[Federal Register Volume 75, Number 233 (Monday, December 6, 2010)]
[Proposed Rules]
[Pages 75650-75655]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-30590]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-3118; File No. S7-23-07]
RIN 3235-AJ96


Temporary Rule Regarding Principal Trades With Certain Advisory 
Clients

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission is proposing to amend 
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 would extend the date on which rule 
206(3)-3T will sunset from December 31, 2010 to December 31, 2012.

DATES: Comments must be received on or before December 20, 2010.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

    <bullet> Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
    <bullet> Send an e-mail to <a href="/cdn-cgi/l/email-protection#f183849d94dc929e9c9c949f8582b1829492df969e87"><span class="__cf_email__" data-cfemail="7b090e171e56181416161e150f083b081e18551c140d">[email protected]</span></a>. Please include 
File Number S7-23-07 on the subject line; or
    <bullet> Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

    <bullet> Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-23-07. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549 on official business days between the hours of 10 a.m. and 3 p.m. 
All comments received will be posted without change; we do not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly.

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 
<a href="/cdn-cgi/l/email-protection#347d754641585147744751571a535b42"><span class="__cf_email__" data-cfemail="21686053544d4452615244420f464e57">[email protected]</span></a>, 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 
proposing 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 
would extend 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 registered with us 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\ The purpose of the rule was to permit broker-
dealers to sell to their advisory clients, in the wake of Financial 
Planning Association v. SEC (the ``FPA Decision''),\2\ certain 
securities held in the proprietary accounts of their firms that might 
not be available on an agency basis--or might be available on an agency 
basis only on less attractive terms\3\ -- while protecting clients from

[[Page 75651]]

conflicts of interest as a result of such transactions.\4\
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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\ 482 F.3d 481 (DC Cir. 2007). In the FPA Decision, handed 
down on March 30, 2007, the Court of Appeals for the DC Circuit 
vacated (subject to a subsequent stay until October 1, 2007) rule 
202(a)(11)-1 under the Advisers Act. Rule 202(a)(11)-1 provided, 
among other things, that fee-based brokerage accounts were not 
advisory accounts and were thus not subject to the Advisers Act. For 
further discussion of fee-based brokerage accounts, see 2007 
Principal Trade Rule Release, Section I.
    \3\ See 2007 Principal Trade Rule Release at nn.19-20 and 
Section VI.C.
    \4\ As a consequence of the FPA Decision, broker-dealers 
offering fee-based brokerage accounts with an advisory component 
became subject to the Advisers Act with respect to those accounts, 
and the client relationship became fully subject to the Advisers 
Act. These broker-dealers -- to the extent they wanted to continue 
to offer fee-based accounts and met the requirements for 
registration -- had to: Register as investment advisers, if they had 
not done so already; act as fiduciaries with respect to those 
clients; disclose all material conflicts of interest; and otherwise 
fully comply with the Advisers Act, including the restrictions on 
principal trading contained in section 206(3) of the Act. See 2007 
Principal Trade Rule Release, Section I.
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    As initially adopted on an interim final basis, rule 206(3)-3T was 
set to expire on December 31, 2009. In December 2009, however, we 
adopted rule 206(3)-3T as a final rule in the same form in which it was 
adopted on an interim final basis in 2007, except that we extended the 
rule's sunset period by one year to December 31, 2010.\5\ We deferred 
final action on rule 206(3)-3T in December 2009 because we needed 
additional time to understand how, and in what situations, the rule was 
being used.\6\
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    \5\ 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)] (``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 
Extension Release).
    \6\ See Extension Release, Section II.c.
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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'').\7\ 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.\8\ We intend to deliver the report concerning this 
study, as required by the Dodd-Frank Act, no later than January 21, 
2011.\9\
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    \7\ Public Law 111-203, 124 Stat. 1376 (2010).
    \8\ 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)].
    \9\ 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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    Our staff has observed the use of the rule by entities that are 
investment advisers also registered with us as broker-dealers.\10\ Of 
the firms contacted by our staff, some firms indicated that they were 
relying on the rule. As discussed more fully below, our staff observed 
several compliance issues. The staff is pursuing those matters where 
appropriate, including referrals to the Division of Enforcement.
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    \10\ Rule 206(3)-3T is available only to an investment adviser 
that is a broker-dealer registered under section 15 of the 
Securities Exchange Act of 1934 [15 U.S.C. 78o]. Rule 206(3)-
3T(a)(7).
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II. Discussion

    We are proposing to amend rule 206(3)-3T only to extend the rule's 
expiration date by two additional years. If the rule is amended, absent 
further action by the Commission, the rule will expire on December 31, 
2012.
    As noted above, 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 standard of care applicable to those intermediaries.\11\ We are 
required to deliver the report concerning this study no later than six 
months after the enactment of the Dodd-Frank Act, in January 2011.\12\
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    \11\ See supra note 8 and accompanying text.
    \12\ See supra note 9 and accompanying text.
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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.\13\
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    \13\ 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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    As part of this study and any rulemaking that may follow, we expect 
to consider the issues raised by principal trading, including the 
restrictions in section 206(3) of the Advisers Act and our experiences 
with, and observations regarding, the operation of rule 206(3)-3T. We 
will not, however, complete our consideration of these issues before 
December 31, 2010, rule 206(3)-3T's current expiration date.
    We believe that firms' compliance with the substantive provisions 
of rule 206(3)-3T as currently in effect provides sufficient 
protections to advisory clients to warrant the rule's continued 
operation for an additional limited period of time while we conduct the 
study mandated by the Dodd-Frank Act and consider more broadly the 
regulatory requirements applicable to broker-dealers and investment 
advisers.\14\
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    \14\ For a discussion of some of the benefits underlying rule 
206(3)-3T, see 2007 Principal Trade Rule Release, Section VI.C.
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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.\15\ In addition, certain of these firms have informed us 
that, if rule 206(3)-3T were to expire on December 31, 2010, they would 
be required to make substantial changes to their disclosure documents, 
client agreements, procedures, and systems.
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    \15\ See id.
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    As noted above, our staff has observed the use of the rule by 
entities that are investment advisers and are also registered as 
broker-dealers.\16\ Of the firms contacted by our staff, some indicated 
that they were relying on the rule. Significantly, among those 
advisers, our staff did not identify instances of ``dumping,'' a 
particular concern underlying section 206(3) of the Advisers Act.\17\ 
However, our staff did

[[Page 75652]]

observe certain compliance issues, including but not limited to 
instances in which firms:
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    \16\ The Office of Compliance Inspections and Examinations 
conducted examinations regarding compliance with rule 206(3)-3T. The 
staff's observations discussed in this release are from these 
examinations.
    \17\ Congress intended section 206(3) to address concerns that 
an adviser might engage in principal transactions to benefit itself 
or its affiliates, rather than the client. In particular, Congress 
was concerned that advisers might use advisory accounts to ``dump'' 
unmarketable securities or those the advisers fear may decline in 
value. See Investment Trusts and Investment Companies: Hearings on 
S. 3580 Before the Subcomm. of the Comm. on Banking and Currency, 
76th Cong., 3d Sess. 320, 322 (1940) (``[i]f a fellow feels he has a 
sour issue and finds a client to whom he can sell it, then that is 
not right. * * * '') (statement of David Schenker, Chief Counsel, 
Securities and Exchange Commission Investment Trust Study).
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    <bullet> Did not comply with section 206(3) or rule 206(3)-3T for 
certain transactions that were executed on a principal basis;\18\
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    \18\ For example, the staff observed instances in which 
transactions in underwritten securities were not identified as being 
executed in a principal capacity, even when these securities passed 
through a firm's inventory. In addition, the staff observed 
instances in which firms executed principal transactions in reliance 
on rule 206(3)-3T in securities that were ineligible for trading 
pursuant to the rule.
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    <bullet> Demonstrated weaknesses relating to compliance monitoring 
of electronic systems to identify principal trades and to validate 
compliance with rule 206(3)-3T's disclosure and consent provisions; 
\19\
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    \19\ For example, in some instances, automated compliance 
systems erroneously permitted advisory client transactions to be 
executed on a principal basis for clients that had not authorized 
such transactions.
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    <bullet> Failed to test periodically the adequacy of their 
compliance programs;
    <bullet> Had inadequate policies and procedures concerning rule 
206(3)-3T;\20\
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    \20\ See 2007 Principal Trade Rule Release, Section II.B.8 (`` * 
* * an adviser relying on rule 206(3)-3T as an alternative means of 
complying with section 206(3) must have adopted and implemented 
written policies and procedures reasonably designed to comply with 
the requirements of the rule.''); Rule 206(4)-7(a) [17 CFR 
275.206(4)-7(a)] (requiring an investment adviser registered with us 
to adopt and implement written policies and procedures reasonably 
designed to prevent violations of the Advisers Act (and the rules 
thereunder) by the adviser or any of its supervised persons).
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    <bullet> Did not provide disclosures or provided disclosures that 
appeared to be potentially confusing, misleading, or incomplete;\21\
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    \21\ Such observations were made with respect to prospective 
written disclosures, transaction-by-transaction disclosures, and 
client annual reports. For example, the staff observed instances in 
which firms placed limitations on clients' ability to revoke their 
permission to execute transactions on a principal basis. The staff 
also observed instances in which annual summary reports were not 
sent to clients or were incomplete.
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    <bullet> Failed to obtain transaction-by-transaction consent;
    <bullet> Provided written confirmations that appeared to be 
potentially confusing or incomplete;\22\ and
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    \22\ For example, the staff observed instances in which 
confirmations did not clearly state that the client's consent was 
given prior to execution.
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    <bullet> Maintained books and records in a manner that did not 
enable the staff meaningfully to assess compliance with rule 206(3)-
3T.\23\
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    \23\ For example, in some instances, the staff was unable to 
verify whether oral transaction-by-transaction disclosures were, in 
fact, provided. The staff also observed instances in which it was 
unable to establish whether certain transactions were, in fact, 
subject to section 206(3).
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    We find it important that the staff found no instances of 
``dumping'' by advisers the staff observed were relying on rule 206(3)-
3T.\24\ However, we remain concerned about the compliance issues 
observed by the staff. As noted above, the staff is pursuing those 
matters where appropriate, including referrals to the Division of 
Enforcement. If the rule is extended, the staff will monitor compliance 
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 if warranted. We further encourage all firms 
that rely on rule 206(3)-3T to evaluate whether they have any of the 
compliance issues discussed in this Release, and if so, to take steps 
to address them.
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    \24\ See supra note 17.
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    In light of these and other considerations discussed in this 
Release, we believe that it would be premature to require these firms 
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. To 
the extent our consideration of these issues leads to new rules 
concerning principal trading, these firms would again be required to 
restructure their operations and client relationships, potentially at 
substantial expense.
    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. In making these determinations, we expect to 
consider, among other things, the results of the study required by 
section 913 of the Dodd-Frank Act, relevant comments received in 
connection with the study and any potential rulemaking that may follow, 
the results of our staff's evaluation of the operation of rule 206(3)-
3T, any relevant comments we receive in connection with this proposal, 
and comments we received in response to the 2007 Principal Trade Rule 
Release.
    We expect to revisit the relief provided in rule 206(3)-3T 
following the completion of our study. Although we anticipate that will 
occur prior to the proposed amended expiration date for the temporary 
rule, we want to ensure that we have sufficient time to complete any 
potential rulemaking process prior to the rule's expiration.

III. Request for Comment

    We request comment on our proposal to extend rule 206(3)-3T for two 
additional years.
    <bullet> Is it appropriate to extend rule 206(3)-3T for a limited 
period of time in its current form while we complete our study and our 
broader consideration of the regulatory requirements applicable to 
broker-dealers and investment advisers? Or should we allow the rule to 
expire?
    <bullet> Given the compliance issues observed, is extending the 
rule appropriate?
    <bullet> Is two years an appropriate period of time to extend the 
rule? Or should we extend the rule for a different period of time? If 
so, for how long?

IV. Paperwork Reduction Act

    Rule 206(3)-3T contains ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995.\25\ The 
Office of Management and Budget (``OMB'') approved the burden estimates 
presented in the 2007 Principal Trade Rule Release,\26\ 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. As noted in the Extension Release, the 
2007 Principal Trade Rule Release solicited comments on our PRA 
estimates, but we did not receive comment on them.\27\
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    \25\ 44 U.S.C. 3501 et seq.
    \26\ See 2007 Principal Trade Rule Release, Section V.B&C.
    \27\ See Extension Release, Section IV.
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    The amendment to the rule we are proposing 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.
    We request comment on whether the estimates and underlying 
assumptions that are more fully described in the 2007 Principal Trade 
Rule Release continue

[[Page 75653]]

to be reasonable.\28\ Have circumstances changed since that time such 
that these estimates should be modified or revised? Persons submitting 
comments should direct the comments to the Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Washington, 
DC 20503, and should send a copy to Elizabeth M. Murphy, Secretary, 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549-1090, with referece to File No. S7-23-07.
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    \28\ See 2007 Principal Trade Rule Release, Section V.
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V. Cost-Benefit Analysis

    Other than proposing to extend rule 206(3)-3T's sunset period for 
two years, we are not otherwise proposing to modify 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 Extension Release.
    In summary, as explained in the 2007 Principal Trade Rule Release 
and the Extension Release,\29\ 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'')\30\ 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. We did not receive comments directly 
addressing with supporting data the cost-benefit analysis we presented 
in the 2007 Principal Trade Rule Release and we continue to believe 
those benefits apply today.
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    \29\ See id., Section VI; Extension Release, Section V.
    \30\ 15 U.S.C. 78 et seq.
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    In addition to the general benefits described in those releases, 
there also are benefits to extending the rule for an additional two 
years. If we do not 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). 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 would continue to have access to those securities 
without disruption. Firms relying on the rule would continue to be able 
to offer clients and prospective clients access to certain securities 
on a principal basis as well and would 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 would 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 described the costs associated with rule 206(3)-3T, 
including the operational costs associated with complying with the 
rule, in the 2007 Principal Trade Rule Release and the Extension 
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 and we believe the amendments 
we are proposing today would not materially affect those costs.\31\
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    \31\ 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.
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    We recognize that if today's amendment is adopted, firms relying on 
the rule would incur the costs associated with complying with the rule 
for two additional years.
    We request comment on all aspects of the cost-benefit analysis, 
including the accuracy of the potential costs and benefits identified 
and assessed in this Release, the 2007 Principal Trade Rule Release and 
the Extension Release, as well as any other costs or benefits that may 
result from the proposal.

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.\32\
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    \32\ 15 U.S.C. 80b-2(c).
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    We explained in the 2007 Principal Trade Rule Release and the 
Extension Release the manner in which rule 206(3)-3T, in general, would 
promote these aims. We continue to believe that this analysis generally 
applies today.
    As noted in the Extension 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.\33\ Based 
on our experience with the rule to date, just as we noted in the 
Extension 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;\34\ however we intend to continue to 
evaluate the effects of the rule on efficiency, competition and capital 
formation as 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.
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    \33\ See Extension Release, Section VI; Comment Letter of the 
Financial Planning Association (Nov. 30, 2007).
    \34\ See Extension Release, Section VI.

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[[Page 75654]]

    We anticipate no new effects on efficiency, competition and capital 
formation would result from the two-year extension. However, during 
that time, we would continue to assess the rule's operation and impact 
along with intervening developments.
    We request comment on whether the proposal, if adopted, would 
promote efficiency, competition, and capital formation. Commenters are 
requested to provide empirical data to support their views.

VII. Initial Regulatory Flexibility Act Analysis

    The Commission has prepared the following Initial Regulatory 
Flexibility Analysis (``IRFA'') regarding the proposed amendment to 
rule 206(3)-3T in accordance with section 3(a) of the Regulatory 
Flexibility Act.\35\
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    \35\ 5 U.S.C. 603(a).
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A. Reasons for Proposed Action

    We are proposing to extend rule 206(3)-3T 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.

B. Objectives and Legal Basis

    The objective of the proposed 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 proposing to amend 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)].

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.\36\
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    \36\ See 17 CFR 275.0-7.
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    We estimate that as of November 1, 2010, 680 SEC-registered 
investment advisers were small entities.\37\ 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.\38\ We therefore estimate for 
purposes of this IRFA that 38 of these small entities (those that are 
both investment advisers and broker-dealers) could rely on rule 206(3)-
3T.\39\
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    \37\ IARD data as of November 1, 2010.
    \38\ See 2007 Principal Trade Rule Release, Section VIII.B.
    \39\ 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 proposal, if adopted, would extend 
the imposition of these requirements for an additional two years. We do 
not, however, expect that the proposed two-year extension would 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 would be 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 proposed amendment, if adopted, only would 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. Duplicative, Overlapping, or Conflicting Federal Rules

    We believe that there are no rules that duplicate or conflict with 
rule 206(3)-3T, which presents an alternative means of compliance with 
the procedural requirements of section 206(3) of the Advisers Act that 
relate to principal transactions.
    We note, however, that rule 10b-10 under the Exchange Act is a 
separate confirmation rule that requires broker-dealers to provide 
certain information to their customers regarding the transactions they 
effect. Furthermore, FINRA rule 2230 requires broker-dealers that are 
members of FINRA to deliver a written notification containing certain 
information, including whether the member is acting as a broker for the 
customer or is working as a dealer for its own account. Brokers and 
dealers typically deliver this information in confirmations that 
fulfill the requirements of rule 10b-10 under the Exchange Act. Rule G-
15 of the Municipal Securities Rulemaking Board also contains a 
separate confirmation rule that governs member transactions in 
municipal securities, including municipal fund securities. In addition, 
investment advisers that are qualified custodians for purposes of rule 
206(4)-2 under the Advisers Act and that maintain custody of their 
advisory clients' assets must send quarterly account statements to 
their clients pursuant to rule 206(4)-2(a)(3) under the Advisers Act.
    These rules overlap with certain elements of rule 206(3)-3T, but we 
designed the temporary rule to work efficiently together with existing 
rules by permitting firms to incorporate the required disclosure into 
one confirmation statement.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated

[[Page 75655]]

objective, while minimizing any significant adverse impact on small 
entities.\40\ 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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    \40\ 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 proposals 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.\41\ 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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    \41\ 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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G. Solicitation of Comments

    We solicit written comments regarding our analysis. We request 
comment on whether the rule will have any effects that we have not 
discussed. We request that commenters describe the nature of any impact 
on small entities and provide empirical data to support the extent of 
the impact.
    Do small investment advisers believe an alternative means of 
compliance with section 206(3) of the Advisers Act should be available 
to more of them?

VIII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \42\ we must advise OMB whether a proposed 
regulation constitutes a ``major'' rule. Under SBREFA, a rule is 
considered ``major'' where, if adopted, it results in or is likely to 
result in: (1) An annual effect on the economy of $100 million or more; 
(2) a major increase in costs or prices for consumers or individual 
industries; or (3) significant adverse effects on competition, 
investment or innovation.
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    \42\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
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    We request comment on the potential impact of the proposed 
amendment on the economy on an annual basis. Commenters are requested 
to provide empirical data and other factual support for their views to 
the extent possible.

IX. Statutory Authority

    The Commission is proposing to amend 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 Proposed Rule Amendment

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is proposed to be amended as follows.

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    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]

    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 1, 2010.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-30590 Filed 12-2-10; 4:15 pm]
BILLING CODE 8011-01-P


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