[Federal Register Volume 62, Number 18 (Tuesday, January 28, 1997)]
[Proposed Rules]
[Pages 4106-4114]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-2010]



Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / 
Proposed Rules

[[Page 4106]]



SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 240, 270, and 275

[Release Nos. 33-7383, 34-38190, IC-22478, and IA-1609; File No. S7-4-
97]
RIN 3235-AG62; 3235-AH01


Definitions of ``Small Business'' or ``Small Organization'' Under 
the Investment Company Act of 1940, the Investment Advisers Act of 
1940, the Securities Exchange Act of 1934, and the Securities Act of 
1933

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule amendments.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
publishing for comment proposed amendments to the definitions of 
``small business'' and ``small organization'' that are used in 
connection with Commission rulemaking under the Investment Company Act 
of 1940, the Investment Advisers Act of 1940, the Securities Exchange 
Act of 1934, and the Securities Act of 1933 regarding regulatory 
requirements applicable to investment companies, investment advisers, 
exchanges, securities information processors, transfer agents and 
issuers, and broker-dealers. These definitions are used specifically 
for purposes of the Regulatory Flexibility Act, which requires the 
Commission to consider the impact of its regulations on small entities. 
The Commission is proposing amendments to these definitions to reflect 
recent changes in the law as well as changes in the securities markets 
over the past decade, including technological innovations and increased 
business relationships among participants in the securities industry.

DATES: Comments should be received on or before February 27, 1997.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, U.S. Securities and Exchange Commission, Mail Stop 6-
9, 450 Fifth Street, N.W., Washington, D.C. 20549. Comments also may be 
submitted electronically at the following E-mail address: <a href="/cdn-cgi/l/email-protection#394b4c555c14335a5654545c574d4a794a5c5a175e564f">rule-
<span class="__cf_email__" data-cfemail="a3c0cccecec6cdd7d0e3d0c6c08dc4ccd5">[email protected]</span></a>. All comment letters should refer to File Number S7-4-
97. This file number should be included on the subject line if E-mail 
is used. Comment letters will be available for inspection and copying 
in the Public Reference Room, 450 Fifth Street, N.W., Washington D.C. 
20549. Electronically submitted comment letters will be posted on the 
Commission's Internet web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT:

    General: Penelope W. Saltzman, Special Counsel, at (202-942-0915), 
or Anne H. Sullivan, Senior Counsel, at (202-942-0954), Office of the 
General Counsel, Securities and Exchange Commission, 450 Fifth Street, 
N.W., Mail Stop 6-6, Washington, D.C. 20549.
    Offices with Particular Responsibility: Thomas M.J. Kerwin, Senior 
Counsel, Division of Investment Management, (definitions applicable to 
investment companies and investment advisers) (202-942-0690).
    Glenn J. Jessee, Special Counsel, Office of the Chief Counsel, 
Division of Market Regulation (definitions applicable to brokers, 
dealers, exchanges, transfer agents and issuers, securities information 
processors, and broker-dealers) (202-942-0073).

SUPPLEMENTARY INFORMATION: The Commission is requesting public comment 
on proposed amendments to the definitions of ``small business'' and 
``small organization'' set forth in Rule 0-10 [17 CFR 270.0-10] under 
the Investment Company Act of 1940 [15 U.S.C. 80a-1] (``Investment 
Company Act''), Rule 0-7 [17 CFR 275.0-7] under the Investment Advisers 
Act of 1940 [15 U.S.C. 80b-1] (the ``Advisers Act''), Rule 0-10 [17 CFR 
240.0-10] under the Securities Exchange Act of 1934 [15 U.S.C. 78a] 
(the ``Exchange Act''), and Rule 157 [17 CFR 230.157] under the 
Securities Act of 1933 [15 U.S.C. 77a] (the ``Securities Act'') as 
those terms are used for purposes of Chapter Six of the Administrative 
Procedure Act, 5 U.S.C. 601 et seq. (the Regulatory Flexibility Act, 
Pub. L. No. 96-354, 94 Stat. 1164 (1980), as amended, Pub. L. No. 104-
121, Title II, Subtitle D, 110 Stat. 864 (1996) (``RFA'')). The RFA 
requires the Commission to, among other things, consider the impact of 
Commission rulemaking on entities that qualify as ``small'' under 
applicable standards set forth in the RFA, the Small Business 
Act,<SUP>1 or regulations promulgated by the Small Business 
Administration (``SBA'').<SUP>2 In 1982, the Commission adopted 
definitions that it considered appropriate for issuers and other 
entities subject to its regulation, and the Commission is now, after 
consultation with the Office of Advocacy of the SBA, proposing for 
public comment amendments to those definitions applicable to investment 
companies, investment advisers, exchanges, clearing agencies, transfer 
agents and issuers,<SUP>3 securities information processors, and 
broker-dealers. The proposed amendments are discussed below.
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    \1\ 15 U.S.C. 631 et seq.
    \2\ The RFA provides that an agency, after consultation with the 
Office of Advocacy of the SBA and an opportunity for public comment, 
may establish one or more definitions of ``small entity'' that are 
applicable to the activities of the agency. See 5 U.S.C. 601(3) and 
601(4).
    \3\ The Commission is not proposing to change the definition of 
small business issuer, but is proposing to delete the limitation of 
the definition of small business, as it refers to ``issuer'' or 
``person'' under the Exchange Act rules, to Sections 12, 13, 14, 
15(d), and 16 of the Exchange Act [15 U.S.C. 78l, 78m, 78n, 78o(d), 
78p]. See supra p. 26.
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I. Background

    The Commission has a longstanding commitment to understanding and 
addressing the special concerns of small business. Nearly two decades 
ago, in 1979, the Commission established the Office of Small Business 
Policy in the Division of Corporation Finance, whose mission is to 
direct the Commission's small business rulemaking initiatives, review 
and comment on the impact of Commission rule proposals on small 
issuers, and serve as liaison with Congressional committees, government 
agencies, and other groups concerned with small business. Since then, 
the Commission has conducted regular reviews of its rules, and their 
impact on small business, in response to changing market conditions, 
advances in technology, and innovations in financial products, as well 
as to determine whether the rules continue to meet appropriate 
regulatory objectives. These ongoing efforts have resulted in a number 
of rule proposals or amendments and other initiatives specifically 
intended to assist small businesses. They include:
    <bullet> 1992 Small Business Initiative. In 1992, the Commission 
undertook a major initiative to make raising capital easier for small 
businesses, which included the introduction of a new small business 
integrated disclosure system, increased exemptions permitting 
unregistered public and private sale of securities, and simplified 
ongoing periodic reporting requirements of registered small 
issuers.<SUP>4
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    \4\ Securities Act Release No. 6949, 57 FR 36442 (Aug. 13, 1992) 
(included adopting Regulation S-B, which provided integrated 
disclosure requirements for small business issuers and simplified 
the process for registering securities of small business issuers for 
public sale, amending Regulation A to raise the ceiling for exempt 
offerings from $1.5 million to $5 million, and adopting Regulation 
D, which permitted nonpublic companies to raise up to $1 million in 
12 months from any number or type of investor without federal 
registration and disclosure obligations except anti-fraud 
provisions).
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    <bullet> Mutual Fund Investments. In 1992, the Commission also 
published revisions to the Guidelines to Form N-1A relating to mutual 
fund investments in illiquid securities, a change specifically intended 
to provide small

[[Page 4107]]

businesses better access to capital markets.<SUP>5
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    \5\ Revisions of Guidelines to Form N-1A, Investment Company Act 
Release No. 18612, 57 FR 9828 (Mar. 20, 1992) (permitting mutual 
funds, other than money market funds, to increase from 10 percent to 
15 percent the amount of illiquid assets they may hold).
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    <bullet> New Registration Exemption. The Commission recently 
adopted a new exemption from registration requirements for limited 
offerings of up to $5 million that are exempt from qualification under 
California law.<SUP>6
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    \6\ Securities Act Release No. 7285, 61 FR 21356 (May 9, 1996).
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    <bullet> Fewer Small Businesses Subject to Exchange Act 
Registration. The Commission also recently doubled the asset threshold 
that subjects companies to registration under the Exchange Act from $5 
million to $10 million so that fewer small businesses are subject to 
reporting requirements under the Exchange Act.<SUP>7
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    \7\ Exchange Act Release No. 37157, 61 FR 21354 (May 9, 1996).
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    <bullet> Pending Initiatives. The Commission's Task Force on 
Capital Formation and Regulatory Processes has proposed a number of 
initiatives to further increase small business access to capital 
markets, including liberalizing and expanding the local offering 
exemption and creating a new limited exemption for certain local 
offerings that cross state lines, expanding the small offering 
exemption by permitting small businesses to raise $5 million every six 
months rather than once a year, and permitting companies engaged in 
certain exempt offerings of $5 million or less to use uncertified 
financial statements.<SUP>8
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    \8\ See Report of the Task Force on Disclosure Simplification 
(March 1996).
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    In keeping with its attention to small business issues, the 
Commission acted quickly to implement the RFA after it was enacted in 
1980. The Commission published its first semiannual agendas identifying 
rulemaking proposals that could affect small entities on April 9, 1981 
and has regularly published semiannual agenda since then.<SUP>9 On June 
29, 1981, the Commission published its ten-year plan to evaluate 
existing rules for their impact on small entities and has since 
completed all required rule reviews under the RFA.<SUP>10 Indeed, the 
Chief Counsel for Advocacy of the SBA, in its first report regarding 
the RFA, stated that the Commission's rule review ``epitomizes the 
initiative that all agencies should be taking in the area.'' <SUP>11
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    \9\ 46 FR 23942 (Apr. 29, 1981). The Commission first published 
the semiannual agenda independently. Beginning in October 1982 the 
Commission included its semiannual agenda in the Unified Agenda of 
Federal Regulations compiled by the Regulatory Service Information 
Center. See 47 FR 48300, 48988 (Oct. 28, 1982).
    \10\ 46 FR 33287 (June 29, 1981). The requirements regarding 
publication of a semiannual agenda and the ten-year rule review are 
set forth in 5 U.S.C. 602 and 610, respectively.
    \11\ Oversight of Regulatory Flexibility Act: Hearings Before 
the Subcomm. on Export Opportunities and Special Small Business 
Problems of the House Comm. on Small Business, 97th Cong., 1st Sess. 
51 (1981) (statement of Frank Swain, Chief Counsel for Advocacy, 
SBA).
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    As part of its RFA implementation efforts, in early 1982, the 
Commission also became the first agency to adopt rules under which 
entities it regulates would qualify as ``small'' for purposes of the 
RFA.\12\ The RFA defines the term ``small entity'' as a ``small 
business,'' ``small organization,'' or ``small governmental 
jurisdiction.'' \13\ ``Small business'' under the RFA incorporates the 
Small Business Size Regulations established by the SBA (``SBA size 
standards'') \14\ under the Small Business Act.\15\ The RFA definitions 
of ``small business'' and ``small organization'' also authorize 
agencies to establish their own definitions of ``small business'' and 
``small organization'' if they determine that specialized definitions 
are more appropriate to the activities of the agency.\16\ After 
reviewing SBA size standards, the Commission chose to adopt its own 
definitions of these terms for purposes of Commission rulemaking.\17\
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    \12\ Final Definitions of ``Small Business'' and ``Small 
Organization'' for Purposes of the Regulatory Flexibility Act, 
Securities Act Release No. 6380, Exchange Act Release No. 18452, 
PUHCA Release No. 22371, Trust Indenture Act Release No. 693, 
Investment Company Act Release No. 12194, Investment Advisers Act 
Release No. 791, 47 FR 5215 (Feb. 4, 1982) (``1982 Adopting 
Release''). Other agencies have adopted notices or policy statements 
respecting their views regarding the definition of ``small 
business.'' See, e.g., Definitions of Small Entity and Significant 
Economic Impact for Making Determinations Required by the Regulatory 
Flexibility Act of 1980, 51 FR 45831 (Dec. 22, 1986) (Federal 
Aviation Administration, Department of Transportation); Policy 
Statement and Establishment of Definitions of ``Small Entities'' for 
Purposes of the Regulatory Flexibility Act, 47 FR 18618 (Apr. 30, 
1982) (Commodity Futures Trading Commission).
    \13\ 5 U.S.C. 601(6).
    \14\ 13 CFR Part 121.
    \15\ 5 U.S.C. 601(3) (defining ``small business'' to mean 
``small business concern'' under the Small Business Act, 15 U.S.C. 
632(a), which in turn allows the SBA to establish standards for 
determining ``small business concern'').
    \16\ Id. Secs. 601(3), 601(4).
    \17\ The Commission determined that the industry size standards 
adopted by the SBA were generally inappropriate in the context of 
regulations affecting securities issuers and reporting companies. 
See Proposed Definitions of ``Small Business'' and ``Small 
Organization'' for Purposes of the Regulatory Flexibility Act, 
Securities Act Release No. 6302, Exchange Act Release No. 17645, 
PUHCA Release No. 21970, Trust Indenture Act Release No. 619, 
Investment Company Act Release No. 11694, Investment Advisers Act 
Release No. 754, 46 FR 19251 (Mar. 30, 1981) (``1981 Proposing 
Release''); See also 1982 Adopting Release, 47 FR at 5216.
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    The regulations the Commission adopted in 1982 were, in many ways, 
more expansive than the statutory definitions of ``small business'' and 
``small organization'' in the RFA. Under the RFA, a business is not 
considered ``small'' if it is not ``independently owned and operated.'' 
\18\ The Commission's definitions go beyond RFA requirements because, 
for the most part, the Commission's definitions do not limit ``small 
businesses'' to those that are independently owned and operated. The 
Commission's existing definitions also are broader in certain respects 
than the SBA size standards, which consider various limiting factors 
when determining if an entity is ``small.'' \19\ For example, the SBA 
size standards consider if entities are affiliated by such factors as 
control, management, ownership, and contractual relationships in 
determining whether an entity is ``independently owned and operated,'' 
and thus, ``small.'' \20\ In addition, the SBA may treat multiple 
entities that have identical or substantially identical business or 
economic interests as a single entity.\21\ Although the Commission's 
definitions in some cases address the concept of control,\22\ none of 
these other affiliation concepts set forth in the SBA size standards is 
considered in the Commission's definitions of ``small business.''
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    \18\ A ``small'' entity also cannot be dominant in its field of 
operation. See 5 U.S.C. 601(4) (``small organization'' under RFA 
means an entity that is ``independently owned and operated and is 
not dominant in its field''); 15 U.S.C. 632(a)(1) (definition of 
``small business concern'' under the Small Business Act (as 
incorporated in the RFA definition of ``small business,'' 5 U.S.C. 
601(3)) means an entity that is ``independently owned and operated 
and which is not dominant in its field'').
    \19\ See SBA size standards, 13 CFR 121.103 (size eligibility 
provisions and standards).
    \20\ Id.  Sec. 121.103(a)(1) (describing control relationships 
that constitute affiliation); id. Sec. 121.103(a)(2) (describing 
factors such as ownership, management, previous relationships with 
or ties to another concern, and contractual relationships that SBA 
considers in determining whether affiliation exists).
    \21\ See id. Sec. 121.103(a)(3).
    \22\ In certain definitions of ``small business'' and ``small 
organization'' under the Exchange Act (broker, dealer, clearing 
agency, municipal securities dealer, securities information 
processor, transfer agent), the Commission considers control 
interests in determining whether the entity is ``small.'' Exchange 
Act rule 0-10 [17 CFR 240.10]. The SBA regulations also address 
factors of control. 13 CFR 121.103(a)(1).
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    Under the Commission's existing definitions, which were adopted in 
1982, a majority of investment advisers and broker-dealers qualify as 
small.<SUP>23 Many of these ``small'' investment

[[Page 4108]]

advisers handle as much as $50 million in client funds. In addition, 
some ``small'' broker-dealers handle customer orders in excess of $200 
million from which they earn more than $6 million per year in 
revenue.<SUP>24 These entities continue to be classified as ``small'' 
under Commission rules even though they may be affiliated with larger 
entities that are responsible for many of the smaller firms' securities 
functions. For example, today most mutual funds are affiliated with 
large mutual fund families, and many investment advisers are affiliated 
with larger financial services firms. These relationships allow the 
``small'' affiliates to rely on a larger entity that centralizes 
administrative and compliance systems for all affiliates, significantly 
reducing regulatory burdens for each individual affiliate. A similar 
relationship exists between introducing broker-dealers and the large 
firms through which they clear securities trades. Although introducing 
and clearing firms share responsibility for ensuring that a customer's 
account is handled properly, introducing firms typically depend on 
clearing firms to execute customer trades, to handle customer funds and 
securities, and to handle many back-office functions, including issuing 
the confirmation of the customer's trade. The increase in these 
affiliations since 1982 occurred along with tremendous growth and 
significant technological changes in the securities industry that 
facilitate such arrangements.<SUP>25 These changes in the securities 
industry prompted the Commission to begin reviewing certain of its 
``small business'' definitions in 1995.<SUP>26
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    \23\ Currently, approximately 75 percent of registered 
investment advisers and 60 percent of registered broker-dealers 
qualify as ``small.''
    \24\ The revenue amount is based on information provided by 
broker-dealers in quarterly FOCUS reports. The amount of customer 
order flow is derived using revenue data in the FOCUS reports.
    \25\ Between 1980 and 1995, the value of public offerings 
(including debt and equity, but not investment company securities) 
increased from $58 billion to $768 billion. Between 1990 and 1995, 
the dollar volume of equity securities traded on U.S. securities 
exchanges and National Association of Securities Dealers Automated 
Quotation System (``Nasdaq'') grew 182 percent, with over $5.94 
trillion traded in 1995. Assets under management by investment 
advisers (excluding investment advisers to registered investment 
companies) rose from $205 billion to $7.6 trillion (a 3,607 percent 
increase) between 1980 and 1995. Over the same period, assets of 
investment companies increased 1,203 percent from $235 billion to 
$3.062 trillion. The number of securities firms and professionals 
registered with the Commission or with self-regulating organizations 
has also surged. Between 1980 and 1995, the number of registered 
advisers increased from 3,500 to 22,000 (an increase of 529 
percent). The number of broker-dealers grew, over the same period, 
from around 5,200 to approximately 7,613 (a 46 percent increase). In 
addition, technological progress has changed the securities 
industry. For example, advances in information technology have 
resulted in the proliferation of information vendors and electronic 
trading systems not contemplated in 1982. Since 1982, the markets 
have seen the development of fully automated electronic broker-
dealers and exchanges, improved electronic order execution systems 
at broker-dealers, exchanges, and national securities associations, 
and improved electronic linkages among markets and between broker-
dealers and their customers. These changes have created 
substantially deeper and more liquid markets and have made trading 
more immediate and less expensive for both institutional and retail 
customers.
    \26\ See The Regulatory Plan and the Unified Agenda of Federal 
Regulations, 60 FR 59503, 61073 ( Nov. 28, 1995) (Division of 
Investment Management considering whether to recommend to the 
Commission to propose amendment of definition of ``small entity'' in 
Rule 0-10 [17 CFR 270.0-10] under the Investment Company Act).
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    In March 1996, Congress revisited small business concerns when it 
enacted the Small Business Regulatory Enforcement Fairness Act of 1996 
(``SBREFA'').<SUP>27 Among other things, SBREFA imposed new obligations 
on the Commission and other agencies to assist small entities in 
understanding and complying with regulatory requirements, including the 
adoption of small business compliance guides and an informal guidance 
program for small businesses.<SUP>28 In addition, SBREFA amended the 
RFA to allow small entities to seek judicial review of agency 
compliance with the RFA.<SUP>29 SBREFA also amended the Equal Access to 
Justice Act (``EAJA'') <SUP>30 by expanding the class of litigants 
eligible to receive EAJA awards to include small entities as defined 
under the RFA.<SUP>31
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    \27\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996).
    \28\ Id. Secs. 212, 213(b), 110 Stat. 858, 859.
    \29\ Id. Sec. 242 110 Stat. 865.
    \30\ 5 U.S.C. 504; 28 U.S.C. 2412.
    \31\ Pub. L. 104-121, Sec. 232(b)(2), 110 Stat 863.
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    After SBREFA was enacted, the Commission began to develop 
initiatives to meet its new obligations under the Act and to review 
whether the Commission's definitions of ``small business'' and ``small 
organization'' are still appropriate in view of (1) changes in the 
securities industry and (2) the Commission's expanded obligations under 
SBREFA. <SUP>32 As a result of its review, the Commission is proposing 
amendments to the definitions of these terms as they apply to 
investment companies, investment advisers, exchanges, securities 
information processors, transfer agents and issuers, and broker-
dealers. The Commission intends to maintain its definitions of ``small 
business'' as they relate to small business issuers, and other 
regulated entities. <SUP>33 The proposed amendments would take into 
account more of the factors suggested by SBA size standards in 
determining whether an entity qualifies as ``small.''
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    \32\ The Commission is concerned that as a result of the 
Commission's existing broad definitions of ``small business,'' 
certain of the amendments made by SBREFA could result in a 
significant increase in the Commission's exposure to litigation 
beyond that reasonably contemplated by the RFA. The Commission's 
enforcement litigation and other litigation matters have increased 
in recent years. In light of increased exposure to litigation under 
SBREFA, which could further strain the Commission's limited budget, 
the Commission believes it is appropriate to consider revising 
certain definitions of small business to reflect the considerations 
contained in the definition of the term under the RFA and the SBA 
size standards.
    \33\ The Commission does not propose to revise the ``small 
business'' definitions with respect to clearing agencies, bank 
municipal securities dealers, or public utility holding company 
systems. In a separate release, the Commission has, however, 
proposed conforming changes to the definition of ``small business 
issuer'' to allow registrants to include non-voting as well as 
voting common equity, when computing the required $75 million 
aggregate market value of common equity held by non-affiliates of 
the registrant.
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    The Commission's proposal to amend certain ``small business'' 
definitions should be considered in light of the Commission's ongoing 
efforts to assist small business. On June 4, 1996, the Commission 
appointed a special ombudsman to serve as the liaison and agency 
spokesman for the concerns of small business. <SUP>34 The Commission 
also recently held the first in a series of town meetings (to be held 
nationwide) to educate small business issuers about the many 
opportunities to raise capital in the securities markets. <SUP>35 More 
generally, the Commission has established a World Wide Web site, which 
provides, among other things, a special package of information for 
small businesses, including Commission rulemaking and initiatives 
affecting small business. <SUP>36 The Commission also has established 
an electronic mailbox to receive comments on Commission rulemaking. 
<SUP>37 These communication efforts supplement the Commission's annual 
government-business forum on small business capital formation. This 
forum is held in a different place across the country each year to make 
attendance by small businesses easier, and it is the only government-
sponsored national gathering for small businesses that annually offers 
small business the chance to tell government officials how the laws, 
rules, and regulations impact their ability to raise capital. Through 
these and other efforts, the Commission

[[Page 4109]]

will continue to involve small businesses in its rulemaking efforts, in 
furtherance of the RFA and the Commission's policy of addressing small 
business concerns.
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    \34\ The Ombudsman is available to receive information from 
small businesses concerning the impact of any Commission proposal, 
rule, or regulation and may be contacted at the Division of 
Corporation Finance's Office of Small Business Policy at (202) 942-
2950.
    \35\ See Remarks of Arthur Levitt, Chairman, U.S. Securities and 
Exchange Commission, Los Angeles Venture Association Town Meeting 
(Sept. 13, 1996).
    \36\ The Commission's Web site is located at http://www.sec.gov.
    \37\ The Commission's address for rulemaking comments is: <a href="/cdn-cgi/l/email-protection#98eaedf4fdb592fbf7f5f5fdf6ecebd8ebfdfbb6fff7ee">rule-
<span class="__cf_email__" data-cfemail="d9bab6b4b4bcb7adaa99aabcbaf7beb6af">[email protected]</span></a>.
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    Although the Commission has worked hard to meet the needs of small 
businesses, the Commission believes that RFA and SBREFA requirements 
must be viewed in the context of the requirements of the federal 
securities laws, which mandate the maintenance of fair, honest, and 
competitive securities markets and the protection of investors in those 
markets. As a general matter, the Commission carefully weighs the 
economic impact of its rules on all regulated entities, including small 
business. However, the Commission's primary considerations as to each 
rule it adopts must be the rule's effects on market integrity and 
investor protection. Thus, uniform rules must be applied to firms that 
are part of a larger national market system to ensure (1) fair and 
efficient securities markets and (2) the same level of protection for 
all investors regardless of the size of the firm to which they entrust 
their funds. In those situations in which market integrity and investor 
protection will not be compromised, however, the Commission carefully 
tailors its regulations to the relevant characteristics of the 
particular entities regulated.<SUP>38 In this way, the Commission works 
to meet its mandate under the federal securities laws while at the same 
time reducing costs and regulatory burdens for small business. The 
Commission intends to continue this careful, measured regulation that 
addresses small business concerns within the protections of the federal 
securities laws.
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    \38\ See supra note 7 and accompanying text (describing 
exemptions from registration for small business issuers); Exchange 
Act rule 15c3-1 [17 CFR 240.15c3-1] (varying capital requirements 
for broker-dealers based on their activities).
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Discussion of Proposed Amendments

A. Investment Companies

    Rule 0-10 under the Investment Company Act currently defines 
``small business'' or ``small organization'' (together, ``small 
entity'') to include each investment company (``fund'') that has $50 
million or less in assets as of the end of its most recent fiscal 
year.<SUP>39 Thus, the definition focuses only on the fund's own 
assets.
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    \39\ 17 CFR 270.0-10.
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    This approach no longer seems appropriate in the business 
environment in which most funds now operate.<SUP>40 Most funds are part 
of a large ``family of funds'' sponsored by a highly sophisticated 
third-party investment adviser or administrator that typically oversees 
assets well in excess of $50 million.<SUP>41 The adviser or 
administrator generally uses the same administrative, management, and 
compliance systems to oversee all of the funds in the complex. The fees 
imposed on the fund by the adviser or administrator (and the fund's 
resulting expense ratio) typically reflect economies of scale that the 
adviser or administrator achieves from managing other funds. Treating a 
new fund with less than $50 million of net assets as a small entity 
seems anomalous if the fund's adviser or administrator oversees other 
funds holding billions of dollars.<SUP>42
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    \40\ It is appropriate to take into account the structure of 
business concerns in the securities industry in determining size 
standards. See 15 CFR 121.103(a)(3) (SBA rule providing for the 
calculation of size standards on a consolidated basis for 
individuals or firms with identical or substantially identical 
business or economic interests or that are economically dependent); 
id. Sec. 121.103(a)(4) (SBA rule providing for the aggregation of 
receipts or employees of an entity and all its domestic or foreign 
``affiliates'' in calculating size standards). See also 1981 
Proposing Release, 46 FR at 19257.
    \41\ Nearly half (47 percent) of all fund families manage assets 
exceeding $1 billion per family.
    \42\ In the 1981 Proposing Release, the Commission noted its 
belief that ``the Congress did not intend to confer the benefit of 
any determination that an entity is small upon the affiliates of 
large businesses, because only those businesses and organizations 
that are `independently owned' may qualify as small entities 
pursuant to the definitions contained in the RFA'' (citing 5 U.S.C. 
601(4) and 15 U.S.C. 632). 46 FR at 19257. The Commission further 
noted its belief that it is appropriate to preclude entities with 
significant economic and financial resources from obtaining 
potential regulatory benefits under the RFA. Id.
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    The Commission, therefore, is proposing to amend Rule 0-10 to treat 
a fund as a small entity only if it and other funds in its related 
group have net assets of $50 million or less in the aggregate.<SUP>43 
The proposed amendments would define a group of related investment 
companies generally to include two or more management funds that hold 
themselves out to investors as related companies for purposes of 
investment and investor services, and share either a common investment 
adviser (or affiliated advisers) or a common administrator.<SUP>44 In 
the case of unit investment trusts (``UITs''), a related group would 
mean two or more trusts that have a common sponsor.<SUP>45
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    \43\ Conforming amendments to Rules 157(b) [17 CFR 230.157(b)] 
under the Securities Act and 0-10(b) [17 CFR 240.0-10(b)] under the 
Exchange Act would take the same approach when those statutes 
address investment companies. The Commission originally selected the 
$50 million threshold because it believed that funds having assets 
of $50 million or less had significantly higher expense ratios than 
funds with more assets, and that funds with higher expense ratios 
experienced greater impact from regulatory costs. 1982 Adopting 
Release, 47 FR at 5220. Fifty million dollars appears to remain a 
significant threshold for expense ratios for fund families as well 
as stand-alone funds, which derive similar benefits from economies 
of scale at lower ratios.
    \44\ Proposed rule 0-10(a)(1).
    \45\ Proposed rule 0-10(a)(2). A UIT holds a fixed portfolio of 
securities generally deposited with the fund by its sponsor, and 
does not have an investment adviser. See generally section 4(2) of 
the Investment Company Act [15 U.S.C. 80a-4(2)].
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    The proposed amendments would apply a special rule to insurance 
company separate accounts.<SUP>46 Because state law generally treats 
separate account assets as the property of the sponsoring insurance 
company, the rule would aggregate separate account assets with the 
assets of their sponsors, including other sponsored accounts.<SUP>47
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    \46\ Separate accounts contain assets used to fund certain 
insurance and investment contracts between the sponsoring insurance 
company and contract owners. Each account typically is organized as 
a UIT, or in some cases as a management fund having a sponsor-
affiliated investment adviser. See generally section 2(a)(37) of the 
Investment Company Act [15 U.S.C. 80a-2(a)(37)].
    \47\ Proposed rule 0-10(b). This amendment would codify the 
Commission's longstanding approach in addressing separate accounts' 
status under rule 0-10. The proposed amendments would not provide a 
special rule for another type of fund, face amount certificate 
companies, which would continue to be subject to the $50 million 
test on a company-by-company basis.
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    To standardize the determination of net assets, the proposed 
amendments would provide that the Commission may base its count of the 
net assets of any related group of funds on the net assets of each fund 
in the group at the end of each fund's fiscal year, as generally 
reported in Form N-SAR.<SUP>48
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    \48\ Proposed rule 0-10(c); see 17 CFR 274.101; Form N-SAR, Item 
74T.
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    The Commission estimates that as a result of the proposed 
amendments, approximately 400 funds would no longer be treated as small 
entities because they are affiliated with large fund families. 
Commission data suggests that approximately 800 of an estimated 3700 
total active registered investment companies may be considered small 
entities under current Rule 0-10. Approximately 300 of these 800 funds 
do not identify themselves as members of a fund family, and would 
therefore continue to be deemed small entities. Of the remaining 500 
funds, approximately 100 appear to be affiliated with fund families 
that have $50 million or less in aggregate assets, and therefore would 
continue to be deemed small entities under the proposed amendments.
    The Commission requests comment on the proposed amendments to Rule 
0-10. Should the definition of a group of related funds consider 
relationships other than a common investment adviser or administrator? 
When funds (like those in a master/feeder

[[Page 4110]]

arrangement <SUP>49) share a common adviser or administrator, should 
they be deemed a related group even though they may not hold themselves 
out as related (so that a feeder fund, for example, would be deemed a 
small entity only if the master fund is)? Alternatively, should related 
group status depend only on whether funds hold themselves out as 
related, so that funds might be in a related group even if they didn't 
share a common adviser or administrator? Does the $50 million asset 
threshold continue to be appropriate? Should the Commission consider 
tests other than asset size for determining whether a fund or related 
group is a small entity?
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    \49\ In such an arrangement, multiple ``feeder funds'' invest 
all their assets in the shares of a single ``master fund'' managed 
by one investment adviser, thereby reducing the costs of providing 
investment advice to each feeder fund. The various feeder funds 
typically sell their shares to different investors through different 
distribution channels.
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B. Investment Advisers

    Rule 0-7 under the Investment Advisers Act currently defines 
``small business'' or ``small organization'' for purposes of the RFA to 
include each investment adviser (``adviser'') that either (i) manages 
assets (``client assets'') with a total value of $50 million or less as 
of the end of its most recent fiscal year, and performs no other 
advisory services; or (ii) performs other advisory services, manages 
client assets of $50 million or less if it manages client funds, and 
has assets related to its advisory business (``business assets'') that 
do not exceed $50,000.<SUP>50
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    \50\ 17 CFR 275.0-7.
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    Rule 0-7 currently does not distinguish between an independent 
adviser and an adviser that is controlled by, or under common control 
with, a large firm.<SUP>51 An adviser in a control relationship with a 
large broker-dealer or other large financial services firm typically 
benefits from the financial and technical resources of the large firm. 
The large firm may handle much of the administrative and compliance 
needs of its affiliated adviser using resources not reflected in the 
adviser's client assets or business assets.
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    \51\ Such affiliations typically involve advisory firms that are 
controlled by or under common control with the large firm (such as a 
broker-dealer-owned subsidiary that advises institutional clients).
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    As noted above, the Commission believes that Congress did not 
intend affiliates of large businesses to receive benefits under the 
RFA.<SUP>52 Rule 0-10 under the Exchange Act currently excludes 
regulated persons from small entity status when they are affiliated 
with a large firm through a control relationship.<SUP>53 The Commission 
is proposing to amend Rule 0-7 to apply a comparable provision to 
investment advisers.<SUP>54 Like the current definition under Exchange 
Act Rule 0-10, the proposed amendments to Rule 0-7 would deem an 
adviser ``affiliated'' with a large firm when the adviser controls, is 
controlled by, or is under common control with the large firm.<SUP>55 A 
non-control affiliation with a large firm, or a control relationship 
with a firm that is itself a small entity, would not trigger the 
exclusion.<SUP>56
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    \52\ See supra note 42.
    \53\ See 17 CFR 240.0-10(c), (d), (f), (g), and (h) (excluding 
from ``small'' status a broker or dealer, clearing agency, bank 
municipal securities dealer, securities information processor, or 
transfer agent affiliated through a control relationship with any 
person (other than a natural person) that is not a small business or 
small organization).
    \54\ The Commission is also proposing to amend the definition of 
``small business'' under the Exchange Act to include consideration 
of other factors in addition to control relationships in determining 
affiliation. See discussion infra pp. 27-31. However, the Commission 
does not propose to include those factors in the definition of 
``small business'' under the Investment Advisers Act at this time.
    \55\ Proposed rule 0-7(a)(2). Also in conformity with rule 0-10, 
``control'' would mean the right to vote 25 percent or more of the 
voting securities of another person, to receive 25 percent or more 
of the net profits of the other person, or otherwise to direct the 
person's management or policies. Proposed rule 0-7(b). Many 
individual advisers affiliated with large firms would continue to 
meet the definition of ``small business'' notwithstanding the new 
affiliation standard because the advisers' large firm affiliates do 
not have the right to vote 25 percent or more of any stock issued by 
the advisers, do not receive 25 percent or more of the advisers' net 
profits, and do not direct the management of the individual 
advisers' business.
    \56\ See proposed rule 0-7(a)(2) and (b).
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    The proposed amendments also would simplify Rule 0-7 by applying 
the $50,000 business asset test to all advisers, rather than solely to 
advisers that render services other than or in addition to managing 
client assets.<SUP>57 In addition to facilitating application of the 
rule,<SUP>58 this approach would eliminate the anomaly of treating as 
``small'' an adviser that manages $49 million in client assets and has 
$5 million in business assets (because its only advisory service is 
managing money for clients), while treating as ``large'' an adviser 
that manages $20,000 in client assets and has $55,000 in business 
assets (because it renders other advisory services).
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    \57\ Proposed rule 0-7(a)(1). The current rule's definition of 
``other advisory services'' would be eliminated because it would no 
longer be necessary. The $50,000 threshold for the business asset 
test appears to remain a meaningful divide between small advisers 
and others. The Commission originally selected that figure because 
it was approximately the median value of advisers' business assets. 
1982 Adopting Release, 47 FR at 5221. The median may have changed in 
recent years, but that figure remains significant inasmuch as more 
than half of all advisers apparently do not have assets exceeding 
it.
    \58\ See 1981 Proposing Release, 46 FR at 19257, 19263 (two 
attributes desirable in size standards are capacity to differentiate 
the small members of an industry from other members, and the use of 
readily available information to derive standards).
---------------------------------------------------------------------------

    The proposed amendments appear likely to have limited impact on the 
total number of advisers deemed small entities. The Commission 
estimates that up to 17,000 of approximately 22,500 total registered 
investment advisers meet the current rule's definition of small entity 
based on reported client assets or business assets.<SUP>59 
Approximately 10,000 of those ``small'' advisers report that they are 
affiliated with broker-dealers (some of which are themselves 
``small'')--but not necessarily through a control affiliation. In many 
cases, the affiliated broker-dealer does not own or otherwise control 
the adviser's advisory business. Thus, many advisers that are broker-
dealer affiliates (and most other ``small'' advisers affiliated with 
non-brokers or having independent status) would remain small entities 
under the proposed amendments.
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    \59\ Under the recently enacted National Securities Markets 
Improvement Act of 1996, the Commission will soon lose 
responsibility for regulating an estimated 16,000 of these 17,000 
``small'' advisers. See Pub. L. 104-290, sec. 303, 110 Stat. 3416 
(1996) (transferring from the Commission to the states the primary 
responsibility for regulating advisers managing less than $25 
million in client assets).
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    Of the ``small'' advisers that for the first time would be subject 
to the $50,000 business asset test (i.e., the limited group that does 
not render advisory services other than managing client funds of $50 
million or less), only a limited percentage would likely have business 
assets exceeding $50,000. The number of such advisers no longer treated 
as ``small'' probably would not exceed 2000 (or 11 percent of the total 
number of ``small'' advisers under the current definition), because 
most advisers that simply manage client funds require only modest 
business assets.
    The Commission requests comment on the proposed amendments to Rule 
0-7. Does the proposed treatment of advisers affiliated with large 
firms properly focus only on control affiliations? Do the thresholds of 
$50 million for client assets and $50,000 for business assets continue 
to be appropriate? Recent federal legislation transfers to states 
primary responsibility for regulating ``small'' advisers--those who 
manage less than $25 million of client assets.<SUP>60 In light of this

[[Page 4111]]

legislation, is a threshold of $25 million for client assets under 
management more appropriate than the $50 million threshold?
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    \60\ See id.; See also Report on S. 1815, The Securities 
Investment Promotion Act of 1996, S. Rep. No. 293, 104th Cong., 2d 
Sess. at 3-4 (1996) (legislation would focus SEC supervision ``on 
investment advisers most likely to be engaged in interstate 
commerce'' and focus state supervision ``on advisers whose 
activities are most likely to be centered in their home state''; 
``legislation allows states to assume the primary role with respect 
to regulating advisers that are small, local businesses, managing 
less than $25 million in client assets, while the Commission's role 
is focused on larger advisers with $25 million or more in client 
assets under management''). The Commission estimates that limiting 
small advisers to those managing less than $25 million in client 
assets would reduce the total number of small advisers by less than 
500.
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C. Definitions Under the Exchange Act

1. Exchanges
    In the 1981 Proposing Release, the Commission expressed its doubt 
that Congress intended for the RFA to apply to exchanges.<SUP>61 
Nevertheless, the Commission adopted a definition of ``small business'' 
and ``small organization'' applicable to exchanges. The Commission's 
proposed amendment to this definition would retain the existing 
provisions of Rule 0-10 that define as ``small'' those exchanges that 
are exempt from the requirements of Rule 11Aa3-1 regarding the 
dissemination of transaction reports and last sale data with respect to 
transactions in securities.<SUP>62
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    \61\ The term ``exchange'' is defined in Section 3(a)(1) of the 
Exchange Act. [15 U.S.C. 78c(a)(1).] Currently, none of the eight 
registered exchanges is considered a ``small business'' or ``small 
organization'' under Rule 0-10.
    \62\ 17 CFR 240.11Aa3-1. In the 1981 Proposing Release, the 
Commission noted that those exchanges that are exempt from the 
requirements of Rule 11Aa3-1 would appropriately be considered 
small, mentioning in particular that the Spokane Stock Exchange and 
the Intermountain Stock Exchange had been granted exemptions from 
the rule, in part, because of their low trading volume. Since 1981, 
both of these exchanges have withdrawn from registration. Currently, 
no exchanges are fully exempted from the requirements of Rule 11Aa3-
1.
---------------------------------------------------------------------------

    The Commission is proposing to add a requirement that the exchange 
also must not be affiliated with any person (other than a natural 
person) that is not a small business or small organization as defined 
in Rule 0-10. The proposed amendment would deem an exchange 
``affiliated'' with another entity when the exchange controls, is 
controlled by, or is under common control with the other entity. In 
adopting Rule 0-10 in 1982, the Commission applied this standard to 
broker-dealers, clearing agencies, bank municipal securities dealers, 
securities information processors, and transfer agents. The 1981 
Proposing Release noted that such entities were not small if they were 
affiliated with another entity that did not qualify as small. The 
Commission is proposing to conform the definition of small exchange to 
that of other small entities by adding this affiliation 
standard.<SUP>63
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    \63\ The Commission believes that it is appropriate to consider 
precluding entities with significant economic and financial 
resources from obtaining potential regulatory benefits under the 
RFA. See supra note 42. The definitions set forth in Rule 0-10 
generally incorporate the concept of affiliation and provide that a 
broker-dealer, clearing agency, bank municipal securities dealer, 
securities information processor, or transfer agent is not a small 
business or small organization if that entity is affiliated with any 
person (other than a natural person) that is not a small business or 
small organization as defined in Rule 0-10. Under paragraph (i) of 
Rule 0-10, a person is affiliated with another if that person 
controls, is controlled by, or is under common control with such 
other person. Control within this context constitutes the right to 
vote 25 percent or more of the voting securities of any entity, the 
right to receive 25 percent or more of the net profits of such 
entity, or the ability otherwise to direct or cause the direction of 
the management or policies of such entity.
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2. Securities Information Processors
    The Commission proposes to retain the existing criteria for 
determining whether a securities information processor is a ``small 
business'' or ``small organization'' in substantially the same form, 
including the requirement that to be considered small, a securities 
information processor service less than 100 interrogation devices or 
moving tickets during the preceding fiscal year.<SUP>64 As a result of 
changes in technology since Rule 0-10 was adopted, however, the 
Commission is proposing to modify the definition of ``interrogation 
device'' for purposes of Rule 0-10 to take into account new 
technologies used to disseminate securities industry information to 
markets and market participants through increasingly diverse methods. 
Technological developments regarding the amount of information 
available electronically, the ease and speed of retrieving such 
information, and the increasing interconnectivity between market 
participants and data vendors all support a broader reading of the term 
interrogation device.
---------------------------------------------------------------------------

    \64\ The term ``securities information processor'' is defined in 
Section 3(a)(22) of the Exchange Act. [15 U.S.C. 78c(a)(22).] 
Currently, neither of the two registered exclusive securities 
information processors is designated as a ``small business'' or 
``small organization'' under Rule 0-10.
---------------------------------------------------------------------------

    Accordingly, for purposes of the small business definition, the 
Commission believes it is appropriate to consider whether the term 
interrogation device should refer to any device that may be used to 
read or receive electronic information, including proprietary terminals 
or personal computers via computer to computer interfaces, or gateway 
access. Also, the Commission believes that it is appropriate to 
consider whether this definition should include all interrogation 
devices that display securities information such as quotations and 
indications of interest in addition to devices that display last sale 
data or transaction reports.<SUP>65
---------------------------------------------------------------------------

    \65\ Formerly, paragraph (g)(2) of Rule 0-10 referenced the 
definition of ``interrogation device'' set forth in Rule 11Aa3-1. 
This definition reflects the historical use of interrogation devices 
to display only transaction reports or last sale data.
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3. Transfer Agents and Issuers
    The Commission's proposal would retain the existing criteria based 
on volume of transfer business and number of shareholder accounts for 
determining whether a transfer agent is a ``small business'' or ``small 
organization,'' <SUP>66 and would add the requirement that small 
transfer agents restrict their activities to transferring the items of 
small issuers as defined in Exchange Act Rule 0-10.<SUP>67 The shares 
of small issuers, as opposed to those of large publicly traded 
companies, typically are held by a small portion of the investing 
public and are less likely to be the subject of a substantial amount of 
trading activity. Thus, the activities of small transfer agents, many 
of which are not subject to registration under Section 17A of the 
Exchange Act, are not likely to have a substantial effect on the 
investing public or the operation of the national clearance and 
settlement system. In contrast, transfer agents for large companies 
whose shares are heavily traded are likely to have a far greater effect 
on securities processing, generally, and on the operation of the 
national clearance and settlement system.<SUP>68
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    \66\ The term ``transfer agent'' is defined in Section 3(a)(25) 
of the Exchange Act. [15 U.S.C. 78c(a)(25).] It is estimated that 
approximately 180 registered transfer agents would be designated as 
``small businesses'' or ``small organizations'' under the proposed 
amendments to Rule 0-10.
    \67\ Any transfer agent that transfers items for any issuer that 
has total assets of greater than $5 million would not be deemed a 
``small business'' or ``small organization'' under the proposed 
rule. Generally, transfer agents that transfer the items of small 
issuers are not required to be registered pursuant to Section 
17A(c)(1) of the Exchange Act and are not subject to Commission 
regulation. In this regard, the Commission staff estimates that only 
1,500 (or 21 percent) of the approximately 7,000 entities providing 
transfer agent services in the United States are registered under 
Section 17A of the Exchange Act. These 1,500 entities provide 
services that are essential to the efficient functioning of the 
national market system for securities. Of these 1,500 registered 
transfer agents, approximately one-half are financial institutions 
regulated by the various federal bank regulatory agencies. The 5,500 
unregistered entities that provide transfer agent services generally 
handle the transfer of small issuer securities and exempted 
securities, such as municipal securities.
    \68\ See Securities and Exchange Commission, Study of Unsafe and 
Unsound Practices of Broker-Dealers (1971), pp. 37-39.
---------------------------------------------------------------------------

    Rule 0-10(a) currently applies the definition of ``small business'' 
when

[[Page 4112]]

used with reference to an ``issuer'' or ``person'' under Sections 12, 
13, 14, 15(d), or 16 of the Exchange Act.<SUP>69 To clarify that 
transfer agents who transfer items of issuers with total assets greater 
than $5 million would not be considered small for purposes of the RFA, 
the Commission is proposing to delete language in Rule 0-10(a) that 
limits the definition of small business, as it refers to ``issuer'' or 
``person,'' to Sections 12, 13, 14, 15(d), or 16 of the Exchange 
Act.<SUP>70
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    \69\ 17 CFR 240.0-10(a).
    \70\ 15 U.S.C. 78l, 78m, 78n, 78o(d), and 78p. The proposed 
change would also clarify that a transfer agent, or any other 
regulated entity under the Exchange Act (broker-dealer, exchange, 
clearing agency, securities information processor, or bank municipal 
securities dealer) would not be considered small under Rule 0-10 if 
the entity is affiliated with an issuer that does not qualify as 
``small'' under Rule 0-10. See 17 CFR 240.0-10. For example, a 
broker-dealer that is owned or controlled by a large public company 
with greater than $5 million in assets would not be considered small 
under Rule 0-10. While the Commission does not collect data that 
would indicate how many broker-dealers or other regulated entities 
may be affected by this proposed amendment, it believes such 
amendment is consistent with the intent of the RFA that only 
business and organizations that are ``independently owned'' may 
qualify as small entities. See supra note 42.
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4. Broker-Dealers
    Rule 0-10 under the Exchange Act currently defines ``small 
business'' or ``small organization'' to include any broker <SUP>71 or 
dealer <SUP>72 that has total capital of less than $500,000 and that is 
not affiliated with any person (other than a natural person) that is 
not a small business or small organization under the rule. For purposes 
of defining whether a broker-dealer is a ``small business'' or ``small 
organization,'' the Commission is proposing to retain the existing 
capital standard currently set forth in Rule 0-10. The Commission, 
however, is proposing to expand the affiliation standard applicable to 
broker-dealers.
---------------------------------------------------------------------------

    \71\ The term ``broker'' is defined in Section 3(a)(4) of the 
Exchange Act. [15 U.S.C. 78c(a)(4).]
    \72\ The term ``dealer'' is defined in Section 3(a)(5) of the 
Exchange Act. [15 U.S.C. 78c(a)(5).]
---------------------------------------------------------------------------

    The existing affiliation test, which looks only to whether a 
broker-dealer controls, is controlled by, or is under common control 
with, an entity other than a small business or small organization, 
focuses primarily on relationships between broker-dealers based on 
voting control or the sharing of profits. The structure and operation 
of broker-dealer activities, however, suggest that other kinds of 
business relationships, such as the contractual relationship between an 
introducing broker and its clearing firm, can give rise to an 
opportunity by which a clearing firm can exercise substantial influence 
over the business of its introducing brokers. In order to better 
conform its affiliation standard to the nature of business 
relationships that exist between broker-dealers, the Commission 
proposes to expand the definition of affiliation applicable to broker-
dealers under Rule 0-10 to include arrangements whereby one broker-
dealer introduces transactions in securities to another.
    From a functional perspective, introducing and clearing brokers act 
as a unit in handling a customer's account. In most respects, 
introducing brokers are dependent on clearing firms to clear and to 
execute customer trades,<SUP>73 to handle customer funds and 
securities, and to handle many back-office functions, including issuing 
confirmations of customer trades and customer account 
statements.<SUP>74 The respective duties and obligations of an 
introducing broker and its clearing firm are described in the clearing 
agreement executed by the parties. This agreement typically contains 
various requirements imposed by the clearing firm with respect to the 
handling of customer accounts by the clearing and introducing brokers, 
and the clearing firm's maintenance of customer assets.<SUP>75 In 
addition, as a practical matter, clearing and introducing firms have 
identical business interests to the extent that most introducing 
brokers could not be in business without the capital, technology, and 
back-office support provided by the clearing firm. In addition, as a 
legal matter, for purposes of the Securities Investor Protection Act of 
1970 <SUP>76 and the Commission's financial responsibility rules, a 
customer is the customer of the clearing firm.<SUP>77
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    \73\ Even when introducing brokers execute their own trades, 
they must provide the name of their clearing broker in order that 
the trade may be settled and cleared.
    \74\ Increasingly, the back-office functions of introducing and 
clearing firms are linked electronically, which allows introducing 
brokers to transmit trades directly to the back-office systems 
maintained by the clearing broker using either a personal computer 
and modem or a terminal provided for this purpose by the clearing 
broker. These electronic linkages facilitate communication between 
introducing and clearing firms, and allow introducing firms to 
monitor trade execution and settlement, but control over the 
processing of securities trades remains with the clearing firm.
    \75\ For example, clearing agreements generally give clearing 
brokers approval over margin customers and subject margin accounts 
to the clearing firm's standards. Clearing brokers also may set 
general creditworthiness standards for the introducing broker's 
customers to ensure customer performance. Similarly, clearing 
brokers can reject customer trades if they determine a customer is 
unable to fully complete the trade entered through the introducing 
broker. New York Stock Exchange Rule 382 specifically requires 
clearing agreements to identify and allocate the respective 
functions of the introducing and clearing firms in seven areas: the 
opening, approving and monitoring of accounts; extensions of credit; 
the maintenance of books and records; the receipt and delivery of 
funds and securities; the safeguarding of funds and securities; 
confirmations and statements; and the acceptance of orders and 
executions of transactions. Although the customer places its order 
directly with the introducing firm, the Commission considers the 
account to be an account of the clearing firm, which has primary 
legal responsibility with respect to the handling of customer funds 
and securities, and for sending account statements to the customer. 
Thus, both introducing and clearing firms have a shared 
responsibility for ensuring that a customer's account is handled 
properly.
    \76\ 15 U.S.C. 78aaa et seq.
    \77\ Exchange Act Release No. 31511, 57 FR 56973 (Dec. 2, 1992).
---------------------------------------------------------------------------

    Under the Commission's proposal, an introducing broker that 
introduces transactions to a large clearing firm generally would not be 
considered a ``small business'' or ``small organization'' for purposes 
of the RFA. An exception, however, would be carved out for introducing 
firms that handle only investment company securities or interests or 
participations in insurance company separate accounts. Typically, 
persons or firms that limit their activities to these products are 
small, sometimes one-person operations that combine limited securities 
activities with broader tax, financial planning, and insurance 
services. Applying this new affiliation standard in addition to the 
existing total capital standard, it is estimated that approximately 12 
percent of all registered broker-dealers could be characterized as the 
type of independently owned and operated enterprise specifically 
addressed under the RFA.<SUP>78
---------------------------------------------------------------------------

    \78\ See supra note 18 (RFA definitions of ``small business''). 
See also Report to Accompany H.R. 4660, H.R. Rep. No. 519, 96th 
Cong., 1st Sess., 19 (1980) (suggesting that the definition of 
``small businesses'' was intended to encompass businesses that are 
independently owned and operated and not dominant in their field of 
operation). Consistent with the RFA definitions of small business 
and small organization, SBA regulations that address affiliation 
consider whether individuals or firms have identical or 
substantially identical business interests, as in the case of firms 
that are economically dependent through contractual or other 
relationships. 13 CFR 121.103(a).
---------------------------------------------------------------------------

    The Commission requests comments on whether alternative approaches 
would be more appropriate for determining whether a broker-dealer 
should be designated as small under Rule 0-10. One possible approach 
would establish a revenue test. Other approaches would be based on a 
broker-dealer's annual earnings or total assets. The Commission seeks 
comment on these approaches and requests that commenters specifically 
address what revenue, earnings, or total asset levels may be 
appropriate for distinguishing small broker-dealers, and whether

[[Page 4113]]

revenue, earnings, or total asset levels should be averaged over a 
period of years in order to account for annual fluctuations. Commenters 
are asked to discuss how any proposed approach relates to the SBA size 
standards.
5. Request for Comment
    The Commission is soliciting comment on each of the proposed 
amendments to Rule 0-10 and whether commenters believe the proposed 
amendments sufficiently identify entities regulated under the Exchange 
Act that should qualify as either a ``small business'' or a ``small 
organization'' under Rule 0-10.

III. Effects on Competition and Regulatory Flexibility 
Considerations

    Section 23(a)(2) of the Exchange Act <SUP>79 requires the 
Commission, in adopting rules under the Exchange Act, to consider the 
anticompetitive effects of such rules, if any, and to balance any 
anticompetitive impact against the regulatory benefits gained in terms 
of furthering the purposes of the Exchange Act. The Commission is of 
the preliminary view that the proposed amendments to Rule 0-10 would 
not have any effect on the regulation of entities under the Exchange 
Act, or impose any burden on competition among such entities.
---------------------------------------------------------------------------

    \79\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The Commission has conferred with the SBA and believes that no 
regulatory flexibility analysis is required for the proposed 
amendments. The definitions of the terms ``small business'' and ``small 
organization'' and the proposed amendments do not impose any 
substantive requirements on small businesses. Instead the definitions 
are interpretations of terms used to identify those entities that the 
Commission will study for RFA purposes when proposing and adopting 
rules.<SUP>80
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    \80\ An initial regulatory flexibility analysis is required 
whenever an agency is required by section 553 of the Administrative 
Procedure Act or any other law to publish general notice of proposed 
rulemaking for any proposed rule. The RFA does not state that 
agencies that establish definitions of ``small business'' or ``small 
organization'' do so pursuant to rulemaking. See 5 U.S.C. 
Secs. 601(3), 601(4); see also Definitions of Small Entity and 
Significant Economic Impact for Making Determinations Required by 
the Regulatory Flexibility Act of 1980, 51 FR 45831 (Dec. 22, 1986) 
(Federal Aviation Administration, Department of Transportation); NRC 
Size Standard for Making Determinations Required by the Regulatory 
Flexibility Act of 1980, 50 FR 20913 (May 21, 1985) (Nuclear 
Regulatory Commission invitation for public comment on proposed 
definition of small entities); Proposed Establishment of Definitions 
of ``Small Entities'' for Purposes of the Regulatory Flexibility 
Act, 46 Fed. Reg. 23940 (Apr. 29, 1981) (Commodity Futures Trading 
Commission); 1982 Adopting Release, 47 FR at 5216 (noting that the 
rules providing the definitions of ``small business'' for entities 
regulated under the securities laws also provide, as permitted by 
the RFA, that the Commission may, in particular instances, define a 
particular entity in a manner different from that set forth in the 
rules).
---------------------------------------------------------------------------

IV. Statutory Authority

    The Commission is proposing to amend Rule 157 [17 CFR 230.157], 
Rule 0-10 [17 CFR 240.0-10], Rule 0-10 [17 CFR 270.0-10], and Rule 0-7 
[17 CFR 275.0-7] pursuant to chapter 6 of title 5 of the United States 
Code (particularly section 601 thereof [5 U.S.C. 601]), and pursuant to 
the Securities Act of 1933 [15 U.S.C. 77a et seq.] (particularly 
section 19 thereof [15 U.S.C. 77s]), the Securities Exchange Act of 
1934 [15 U.S.C. 78a et seq.] (particularly section 23 thereof [15 
U.S.C. 78w]), the Investment Company Act of 1940 [15 U.S.C. 80a-1 et 
seq.] (particularly section 38 thereof [15 U.S.C. 80a-37]), and the 
Investment Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.] (particularly 
section 211 thereof [15 U.S.C. 80b-11]).

Text of Proposed Rule Amendments

List of Subjects

17 CFR Parts 230 and 270

    Investment companies, Securities.

17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.

17 CFR Part 275

    Investment advisers, Reporting and recordkeeping requirements, 
Securities.

    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 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    1. The authority citation for Part 230 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77s, 77sss, 78c, 
78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 78t, 80a-8, 80a-29, 80a-30, 
and 80a-37, unless otherwise noted.
* * * * *
    2. Section 230.157 is amended by revising paragraph (b) to read as 
follows:


Sec. 230.157  Small entities for purposes of the Regulatory Flexibility 
Act.

* * * * *
    (b) When used with reference to an investment company that is an 
issuer for purposes of the Act, have the meaning ascribed to those 
terms by Sec. 270.0-10 of this chapter.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    3. The authority citation for Part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg, 
77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78k, 78k-1, 78l, 78m, 
78n, 78o, 78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-
23, 80a-29, 80a-37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
    4. Section 240.0-10 is amended to revise the section heading and 
paragraphs (a), (b), (e), (g)(2), (g)(3), and (i); redesignate 
paragraphs (h)(2) and (h)(3) as paragraphs (h)(3) and (h)(4), 
respectively; and add paragraphs (h)(2), (j) and (k) to read as 
follows:


Sec. 240.0-10  Small entities under the Securities Exchange Act for 
purposes of the Regulatory Flexibility Act.

* * * * *
    (a) When used with reference to an ``issuer'' or a ``person,'' 
other than an investment company, mean an ``issuer'' or ``person'' 
that, on the last day of its most recent fiscal year, had total assets 
of $5,000,000 or less;
    (b) When used with reference to an ``issuer'' or ``person'' that is 
an investment company, have the meaning ascribed to those terms by 
Sec. 270.0-10 of this chapter;
* * * * *
    (e) When used with reference to an exchange, mean any exchange 
that:
    (1) Has been exempted from the reporting requirements of 
Sec. 240.11Aa3-1; and
    (2) Is not affiliated with any person (other than a natural person) 
that is not a small business or small organization as defined in this 
section;
* * * * *
    (g) * * *
    (2) Provided service to fewer than 100 interrogation devices or 
moving tickers at all times during the preceding fiscal year (or in the 
time that it has been in business, if shorter); and
    (3) Is not affiliated with any person (other than a natural person) 
that is not a small business or small organization under this section;
    (h) * * *
    (2) Transferred items only of issuers that would be deemed ``small 
businesses'' or ``small organizations'' as defined in this section;
* * * * *
    (i) For purposes of paragraph (c) of this section, a broker or 
dealer is affiliated with another person if:
    (1) Such broker or dealer controls, is controlled by, or is under 
common control with such other person; a person

[[Page 4114]]

shall be deemed to control another person if that person has the right 
to vote 25% or more of the voting securities of such other person or is 
entitled to receive 25% or more of the net profits of such other person 
or is otherwise able to direct or cause the direction of the management 
or policies of such other person; or
    (2) Such broker or dealer introduces transactions in securities, 
other than registered investment company securities or interests or 
participations in insurance company separate accounts, to such other 
person, or introduces accounts of customers or other brokers or 
dealers, other than accounts that hold only registered investment 
company securities or interests or participations in insurance company 
separate accounts, to such other person that carries such accounts on a 
fully disclosed basis.
    (j) For purposes of paragraphs (d) through (h) of this section, a 
person is affiliated with another person if that person controls, is 
controlled by, or is under common control with such other person; a 
person shall be deemed to control another person if that person has the 
right to vote 25% or more of the voting securities of such other person 
or is entitled to receive 25% or more of the net profits of such other 
person or is otherwise able to direct or cause the direction of the 
management or policies of such other person.
    (k) For purposes of paragraph (g) of this section, ``interrogation 
device'' shall refer to any device that may be used to read or receive 
securities information, including quotations, indications of interest, 
last sale data and transaction reports, and shall include proprietary 
terminals or personal computers that receive securities information via 
computer to computer interfaces or gateway access.

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    5. The authority citation for Part 270 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-37, 80a-38, unless 
otherwise noted;
* * * * *
    6. Section 270.0-10 is revised to read as follows:


Sec. 270.0-10  Small entities under the Investment Company Act for 
purposes of the Regulatory Flexibility Act.

    (a) General. For purposes of Commission rulemaking in accordance 
with the provisions of Chapter Six of the Administrative Procedure Act 
(5 U.S.C. 601 et seq.) and unless otherwise defined for purposes of a 
particular rulemaking, the term small business or small organization 
for purposes of the Act shall mean an investment company that, together 
with other investment companies in the same group of related investment 
companies, has net assets of $50 million or less as of the end of its 
most recent fiscal year. For purposes of this section:
    (1) In the case of a management company, the term group of related 
investment companies shall mean two or more management companies 
(including series thereof) that:
    (i) Hold themselves out to investors as related companies for 
purposes of investment and investor services; and
    (ii) Either:
    (A) Have a common investment adviser or have investment advisers 
that are affiliated persons of each other; or
    (B) Have a common administrator; and
    (2) In the case of a unit investment trust, the term group of 
related investment companies shall mean two or more unit investment 
trusts (including series thereof) that have a common sponsor.
    (b) Special rule for insurance company separate accounts. In 
determining whether an insurance company separate account is a small 
business or small entity pursuant to paragraph (a) of this section, the 
assets of the separate account shall be cumulated with the assets of 
the general account and all other separate accounts of the insurance 
company.
    (c) Determination of net assets. The Commission may calculate its 
determination of the net assets of a group of related investment 
companies based on the net assets of each investment company in the 
group as of the end of such company's fiscal year.

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

    7. The authority citation for Part 275 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 80b-1 et seq., 80b-11, unless otherwise 
noted.
* * * * *
    8. Section 275.0-7 is amended by revising the section heading and 
paragraphs (a)(1), (a)(2) and (b) to read as follows:


Sec. 275.0-7  Small entities under the Investment Advisers Act for 
purposes of the Regulatory Flexibility Act.

    (a) * * *
    (1) Manages assets with a total value of $50 million or less, in 
discretionary or non-discretionary accounts, as of the end of its most 
recent fiscal year, provided that the adviser's own assets related to 
its advisory business do not exceed in value $50,000 as of the end of 
its most recent fiscal year; and
    (2) Is not affiliated with any person (other than a natural person) 
that is not a small business or small organization as defined in this 
section, Sec. 240.0-10 or Sec. 270.0-10 of this chapter.
    (b) For purposes of this section, a person is affiliated with 
another person if that person controls, is controlled by, or is under 
common control with such other person; a person shall be deemed to 
control another person if that person has the right to vote 25% or more 
of the voting securities of such other person or is entitled to receive 
25% or more of the net profits of such other person or is otherwise 
able to direct or cause the direction of the management or policies of 
such other person.

    Dated: January 22, 1997.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-2010 Filed 1-27-97; 8:45 am]
BILLING CODE 8010-01-P


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