Flexibility Analysis (``FRFA'') regarding the amendment to rule 206(3)-
3T in accordance with 5 U.S.C. 604. We prepared and included an Initial
Regulatory Flexibility Analysis (``IRFA'') in the Proposing
Release.\57\
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\57\ See Proposing Release, Section VII.
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A. Need for the Rule Amendment
We are adopting an amendment to rule 206(3)-3T to extend the rule
for two years in its current form because we believe that it would be
premature to require firms relying on the rule to restructure their
operations and client relationships before we complete our study and
our broader consideration of the regulatory requirements applicable to
broker-dealers and investment advisers. The objective of the amendment
to rule 206(3)-3T, as discussed above, is to permit firms currently
relying on rule 206(3)-3T to limit the need to modify their operations
and relationships on multiple occasions, both before and potentially
after we complete our study and any related rulemaking.
We are amending rule 206(3)-3T pursuant to sections 206A and 211(a)
of the Advisers Act [15 U.S.C. 80b-6a and 15 U.S.C. 80b-11(a)].
B. Significant Issues Raised by Public Comments
We received one comment letter related to our IRFA.\58\ The
commenter stated that extending the rule temporarily, rather than
permanently, would create uncertainty, thereby causing certain
inefficiencies, particularly with regard to smaller firms.\59\ We
recognize that a temporary rule, by nature, creates uncertainty, which
in turn may generate costs and inefficiency, especially for smaller
firms. However, as discussed above, we believe that a temporary
extension of the rule is the most appropriate approach at this time
while we conduct the study mandated by section 913 of the Dodd-Frank
Act and consider more broadly the regulatory requirements applicable to
broker-dealers and investment advisers.\60\
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\58\ See Winslow, Evans & Crocker Letter.
\59\ See id.
\60\ See CFA Letter (``If, as we hope, more extensive revisions
to the principal trading requirements are just around the corner, it
would be unduly disruptive to abandon the existing system now absent
evidence of significant harm to investors.'').
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C. Small Entities Subject to the Rule
Rule 206(3)-3T is an alternative method of complying with Advisers
Act section 206(3) and is available to all investment advisers that:
(i) Are registered as broker-dealers under the Exchange Act; and (ii)
effect trades with clients directly or indirectly through a broker-
dealer controlling, controlled by or under common control with the
investment adviser, including small entities. Under Advisers Act rule
0-7, for purposes of the Regulatory Flexibility Act an investment
adviser generally is a small entity if it: (i) Has assets under
management having a total value of less than $25 million; (ii) did not
have total assets of $5 million or more on the last day of its most
recent fiscal year; and (iii) does not control, is not controlled by,
and is not under common control with another investment adviser that
has assets under management of $25 million or more, or any person
(other than a natural person) that had $5 million or more on the last
day of its most recent fiscal year.\61\
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\61\ See 17 CFR 275.0-7.
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As noted in the Proposing Release, we estimate that as of November
1, 2010, 680 SEC-registered investment advisers were small
entities.\62\ As discussed in the 2007 Principal Trade Rule Release, we
opted not to make the relief provided by rule 206(3)-3T available to
all investment advisers, and instead have restricted it to investment
advisers that also are registered as broker-dealers under the Exchange
Act.\63\ We therefore estimate for purposes of this FRFA that 38 of
these small entities (those that are
[[Page 82241]]
both investment advisers and broker-dealers) could rely on rule 206(3)-
3T.\64\ We did not receive any comments on these estimates.
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\62\ IARD data as of November 1, 2010.
\63\ See 2007 Principal Trade Rule Release, Section VIII.B.
\64\ IARD data as of November 1, 2010.
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D. Reporting, Recordkeeping, and Other Compliance Requirements
The provisions of rule 206(3)-3T impose certain reporting or
recordkeeping requirements, and our amendment will extend the
imposition of these requirements for an additional two years. The two-
year extension will not alter these requirements.
Rule 206(3)-3T is designed to provide an alternative means of
compliance with the requirements of section 206(3) of the Advisers Act.
Investment advisers taking advantage of the rule with respect to non-
discretionary advisory accounts are required to make certain
disclosures to clients on a prospective, transaction-by-transaction and
annual basis.
Specifically, rule 206(3)-3T permits an adviser, with respect to a
non-discretionary advisory account, to comply with section 206(3) of
the Advisers Act by, among other things: (i) Making certain written
disclosures; (ii) obtaining written, revocable consent from the client
prospectively authorizing the adviser to enter into principal trades;
(iii) making oral or written disclosure and obtaining the client's
consent orally or in writing prior to the execution of each principal
transaction; (iv) sending to the client confirmation statements for
each principal trade that disclose the capacity in which the adviser
has acted and indicating that the client consented to the transaction;
and (v) delivering to the client an annual report itemizing the
principal transactions. Advisers are already required to communicate
the content of many of the disclosures pursuant to their fiduciary
obligations to clients. Other disclosures are already required by rules
applicable to broker-dealers.
Our amendment will only extend the rule for two years in its
current form. Advisers currently relying on the rule already should be
making the disclosures described above.
E. Agency Action To Minimize Effect on Small Entities
The Regulatory Flexibility Act directs us to consider significant
alternatives that would accomplish our stated objective, while
minimizing any significant adverse impact on small entities.\65\
Alternatives in this category would include: (i) Establishing different
compliance or reporting standards or timetables that take into account
the resources available to small entities; (ii) clarifying,
consolidating, or simplifying compliance requirements under the rule
for small entities; (iii) using performance rather than design
standards; and (iv) exempting small entities from coverage of the rule,
or any part of the rule.
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\65\ See 5 U.S.C. 603(c).
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We believe that special compliance or reporting requirements or
timetables for small entities, or an exemption from coverage for small
entities, may create the risk that the investors who are advised by and
effect securities transactions through such small entities would not
receive adequate disclosure. Moreover, different disclosure
requirements could create investor confusion if it creates the
impression that small investment advisers have different conflicts of
interest with their advisory clients in connection with principal
trading than larger investment advisers. We believe, therefore, that it
is important for the disclosure protections required by the rule to be
provided to advisory clients by all advisers, not just those that are
not considered small entities. Further consolidation or simplification
of the rule for investment advisers that are small entities would be
inconsistent with the Commission's goals of fostering investor
protection.
We have endeavored through rule 206(3)-3T to minimize the
regulatory burden on all investment advisers eligible to rely on the
rule, including small entities, while meeting our regulatory
objectives. It was our goal to ensure that eligible small entities may
benefit from the Commission's approach to the new rule to the same
degree as other eligible advisers. The condition that advisers seeking
to rely on the rule must also be registered as broker-dealers and that
each account with respect to which an adviser seeks to rely on the rule
must be a brokerage account subject to the Exchange Act, and the rules
thereunder, and the rules of the self-regulatory organization(s) of
which it is a member, reflect what we believe is an important element
of our balancing between easing regulatory burdens (by affording
advisers an alternative means of compliance with section 206(3) of the
Act) and meeting our investor protection objectives.\66\ Finally, we do
not consider using performance rather than design standards to be
consistent with our statutory mandate of investor protection in the
present context.
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\66\ See 2007 Principal Trade Rule Release, Section II.B.7
(noting commenters that objected to this condition as disadvantaging
small broker-dealers (or affiliated but separate investment advisers
and broker-dealers)).
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VIII. Statutory Authority
The Commission is amending rule 206(3)-3T pursuant to sections 206A
and 211(a) of the Advisers Act.
List of Subjects in 17 CFR Part 275
Investment advisers, Reporting and recordkeeping requirements.
Text of Rule Amendment
0
For the reasons set out in the preamble, Title 17, Chapter II of the
Code of Federal Regulations is amended as follows.
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
0
1. The authority citation for part 275 continues to read in part as
follows:
Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *
Sec. 275.206(3)-3T [Amended]
0
2. In Sec. 275.206(3)-3T, amend paragraph (d) by removing the words
``December 31, 2010'' and adding in their place ``December 31, 2012''.
Dated: December 28, 2010.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-33077 Filed 12-28-10; 4:15 pm]
BILLING CODE 8011-01-P