4106 Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules

1 15 U.S.C. 631 et seq.

2The 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).

3The 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.

4Securities 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 antifraud provisions).

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.

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: rule-comments@sec.gov.

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,1 or regulations promulgated by the

Small Business Administration

(‘‘SBA’’).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,3

securities information processors, and

broker-dealers. The proposed

amendments are discussed below.

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:

• 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.4

• 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
Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules 4107

5Revisions 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).

6Securities Act Release No. 7285, 61 FR 21356

(May 9, 1996).

7Exchange Act Release No. 37157, 61 FR 21354

(May 9, 1996).

8See Report of the Task Force on Disclosure

Simplification (March 1996).

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.

11Oversight 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).

12Final 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).

17The 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.

18A ‘‘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’’).

19See SBA size standards, 13 CFR 121.103 (size

eligibility provisions and standards).

20 Id. § 121.103(a)(1) (describing control

relationships that constitute affiliation); id.

§ 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).

21See id. § 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).

23Currently, approximately 75 percent of

registered investment advisers and 60 percent of

registered broker-dealers qualify as ‘‘small.’’

businesses better access to capital

markets.5

• 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.6

• 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.7

• 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.8

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.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.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.’’ 11

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

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.’’

Under the Commission’s existing

definitions, which were adopted in

1982, a majority of investment advisers

and broker-dealers qualify as small.23

Many of these ‘‘small’’ investment
4108 Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules

24The 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.

25Between 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 selfregulating 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.

26See 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).

27Pub. 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.

31Pub. L. 104–121, Sec. 232(b)(2), 110 Stat 863.

32The 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.

33The 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.

34The 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.

35See Remarks of Arthur Levitt, Chairman, U.S.

Securities and Exchange Commission, Los Angeles

Venture Association Town Meeting (Sept. 13, 1996).

36The Commission’s Web site is located at http:/

/www.sec.gov.

37The Commission’s address for rulemaking

comments is: rule-comments@sec.gov.

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.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.25 These changes in the

securities industry prompted the

Commission to begin reviewing certain

of its ‘‘small business’’ definitions in

1995.26

In March 1996, Congress revisited

small business concerns when it

enacted the Small Business Regulatory

Enforcement Fairness Act of 1996

(‘‘SBREFA’’).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.28 In addition, SBREFA

amended the RFA to allow small

entities to seek judicial review of agency

compliance with the RFA.29 SBREFA

also amended the Equal Access to

Justice Act (‘‘EAJA’’) 30 by expanding the

class of litigants eligible to receive EAJA

awards to include small entities as

defined under the RFA.31

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. 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. 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.’’

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. 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. 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. 36

The Commission also has established an

electronic mailbox to receive comments

on Commission rulemaking. 37 These

communication efforts supplement the

Commission’s annual governmentbusiness 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
Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules 4109

38See 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).

39 17 CFR 270.0–10.

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.

§ 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.

41Nearly 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.

43Conforming 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.

44Proposed rule 0–10(a)(1).

45Proposed 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)].

46Separate 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)].

47Proposed 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-bycompany basis.

48Proposed rule 0–10(c); see 17 CFR 274.101;

Form N–SAR, Item 74T.

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.

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.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.

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.39

Thus, the definition focuses only on the

fund’s own assets.

This approach no longer seems

appropriate in the business environment

in which most funds now operate.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.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.42

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.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.44 In the case of

unit investment trusts (‘‘UITs’’), a

related group would mean two or more

trusts that have a common sponsor.45

The proposed amendments would

apply a special rule to insurance

company separate accounts.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.47

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.48

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
4110 Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules

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.

50 17 CFR 275.0–7.

51Such affiliations typically involve advisory

firms that are controlled by or under common

control with the large firm (such as a broker-dealerowned subsidiary that advises institutional clients).

52See supra note 42.

53See 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).

54The 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.

55Proposed 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.

56See proposed rule 0–7(a)(2) and (b).

57Proposed 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.

58See 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).

59Under 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).

60See 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

arrangement 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?

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 $50,000.50

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.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.

As noted above, the Commission

believes that Congress did not intend

affiliates of large businesses to receive

benefits under the RFA.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.53 The Commission is

proposing to amend Rule 0–7 to apply

a comparable provision to investment

advisers.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.55 A noncontrol affiliation with a large firm, or

a control relationship with a firm that is

itself a small entity, would not trigger

the exclusion.56

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.57 In

addition to facilitating application of the

rule,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).

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.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 brokerdealer does not own or otherwise

control the adviser’s advisory business.

Thus, many advisers that are brokerdealer affiliates (and most other ‘‘small’’

advisers affiliated with non-brokers or

having independent status) would

remain small entities under the

proposed amendments.

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.60 In light of this
Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules 4111

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.

61The 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.

63The 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.

64The 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.

65Formerly, 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.

66The 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.

67Any 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.

68See Securities and Exchange Commission,

Study of Unsafe and Unsound Practices of BrokerDealers (1971), pp. 37–39.

legislation, is a threshold of $25 million

for client assets under management

more appropriate than the $50 million

threshold?

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.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.62

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.63

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.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.

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.65

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,’’ 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 0–10.67 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.68

Rule 0–10(a) currently applies the

definition of ‘‘small business’’ when
4112 Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules

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.

71The term ‘‘broker’’ is defined in Section 3(a)(4)

of the Exchange Act. [15 U.S.C. 78c(a)(4).]

72The term ‘‘dealer’’ is defined in Section 3(a)(5)

of the Exchange Act. [15 U.S.C. 78c(a)(5).]

73Even 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.

75For 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.

77Exchange Act Release No. 31511, 57 FR 56973

(Dec. 2, 1992).

78See 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).

used with reference to an ‘‘issuer’’ or

‘‘person’’ under Sections 12, 13, 14,

15(d), or 16 of the Exchange Act.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.70

4. Broker-Dealers

Rule 0–10 under the Exchange Act

currently defines ‘‘small business’’ or

‘‘small organization’’ to include any

broker 71 or dealer 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.

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,73 to

handle customer funds and securities,

and to handle many back-office

functions, including issuing

confirmations of customer trades and

customer account statements.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.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 76 and the Commission’s

financial responsibility rules, a

customer is the customer of the clearing

firm.77

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 oneperson 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.78

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 brokerdealer’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
Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules 4113

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

80An 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. §§ 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).

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 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.

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.80

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 80a37, unless otherwise noted.

* * * * *

2. Section 230.157 is amended by

revising paragraph (b) to read as follows:

§ 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 § 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:

§ 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 § 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 § 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
4114 Federal Register / Vol. 62, No. 18 / Tuesday, January 28, 1997 / Proposed Rules

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:

§ 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:

§ 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, § 240.0–10 or

§ 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