[Federal Register Volume 62, Number 61 (Monday, March 31, 1997)]
[Rules and Regulations]
[Pages 15098-15110]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-8075]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 270 and 274
[Release No. IC-22579; IA-1623; S7-24-95]
RIN 3235-AG07


Status of Investment Advisory Programs Under the Investment 
Company Act of 1940

AGENCY: Securities and Exchange Commission.


[[Page 15099]]


ACTION: Final rule.

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SUMMARY: The Commission is adopting rule 3a-4 under the Investment 
Company Act of 1940 to provide a nonexclusive safe harbor from the 
definition of investment company for certain programs under which 
investment advisory services are provided on a discretionary basis to a 
large number of advisory clients having relatively small amounts to 
invest. An investment advisory program that is organized and operated 
in accordance with the rule's provisions is not required to register as 
an investment company under the Investment Company Act of 1940, or to 
comply with the Act's requirements. In addition, such a program is not 
subject to the registration requirement under section 5 of the 
Securities Act of 1933.

EFFECTIVE DATE: March 31, 1997.

FOR FURTHER INFORMATION CONTACT: Rochelle Kauffman Plesset, Senior 
Counsel, (202) 942-0660, Office of Chief Counsel, Division of 
Investment Management, 450 Fifth Street, N.W., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adopting rule 3a-4 under the Investment Company Act 
of 1940 [15 U.S.C. 80a-1, et seq.] (``Investment Company Act''). Rule
3a-4 provides a nonexclusive safe harbor from the definition of 
investment company for certain programs under which investment advisory 
services are provided to advisory clients (``investment advisory 
programs'').



Table of Contents

Executive Summary
I. Background
II. Discussion
    A. Preliminary Matters
    B. Definitions
    1. The Sponsor
    2. Investment Advisory Program
    C. Provisions Designed to Ensure that Each Client Receives 
Individualized Treatment
    1. Individualized Management of Client Accounts
    2. Initial and Ongoing Client Contact
    3. Reasonable Management Restrictions
    4. Quarterly Account Statements
    5. Minimum Account Size
    D. Client Retention of Ownership of Securities
    1. Ability to Withdraw and Pledge Securities
    2. Right to Vote Securities and Receive Certain Documents as 
Securityholders
    3. Right to Receive Trade Confirmations
    4. Legal Rights as Securityholders
    E. Policies and Procedures and Form N-3a4
    F. Investment Advisers Act Issues Raised by Investment Advisory 
Programs
III. Cost/Benefit Analysis
IV. Paperwork Reduction Act
V. Final Regulatory Flexibility Analysis
VI. Effective Date
VII. Statutory Authority
Text of Rule

Executive Summary

    The Commission is adopting rule
3a-4 under the Investment Company Act to provide a nonexclusive safe 
harbor from the definition of investment company for certain investment 
advisory programs. These programs typically are designed by investment 
advisers or other money managers seeking to provide the same or similar 
professional portfolio management services on a discretionary basis to 
a large number of advisory clients having relatively small amounts to 
invest. Under rule 3a-4, any investment advisory program organized and 
operated in accordance with the rule's provisions is deemed not to be 
an investment company within the meaning of the Investment Company Act. 
In addition, a preliminary note to rule 3a-4 states that there is no 
registration requirement under section 5 of the Securities Act of 1933 
(``Securities Act'') <SUP>1 with respect to investment advisory 
programs that are organized and operated in compliance with the 
provisions of the rule.
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    \1\ 15 U.S.C. 77a, et seq.
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    The rule provides that: (i) each client's account must be managed 
on the basis of the client's financial situation and investment 
objectives, and in accordance with any reasonable restrictions imposed 
by the client on the management of the account; (ii) the sponsor of the 
program must obtain sufficient information from each client to be able 
to provide individualized investment advice to the client; (iii) the 
sponsor and portfolio manager must be reasonably available to consult 
with each client; (iv) each client must have the ability to impose 
reasonable restrictions on the management of the client's account; (v) 
each client must be provided with a quarterly account statement 
containing a description of all activity in the client's account; and 
(vi) each client must retain certain indicia of ownership of all 
securities and funds in the account. The rule is intended to be a 
nonexclusive safe harbor; a program that is not organized and operated 
in a manner consistent with the rule does not necessarily meet the 
Investment Company Act's definition of investment company. The rule, as 
adopted, does not include provisions regarding written policies and 
procedures, the maintenance of records, or the filing of a form with 
the Commission that were proposed for comment in 1995.

I. Background

    In recent years, the number of investment advisory programs that 
are designed to provide professional portfolio management services on a 
discretionary basis to a large number of clients has increased greatly. 
These programs historically have been offered typically to clients who 
are investing amounts of money less than the minimum investments for 
individual accounts otherwise required by participating investment 
advisers, but significantly more than the minimum account sizes of most 
mutual funds.
    These investment advisory programs typically are organized and 
administered by a sponsor, which provides, or arranges for the 
provision of, asset allocation advice and administrative 
services.<SUP>2 In some programs, the sponsor or its employees also 
provide portfolio management services, including the selection of 
particular securities, to the program's clients. In other programs, the 
sponsor selects, or provides advice to clients regarding the selection 
of, another investment adviser (which may or may not be affiliated with 
the sponsor) to act as the client's portfolio manager.<SUP>3 In these 
programs, the sponsor generally is responsible for the ongoing 
monitoring of the management of the account by the manager or managers 
selected. The sponsor, rather than the portfolio manager, often serves 
as the primary contact for the client in connection with the 
program.<SUP>4 Sponsors and portfolio managers usually meet the 
definition of ``investment adviser'' under the Investment Advisers Act 
of 1940

[[Page 15100]]

(``Advisers Act''),<SUP>5 and may be required to register under that 
Act.<SUP>6 Included among investment advisory programs developed in the 
recent past are those commonly referred to as ``wrap fee programs.'' In 
a wrap fee program, the client typically is provided with portfolio 
management, execution of transactions, asset allocation, and 
administrative services for a single fee based on the size of the 
account.<SUP>7 At year-end 1995, assets in wrap fee programs totaled 
approximately $101.6 billion, an increase of over 30 percent in one 
year.<SUP>8
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    \2\ The sponsor often is a money management firm, a broker-
dealer, a mutual fund adviser or, in some instances, a bank. See, 
e.g., Wall Street Preferred Money Managers, Inc. (pub. avail. Apr. 
10, 1992) (broker-dealer); United Missouri Bank of Kansas City, n.a. 
(pub. avail. May 11, 1990, as modified Jan. 23, 1995) (bank); 
Strategic Advisers Inc. (pub. avail. Dec. 13, 1988) (mutual fund 
adviser). The sponsor or one of its affiliates also may execute some 
or all of the transactions for client accounts.
    \3\ More than one portfolio manager may manage the client's 
assets, depending on the program, the client's investment 
objectives, and the size of the client's account. See, e.g., 
Rauscher Pierce Refsnes, Inc. (pub. avail. Apr. 10, 1992); Wall 
Street Preferred Money Managers, Inc., supra note 2; Westfield 
Consultants Group (pub. avail. Dec. 13, 1991).
    \4\ Some investment advisory programs, however, are marketed by 
the sponsor through unaffiliated investment advisers, such as 
financial planners. In some of these programs, the unaffiliated 
investment adviser, rather than the sponsor, may serve as the 
primary contact for its clients that participate in the program. 
See, e.g., Westfield Consultants Group, supra note 3.
    \5\ 15 U.S.C. 80b-1, et seq. Section 202(a)(11) of the Advisers 
Act (15 U.S.C. 80b-2(a)(11)) defines ``investment adviser'' as ``any 
person who, for compensation, engages in the business of advising 
others, either directly or through publications or writings, as to 
the value of securities or as to the advisability of investing in, 
purchasing, or selling securities, or who, for compensation and as 
part of a regular business, issues or promulgates analyses or 
reports concerning securities * * *.'' A bank generally is excepted 
from the definition of investment adviser under Section 
202(a)(11)(A) of the Advisers Act. A broker-dealer that sponsors an 
investment advisory program generally cannot rely on the broker-
dealer exception from the definition of investment adviser in 
Section 202(a)(11)(C) of the Advisers Act. See, e.g., Status of 
Investment Advisory Programs under the Investment Company Act, 
Investment Company Act Release No. 21260 (July 27, 1995), 60 FR 
39574 (Aug. 2, 1995) (``July Release''); National Regulatory 
Services, Inc. (pub. avail. Dec. 2, 1992).
    \6\ The National Securities Markets Improvement Act of 1996 
(Pub. L. No. 104-290) amended the Advisers Act to provide that 
certain investment advisers will be subject primarily to the 
supervision of the Commission, while other advisers will be subject 
primarily to state regulation. Effective April 9, 1997, if an 
investment adviser is regulated or required to be regulated as an 
investment adviser in the state in which it maintains its principal 
office and place of business, it may not register with the 
Commission unless (1) it has assets under management of $25 million 
or more, or (2) it advises a registered investment company. Proposed 
rules published for comment by the Commission would reallocate 
regulatory responsibilities for investment advisers between the 
Commission and the states. Rules Implementing Amendments to the 
Investment Advisers Act of 1940, Investment Advisers Act Release No. 
1601 (Dec. 18, 1996), 61 FR 68480 (Dec. 27, 1996).
    \7\ See paragraph (g)(4) of rule 204-3 under the Advisers Act 
(17 CFR 275.204-3(g)(4)) (defining wrap fee program for purposes of 
wrap fee brochure requirement).
    \8\ Cerulli Associates, Inc. and Lipper Analytical Services, 
Inc., The Cerulli-Lipper Analytical Report: State of the Wrap 
Account Industry 5 (1996). These figures include assets in mutual 
fund wrap programs, also called mutual fund asset allocation 
programs. Unlike traditional wrap fee programs, mutual fund wrap 
programs contemplate that a client's assets are allocated only among 
specified mutual funds. Assets in mutual fund wrap programs 
represented 19% of total assets in wrap fee programs at year-end 
1995. Id. at 7.
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    Under wrap fee and other investment advisory programs, a client's 
account typically is managed on a discretionary basis in accordance 
with pre-selected investment objectives. Clients with similar 
investment objectives often receive the same investment advice and may 
hold the same or substantially the same securities in their accounts. 
In light of this similarity of management, some of these investment 
advisory programs may meet the definition of investment company under 
the Investment Company Act, and may be issuing securities for purposes 
of the Securities Act.<SUP>9
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    \9\ For a detailed discussion of why an investment advisory 
program may meet the definition of investment company and may be 
deemed to be issuing securities, see July Release, supra note 5, at 
Section I. See also In the Matter of Clarke Lanzen Skalla Investment 
Firm, Inc., Investment Company Act Release No. 21140 (June 16, 
1995); SEC v. First National City Bank, Litigation Release No. 4534 
[1969-1970 Transfer Binder] Fed. Sec. L. Rep. (CCH) para. 92,592 
(Feb. 6, 1970).
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    In 1980, the Commission sought to address certain issues presented 
by investment advisory programs by proposing rule 3a-4 under the 
Investment Company Act, which would have provided a safe harbor from 
the definition of investment company for investment advisory programs 
operating in the manner described in the rule.<SUP>10 Commenters 
generally opposed the proposed rule, and it was never adopted.<SUP>11 
After this proposal, however, the Commission's Division of Investment 
Management (``Division'') received numerous requests for assurance that 
it would not recommend enforcement action with respect to investment 
advisory programs if they operated without registering under the 
Investment Company Act. In response to these requests, the staff issued 
a series of no-action letters describing investment advisory programs 
that would not be deemed investment companies for purposes of the 
Investment Company Act.<SUP>12 Many, if not most, of the programs 
described in the no-action letters met the terms specified in the 
proposed rule.
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    \10\ Individualized Investment Management Services, Investment 
Company Act Release No. 11391 (Oct. 10, 1980), 45 FR 69479 (Oct. 21, 
1980) (``1980 Release''). The 1980 Release also stated that the 
Commission's Division of Corporation Finance had indicated that if 
rule 3a-4 were adopted, that Division would not recommend that the 
Commission take enforcement action if interests in an investment 
advisory program operated in accordance with the proposed rule's 
requirements were not registered under the Securities Act. Id. at 
n.15.
    \11\ See July Release, supra note 5, at n.20 and accompanying 
text.
    \12\ See, e.g., Benson White & Company (pub. avail. June 14, 
1995); Wall Street Preferred Money Managers, Inc., supra note 2; 
Rauscher Pierce Refsnes, Inc., supra note 3; Westfield Consultants 
Group, supra note 3; WestAmerican Investment Company (pub. avail. 
Nov. 26, 1991); Rushmore Investment Advisers, Ltd. (pub. avail. Feb. 
1, 1991); Qualivest Capital Management, Inc. (pub. avail. July 30, 
1990); United Missouri Bank of Kansas City, n.a., supra note 2; 
Manning & Napier Advisors, Inc. (pub. avail. Apr. 24, 1990); 
Jeffries & Company (pub. avail. June 16, 1989); Strategic Advisers, 
Inc., supra note 2; Scudder Fund Management Service (pub. avail. 
Aug. 17, 1988); Shearson/American Express, Inc. (pub. avail. July 
13, 1983); Paley & Ganz, Inc. (pub. avail. Dec. 6, 1982).
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    On July 27, 1995, the Commission proposed for comment a revised 
version of rule 3a-4 (``revised proposed rule 3a-4'' or ``revised 
proposed rule,'' proposed for comment in the ``July Release'').<SUP>13 
The objective of the revised proposed rule was to clarify the 
Commission's views regarding the status of investment advisory programs 
under the federal securities laws by describing certain basic 
attributes of an investment advisory program that differ from those of 
an investment company that is required to register under the Investment 
Company Act.<SUP>14 The revised proposed rule was based largely on the 
provisions of the rule as originally proposed, as modified and 
explained in the subsequent no-action letters, but also required the 
creation and maintenance of certain documents and records. Like the 
original proposal, revised proposed rule 3a-4 would have provided a 
nonexclusive safe harbor from the definition of investment company for 
investment advisory programs that are organized and operated in the 
manner described in the rule.<SUP>15
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    \13\ July Release, supra note 5.
    \14\ July Release, supra note 5, at Section I.
    \15\ The Note to the revised proposed rule stated that interests 
in investment advisory programs organized and operated in compliance 
with the rule would not be required to be registered under the 
Securities Act. See July Release, supra note 5, at n.26 and 
accompanying text; Note to revised proposed rule 3a-4.
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    The Commission received comments on the revised proposed rule from 
28 commenters, including three law firms, eight professional and trade 
associations, and 17 financial firms (i.e., brokers, banks, investment 
advisers and others).<SUP>16 Commenters generally expressed support for 
the Commission's goal of providing a nonexclusive safe harbor from the 
definition of investment company for certain investment advisory 
programs. A number of commenters, however, raised concerns about 
particular aspects of the rule. Many of these comments are discussed in 
more detail below.<SUP>17
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    \16\ The comment letters and a summary of the comments prepared 
by the Commission staff are included in File No. S7-24-95.
    \17\ See infra Section II.E.
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II. Discussion

    The Commission is adopting rule 3a-4 under the Investment Company 
Act. Like the proposed and revised proposed rules, rule 3a-4 provides a 
nonexclusive safe harbor from the definition of investment company for 
investment advisory programs that are organized

[[Page 15101]]

and operated in the manner described in the rule. The rule's provisions 
have the effect of ensuring that clients in a program relying on the 
rule receive individualized treatment, including the opportunity to 
place investment restrictions on the management of their accounts and 
the right to receive disclosure documents in connection with securities 
held in their accounts. Moreover, if an advisory program were operated 
by an investment adviser registered under the Advisers Act, clients of 
the program would receive the protections of that Act. The safe harbor 
thus is designed to provide an exemption for certain investment 
advisory programs without undermining the protection of investors who 
participate in those programs.

A. Preliminary Matters

    Several commenters supporting the goals underlying rule 3a-4 asked 
the Commission to clarify the scope of the rule. Two commenters, for 
example, asked the Commission to clarify that investment advisory 
programs that contemplate advisers not having investment discretion 
over their clients' assets generally do not need the safe harbor to 
avoid investment company status. The Commission notes that rule 3a-4 is 
intended to provide a safe harbor for discretionary investment advisory 
programs. A nondiscretionary program (i.e., one in which the investor 
has the authority to accept or reject each recommendation to purchase 
or sell a security made by the portfolio manager, and exercises 
judgment with respect to such recommendations), generally will not meet 
the definition of investment company under the Investment Company Act 
or issue securities that are required to be registered under Section 5 
of the Securities Act, regardless of whether the program is operated in 
accordance with the provisions of rule 3a-4.<SUP>18
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    \18\ Whether a program is nondiscretionary is inherently a 
factual determination. A program designated as ``nondiscretionary'' 
in which the client follows each and every recommendation of the 
adviser may raise a question whether the program in fact is 
nondiscretionary.
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    One commenter asked the Commission to clarify that a program's 
failure to operate in a manner consistent with every provision of the 
rule would not preclude the program from relying on the safe harbor. 
The rule sets forth circumstances under which an investment advisory 
program will not be considered an investment company, and a program 
that is not organized and operated in accordance with the rule's 
provisions cannot rely on the safe harbor. The safe harbor provided by 
the rule, however, is designed to be nonexclusive. Failure to operate 
in the manner described in rule 3a-4 does not necessarily indicate that 
a program is an investment company. Whether a program that operates 
outside of rule 3a-4 is an investment company is a factual 
determination and depends on whether the program is an issuer of 
securities under the Investment Company Act and the Securities 
Act.<SUP>19
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    \19\ In the July Release, the Commission noted that an 
investment advisory program could be considered to be an issuer 
because the client accounts in the program, taken together, could be 
considered to be an organized group of persons. See July Release, 
supra note 5, at nn.11-15 and accompanying text; see also Advisory 
Committee on Investment Management Services for Individual 
Investors: Small Account Investment Management Services at 23 (Jan. 
1973). (``An investment service which is operated on a discretionary 
basis and does not afford investors individual attention would 
appear to be offering an investment contract or security, if 
substantially the same investment advice is given to all clients or 
to discernible groups of clients. * * *'')
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    Commenters suggested that, rather than addressing the status of 
investment advisory programs under the Securities Act in a note to rule 
3a-4, the rule itself should provide that interests in the programs do 
not constitute ``securities'' within the meaning of the Securities 
Act.<SUP>20 While the Commission has not revised the rule in this 
regard, it has revised the Note so that it does not imply that 
investment advisory programs organized and operated in accordance with 
the rule may result in the issuance of securities under the Securities 
Act.<SUP>21
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    \20\ In letters issued by the Division of Investment Management 
granting no-action assurances to investment advisory programs, the 
Division of Corporation Finance also gave assurances that it would 
not recommend enforcement action to the Commission if the requestor 
relied on an opinion of counsel stating that interests in the 
investment advisory program were not ``securities'' within the 
meaning of the Securities Act. See, e.g., Morgan Keegan & Company, 
Inc., supra note 12; Westfield Consultants Group, supra note 3; 
Rauscher Pierce Refsnes, Inc., supra note 3.
    \21\ The Note to rule 3a-4 states, in part, that there is no 
registration requirement under section 5 of the Securities Act with 
respect to programs that are organized and operated in the manner 
described in the rule.
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    The Commission noted in the July Release that the adoption of rule 
3a-4 would not affect the status of no-action letters previously issued 
by the Division with respect to investment advisory programs. 
Therefore, investment advisory programs operated in a manner consistent 
with those letters would continue not to be required to register under 
the Investment Company Act, and interests in the programs would not be 
required to be registered as securities under the Securities Act. The 
Commission also stated in the July Release that the Division, as a 
general matter, would not consider requests for no-action or exemptive 
relief with respect to programs that do not rely on the rule.<SUP>22 In 
making this statement, the Commission sought to indicate that in the 
future, the staff ordinarily will not respond to no-action requests or 
support applications for exemptive relief regarding investment advisory 
programs that are similar to those programs that have been the subject 
of the no-action letters issued by the Division, but that are not 
operated in accordance with all the provisions of rule 3a-4. The staff, 
however, will in the future consider requests raising interpretive 
issues under rule 3a-4, and will continue to entertain no-action 
requests with respect to programs that raise unique or novel 
issues.<SUP>23
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    \22\ July Release, supra note 5, at n.27.
    \23\ The staff previously has indicated that it will no longer 
entertain requests for no-action relief regarding investment 
advisory programs unless they present novel or unusual issues. See, 
e.g., Wall Street Preferred Money Managers, Inc., supra note 2.
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B. Definitions

1. The Sponsor
    A number of the terms of the revised proposed rule provided that 
the ``sponsor'' of a program or another person designated by the 
sponsor must perform the duties and responsibilities set forth in the 
rule. Under paragraph (b) of revised proposed rule 3a-4, ``sponsor'' 
would have been defined as any person who receives compensation for 
sponsoring, organizing or administering the program, or for selecting, 
or providing advice to clients regarding the selection of, persons 
responsible for managing the client's account in the program. Revised 
proposed rule 3a-4 would have provided that, if a program had more than 
one sponsor, one person would need to be designated as the principal 
sponsor, and that person would be responsible for carrying out the 
sponsor's duties and responsibilities under the rule.<SUP>24 The July 
Release noted that this definition and approach was the same as that 
used in paragraph (f) of rule 204-3 under the Advisers Act, which sets 
forth a separate brochure requirement for sponsors of wrap fee 
programs.<SUP>25
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    \24\ July Release, supra note 5, at Section II.A.1.
    \25\ The sponsor of an investment advisory program usually is an 
investment adviser under Section 202(a)(11) of the Advisers Act, and 
may be required to register under the Act. See July Release, supra 
note 5, at nn.5-8 and accompanying text and note 6 of this Release. 
Nonetheless, the rule is available to any investment advisory 
program, regardless of whether the sponsor is excepted from the 
definition of investment adviser (e.g., a bank), or is required to 
be registered under the Act.

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[[Page 15102]]

    Some commenters were critical of the broad scope of the proposed 
definition of sponsor, noting that a program could have multiple 
sponsors under the definition, and asserting that the existence of 
multiple sponsors would serve no purpose in assuring that clients in a 
program receive individualized management services or that the program 
operates in the manner specified in the rule. One commenter suggested 
that the definition should be modified to reach only the manager that 
sponsors the program and participates in the management of the client's 
investment portfolio (or selects another person designated to perform 
such management services). The Commission notes that the structure of 
programs may vary widely, and that the broad definition of the term 
sponsor is intended to anticipate such variations and to provide 
persons involved in a program with the flexibility to designate the 
person in the best position to fulfill the rule's provisions. The 
Commission thus has determined to adopt the definition as proposed in 
order to preserve this flexibility.<SUP>26
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    \26\ Paragraph (b) of rule 3a-4, as adopted.
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2. Investment Advisory Program
    The safe harbor described in revised proposed rule 3a-4 would have 
been available to a ``program under which investment advisory services 
are provided to clients.'' The revised proposed rule, however, did not 
specifically define the term ``program.'' Certain commenters requested 
that the Commission provide further guidance as to what constitutes a 
program. The Commission notes that the use of the term ``program'' in 
the rule is intended to describe the types of advisory services that 
potentially could be subject to the Investment Company Act and the 
Securities Act. The Commission does not believe that it is necessary or 
advisable to include a definition of program in the rule, because such 
a definition could result inadvertently in the exclusion from the scope 
of the rule of an entity that otherwise would be entitled to rely on 
it.

C. Provisions Designed To Ensure That Each Client Receives 
Individualized Treatment

    Revised proposed rule 3a-4 contained four provisions relating to 
the individualized treatment received by clients in investment advisory 
programs covered by the rule. The July Release stated that these 
provisions were based on the terms of rule 3a-4 as originally proposed, 
as those provisions were applied in the no-action letters.<SUP>27 The 
rule as adopted includes these four provisions, with certain 
modifications discussed below.
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    \27\ July Release, supra note 5, at Section II.A.2.
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1. Individualized Management of Client Accounts
    Paragraph (a)(1) of the revised proposed rule provided that a 
client's account must be managed on the basis of the client's financial 
situation, investment objectives and instructions. The July Release 
noted that this provision was designed to delineate a key difference 
between clients of investment advisers and investors in investment 
companies. A client of an investment adviser typically is provided with 
individualized advice that is based on the client's financial situation 
and investment objectives. In contrast, the investment adviser of an 
investment company need not consider the individual needs of the 
company's shareholders when making investment decisions, and thus has 
no obligation to ensure that each security purchased for the company's 
portfolio is an appropriate investment for each shareholder.<SUP>28 The 
Commission is adopting paragraph (a)(1) without substantive 
modification.<SUP>29
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    \28\ July Release, supra note 5, at Section II.A.2.i.
    \29\ As noted above, paragraph (a)(1) of the revised proposed 
rule provided that a client's account must be managed on the basis 
of the client's financial situation, investment objectives and 
instructions (emphasis added). The Commission has determined that 
individualized treatment does not require that the client be 
entitled to give instructions to the adviser with respect to the 
management of the account other than those reasonable restrictions 
referenced in paragraph (a)(3). Therefore, the Commission has 
clarified the rule text by replacing the word ``instructions'' with 
the word ``restrictions.'' Nonetheless, the rule contemplates that a 
client's investment objective will be formulated with appropriate 
input from the client regarding the client's financial goals and 
risk tolerance.
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    In the July Release, the Commission noted that clients of an 
investment advisory program with similar investment objectives may hold 
substantially the same securities in their accounts in accordance with 
a portfolio manager's model, and that this does not necessarily 
indicate that clients in the program have not received individualized 
treatment for purposes of the rule.<SUP>30 The Commission is 
reaffirming this position in connection with the adopted rule.<SUP>31
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    \30\ July Release, supra note 5, at n.34 and accompanying text.
    \31\ As indicated in the July Release, this position is 
consistent with no-action letters issued concerning programs that 
allocate client assets in accordance with computerized investment 
models. July Release, supra note 5, at n.34 and accompanying text; 
see, e.g., Qualivest Capital Management Inc., supra note 12 (sponsor 
proposed to use computerized investment allocation model to allocate 
client assets among money managers).
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    The Commission also stated in the July Release that it would not be 
necessary under the rule for a portfolio manager to make separate 
determinations regarding the appropriateness of each transaction for 
each client prior to effecting the transaction. One commenter 
supporting the Commission's position with respect to model portfolios 
nonetheless urged the Commission to require the sponsor or program 
manager specifically to evaluate the suitability of each transaction 
for each client. This commenter maintained that, without such 
individualized determinations, clients of an investment advisory 
program would not receive individualized advice.
    Investment advisers under the Advisers Act owe their clients the 
duty to provide only suitable investment advice, whether or not the 
advice is provided to clients through an investment advisory 
program.<SUP>32 To fulfill this suitability obligation, an investment 
adviser must make a reasonable determination that the investment advice 
provided is suitable for the client based on the client's financial 
situation and investment objectives. The adviser's use of a model to 
manage client accounts would not alter this obligation in any way.
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    \32\ See Suitability of Investment Advice Provided by Investment 
Advisers: Custodial Account Statements for Certain Advisory Clients, 
Investment Advisers Act Release No. 1406 (Mar. 16, 1994), 59 FR 
13464 (Mar. 22, 1994) at nn.2-5 and accompanying text (``Investment 
advisers are fiduciaries who owe their clients a series of duties, 
one of which is the duty to provide only suitable investment advice. 
This duty is enforceable under the antifraud provisions of the 
Advisers Act, section 206, and the Commission has sanctioned 
advisers for violating this duty.'').
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2. Initial and Ongoing Client Contact
    Paragraph (a)(2) of revised proposed rule 3a-4 reflects the view 
that providing individualized investment advice contemplates an adviser 
having sufficient contact with a client to elicit the information 
necessary to provide the advice. In particular, under paragraph (a)(2), 
a program relying on the rule must provide that the sponsor or a person 
designated by the sponsor (``designated person'') contact and solicit 
information from the client. Such a program also must provide for the 
sponsor and the portfolio manager to be reasonably available to consult 
with the client concerning the management of the client's account.
    Under paragraph (a)(2) of the revised proposed rule, an advisory 
program intended to qualify for the safe harbor

[[Page 15103]]

set out in the rule would have needed to require that the sponsor or a 
designated person: (1) obtain information from the client concerning 
the client's financial situation and investment objectives (including 
any restrictions that the client may wish to impose regarding the 
management of the account) at the time the client opens the account; 
<SUP>33 (2) contact the client at least annually to determine whether 
there have been any changes in the client's financial situation or 
investment objectives, or whether the client wishes to impose any 
reasonable restrictions on the management of the account or modify an 
existing restriction in a reasonable manner; and (3) notify the client 
in writing at least quarterly that the sponsor or designated person 
should be contacted if there have been any changes in the client's 
financial situation or investment objectives, or if the client wishes 
to impose or modify any restrictions on the management of the account. 
The Commission is adopting these three provisions as proposed, with 
minor modifications to clarify their meaning.<SUP>34
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    \33\ A sponsor or designated person seeking to rely on the rule 
as adopted could obtain this information through interviews (either 
in person or by telephone) and/or through questionnaires that 
clients must complete and return prior to the opening of the 
account. This position is consistent with no-action letters 
previously issued by the staff. See, e.g., Rauscher Pierce Refsnes, 
Inc., supra note 3 (prospective client will be interviewed over the 
telephone); Manning & Napier Advisors, Inc., supra note 12 
(prospective client initially submits written questionnaire and 
later is interviewed by telephone).
    \34\ Paragraphs (a)(2)(i), (a)(2)(ii) and (a)(2)(iii) of rule 
3a-4, as adopted.
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    In the July Release, the Commission noted that the provision 
regarding annual client contact was designed to ensure that sponsors 
have current information about clients in the program, which, in the 
Commission's view, is critical to the provision of individually 
tailored advice.<SUP>35 Like the revised proposed rule, the rule as 
adopted does not dictate the manner in which a sponsor contacts its 
clients annually.<SUP>36 Contact can be made, for example, in person, 
by telephone, or by letter or electronic mail that includes a 
questionnaire requesting the client to provide or update relevant 
information.<SUP>37
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    \35\ July Release, supra note 5, at Section II.A.2.ii.
    \36\ Paragraph (a)(2)(ii) of rule 3a-4, as adopted. One 
commenter asked whether the rule permits a sponsor or designated 
person to contact a client by electronic mail. Under appropriate 
circumstances, an electronic mail message requesting information 
from clients in the program would constitute annual client contact 
within the meaning of rule 3a-4. See Use of Electronic Media by 
Broker-Dealers, Transfer Agents, and Investment Advisers for 
Delivery of Information; Additional Examples under the Securities 
Act of 1933, Securities Exchange Act of 1934, and Investment Company 
Act of 1940, Securities Exchange Act Release No. 37182 (May 9, 
1996), 61 FR 24644 (May 15, 1996) (interpretive release in which the 
Commission, among other things, provided general guidance to 
investment advisers that contemplate using electronic media to 
fulfill their disclosure obligations under the Advisers Act).
    \37\ This provision of the rule contemplates a reasonable 
attempt by the sponsor or designated person to reach and obtain 
information from the client. A sponsor or designated person that is 
unable to obtain information from a client after pursuing all 
reasonable means to contact the client would not be precluded from 
relying on the safe harbor.
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    The rule, as adopted, provides that the sponsor or a designated 
person seeking to rely on the rule must notify the client in writing at 
least quarterly that the sponsor or designated person should be 
contacted if there have been any changes in the client's financial 
situation or investment objectives, or if the client wishes to impose 
or modify restrictions concerning the management of the account.<SUP>38 
This provision contemplates only that notice will be given to an 
investor, while the annual contact provision described above 
contemplates that the sponsor (or the designated person) will actively 
attempt to contact the client to obtain information in order to be 
covered by the rule.<SUP>39
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    \38\ Paragraph (a)(2)(iii) of rule 3a-4, as adopted. This notice 
could be included as part of or with another mailing sent to the 
client. For example, the notification could be included as part of 
the quarterly account statement described in paragraph (a)(4) of the 
rule. For a discussion of the provisions of rule 3a-4 stating that 
quarterly account statements must be sent to investment advisory 
clients, see infra Section II.C.4.
    \39\ For this reason, the Commission disagrees with those 
commenters who asserted that the annual contact and quarterly 
notification provisions are duplicative.
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    In the July Release, the Commission noted that, if the sponsor did 
not provide the portfolio manager with information obtained from the 
client, the manager might be unable to manage the client's account on 
the basis of the client's financial situation and investment objectives 
and in accordance with any reasonable restrictions imposed by the 
client. The Commission requested comment whether the rule should state 
explicitly that the sponsor or designated person must convey to the 
portfolio manager the information obtained from the client.<SUP>40 Some 
commenters stated that the rule should contain an explicit provision to 
that effect, while others suggested that such a provision was 
unnecessary. It would appear unlikely that the provision of paragraph 
(a)(1) providing that the account be managed based on the client's 
financial situation and investment objectives and in accordance with 
reasonable restrictions imposed by the client could be satisfied if the 
sponsor failed to transmit the client's financial information to the 
portfolio manager. The Commission therefore has determined not to 
include in rule 3a-4 an explicit requirement that the information must 
be provided to the portfolio manager.
---------------------------------------------------------------------------

    \40\ July Release, supra note 5, at Section II.A.2.ii.
---------------------------------------------------------------------------

    Paragraph (a)(2) of the revised proposed rule would have provided 
that the sponsor and persons authorized to make investment decisions 
for the client's account be reasonably available to consult with the 
client concerning the management of the account. In the July Release, 
the Commission indicated that this provision contemplated a client's 
having reasonable access to the sponsor and the portfolio manager to 
ask questions or to seek additional information about the investment 
advisory program or the client's account.<SUP>41 The Commission 
recognizes that a program's sponsor may serve as the primary contact 
for clients in the program, and that direct client contact with the 
portfolio manager may not occur until after the sponsor and others have 
attempted to address the client's questions or concerns. Nonetheless, 
in the Commission's view, a program seeking to rely on the rule must 
provide a procedure by which each client has reasonable access to 
personnel of the manager who are knowledgeable about the management of 
the client's account, as necessary to respond to the client's 
inquiry.<SUP>42 Therefore, the Commission is adopting this provision of 
the revised proposed rule with the modification discussed below.
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    \41\ Id.
    \42\ This view is reflected in staff no-action letters. See, 
e.g., Rauscher Pierce Refsnes, Inc., supra note 3 (the portfolio 
manager, when necessary, will be available to discuss more complex 
questions regarding the client's account); Westfield Consultants 
Group, supra note 3 (client will be furnished the name and direct 
telephone number of manager, who will be reasonably available during 
business hours). In one no-action request, a representation was made 
that the client would be able to contact his or her financial 
planner or the portfolio manager to obtain information or assistance 
during normal business hours, but the client might be charged hourly 
fees whenever the client requested that certain investment officers 
of the portfolio manager answer specific questions regarding 
investment strategies with respect to the client's account. Manning 
& Napier Advisors, Inc., supra note 12. Rule 3a-4 does not preclude 
a sponsor from charging reasonable fees for this or other services. 
However, such fees must be adequately disclosed to the client. See 
Item 7(f) of Schedule H of Form ADV (requiring disclosure of any 
fees in addition to the wrap fee that a client in a wrap fee program 
may pay).
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    Several commenters suggested that the rule should permit delegation 
of the client consultation responsibilities to an employee of the 
advisory firm managing the client's account who is

[[Page 15104]]

knowledgeable about investment and other matters relevant to the 
account. The rule has been revised to state that ``the sponsor and 
personnel of the manager of the client's account who are knowledgeable 
about the account and its management'' must be reasonably available to 
the client for consultation.<SUP>43 In accordance with this provision, 
the contact person need not be the individual primarily responsible for 
managing the account, but must be sufficiently knowledgeable to discuss 
and explain investment decisions that were made.
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    \43\ Paragraph (a)(2)(iv) of rule 3a-4, as adopted.
---------------------------------------------------------------------------

3. Reasonable Management Restrictions
    The Commission stated in the July Release that the ability of a 
client in an investment advisory program to place reasonable 
restrictions on the management of his or her account is a critical 
factor in determining whether individualized treatment is provided 
under the program.<SUP>44 Paragraph (a)(3) of the revised proposed 
rule, therefore, would have provided that a program relying on the rule 
must include a requirement that each client have the ability to impose 
reasonable restrictions on the management of his or her account. Such 
restrictions were described to include, for example, prohibitions with 
respect to the purchase of particular securities or types of 
securities. This provision of the rule is being adopted as reproposed, 
except that language has been added to the provision to clarify that a 
program relying on rule 3a-4 need not provide clients with the right to 
direct the manager to purchase specific securities or types of 
securities.<SUP>45
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    \44\ July Release, supra note 5, at Section II.A.2.iii.
    \45\ Paragraph (a)(3) of rule 3a-4, as adopted.
---------------------------------------------------------------------------

    Some of the commenters addressing this aspect of the proposal asked 
the Commission to provide additional guidance as to what constitutes a 
reasonable management restriction. As noted in the July Release, 
whether a particular restriction would be reasonable depends on an 
analysis of the relevant facts and circumstances.<SUP>46 In general, a 
restriction would be unreasonable if it is clearly inconsistent with 
the portfolio manager's stated investment strategy or philosophy or the 
client's stated investment objective,<SUP>47 or is fundamentally 
inconsistent with the nature or operation of the program.<SUP>48 Other 
factors that bear on whether a particular restriction is reasonable are 
the difficulty in complying with the restriction,<SUP>49 the 
specificity of the restriction and the number of other restrictions 
imposed by the client.<SUP>50 A restriction would not be unreasonable, 
however, simply because it placed administrative burdens on the 
manager, or could affect the performance of the account.
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    \46\ July Release, supra note 5, at Section II.A.2.iii.
    \47\ July Release, supra note 5, at Section II.A.2.iii. The 
exclusion of individual stocks or stocks from a particular country, 
for example, would appear to be a reasonable restriction under 
ordinary facts and circumstances. A general restriction on the 
purchase of the securities of foreign issuers may be unreasonable, 
however, if the manager's investment strategy is to invest 
exclusively or primarily in foreign securities. Under those 
circumstances, it may be necessary for the client and the sponsor to 
reassess the choice of manager or the client's investment objective 
or strategy.
    \48\ July Release, supra note 5, at Section II.A.2.iii. While 
rule 3a-4 generally contemplates that clients in mutual fund asset 
allocation programs should have the ability to exclude specific 
funds from their accounts, under some circumstances a restriction on 
the purchase of a fund included in the program may be inconsistent 
with the operation of the program. This could be the case, for 
example, when there is only a single fund with a specified 
investment objective available in the program, and that fund plays a 
necessary role in the overall investment strategy determined to be 
appropriate for the client. See Benson White & Company, supra note 
12 (program under which client assets are allocated among four 
mutual funds based upon the client's age need not give clients the 
opportunity to place restrictions on the purchase of any of the 
funds).
    \49\ In the context of a mutual fund asset allocation program, 
for example, compliance with restrictions based on the securities 
held by a fund in which program assets are invested (i.e., a 
restriction that would require a manager to monitor the fund's 
portfolio securities) may be so burdensome as to be unreasonable.
    \50\ The restrictions that a client seeks to impose on his or 
her account could be unreasonable when considered in the aggregate, 
even though each restriction may be reasonable when considered 
separately, or if the client alters them or imposes new restrictions 
with excessive frequency. Paragraph (a)(2)(iii) of the rule, which 
contemplates that a sponsor notify each client at least quarterly to 
contact the sponsor if the client wishes to modify restrictions 
concerning the management of the account, is not intended to imply 
that it necessarily would be reasonable for a client to change his 
or her investment restrictions on a quarterly basis.
---------------------------------------------------------------------------

    The Commission stated in the July Release that if the sponsor or 
portfolio manager of a program concluded that a particular restriction 
sought to be imposed by a client was unreasonable, the client should be 
notified and given an opportunity to restate the restriction more 
reasonably. The Commission also noted that if a client was unable or 
unwilling to modify an unreasonable restriction, then the client could 
be removed from the program without jeopardizing reliance on the safe 
harbor.<SUP>51 The Commission is also of the view that if a sponsor or 
portfolio manager is informed in advance that a client wants to impose 
a restriction the sponsor or portfolio manager deems unreasonable, and 
the client refuses to modify the restriction, then the sponsor or 
portfolio manager may refuse to accept the client. The Commission, 
however, does not agree with the suggestion of some commenters that a 
sponsor or portfolio manager should be permitted to refuse to accept a 
client without giving the client an opportunity to modify or withdraw 
the restriction.
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    \51\ July Release, supra note 5, at Section II.A.2.iii.
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4. Quarterly Account Statements
    Paragraph (a)(4) of the revised proposed rule stated that each 
client in a program covered by the rule must be provided quarterly with 
a statement describing all activity in the client's account during the 
preceding quarter, including all transactions made on behalf of the 
account, all contributions and withdrawals made by the client, and all 
fees and expenses charged to the account. The statement also would have 
included the value of the account at both the beginning and end of the 
quarter. Some commenters asserted that the rule should not specify the 
contents of quarterly statements. The Commission is not persuaded by 
this argument. This provision, which is consistent with several no-
action letters that had specified the contents of the quarterly 
reports,<SUP>52 reflects the view that a key element of individualized 
advisory services is an individualized report about a client's account. 
The Commission therefore is adopting this provision substantially as 
proposed, with one modification clarifying that statements may be sent 
more often than quarterly.<SUP>53
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    \52\ See Westfield Consultants Group, supra note 3 (quarterly 
statements will contain a review and analysis of client account); 
Strategic Advisers, Inc., supra note 2 (quarterly statements will 
contain a description of investments).
    \53\ Paragraph (a)(4) of rule 3a-4, as adopted.
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5. Minimum Account Size
    The revised proposed rule would not have specified a minimum size 
for client accounts in a program.<SUP>54 While the Commission 
acknowledged in the July Release that providing individualized advice 
to a large number of relatively small accounts may be so costly and 
time-consuming as to render individualized treatment impracticable, it 
noted that the provisions of the revised proposed rule should be 
sufficient to ensure individualized treatment, and that innovations in 
computer technology may allow portfolio managers to render 
individualized treatment to relatively small accounts on a cost-
effective

[[Page 15105]]

basis.<SUP>55 Nonetheless, the Commission requested comment whether the 
rule should include a provision specifying a minimum account size.
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    \54\ The Division has granted no-action relief to investment 
advisory programs with varying minimum account sizes. See, e.g., 
Qualivest Capital Management, Inc., supra note 12 ($5 million); Wall 
Street Preferred Money Managers, Inc., supra note 2 ($100,000); 
Strategic Advisers, Inc., supra note 2 ($50,000).
    \55\ July Release, supra note 5, at Section II.A.2.v.
---------------------------------------------------------------------------

    All but one of the commenters responding to the request for comment 
opposed the inclusion of a minimum account size provision in rule 3a-4. 
These commenters asserted that the sponsor and the portfolio manager 
are in the best position to determine the appropriate minimum account 
size for a program based upon the nature of the program. The Commission 
has concluded that a particular account size is not a necessary element 
to ensure that clients are provided with individualized investment 
management services. The Commission recognizes, however, that the 
smaller the minimum account size of an investment advisory program, the 
more likely that clients would not have the ability to demand and 
receive individualized treatment in the program. In assessing the 
status under the Investment Company Act of a program that does not 
qualify for the safe harbor under rule 3a-4, therefore, the Commission 
will consider a relatively large minimum account size as evidence that 
individualized treatment is being provided to clients of the program.

D. Client Retention of Ownership of Securities

    Under paragraph (a)(5) of the revised proposed rule, a program 
covered by the rule would have been characterized by each client 
retaining certain specified indicia of ownership of all securities and 
funds in that client's account.<SUP>56 The Commission stated in the 
July Release that the indicia of ownership specified in revised 
proposed rule 3a-4 are those that provide clients with the ability to 
act as owners of the securities in their accounts.<SUP>57
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    \56\ Rule 3a-4, as originally proposed, would have provided that 
clients maintain to the extent reasonably practicable all indicia of 
ownership of the funds in their accounts, and specified certain 
requisite attributes of ownership. 1980 Release, supra note 10; 
paragraph (c) of rule 3a-4 as originally proposed.
    \57\ Like the revised proposed rule, rule 3a-4 as adopted does 
not provide that the client be the record owner of the securities 
held in its account. The Division has taken the position that an 
investment advisory program would not be deemed to be an investment 
company solely because securities of clients participating in the 
program are held in nominee or street name. United Missouri Bank of 
Kansas City, n.a., supra note 2 (investment company securities held 
in nominee name). See, e.g., Manning & Napier Advisors, Inc., supra 
note 12 (non-investment company securities held in nominee name).
---------------------------------------------------------------------------

    A number of commenters addressing this aspect of the revised 
proposed rule noted circumstances in which the client's ability to 
exercise ownership rights over securities in his or her account could 
be restricted for reasons external to the program. One commenter 
pointed out, for example, that the assets in the account of a self-
directed retirement plan may be subject to restrictions imposed by the 
terms of the plan or by federal tax law.<SUP>58 These commenters were 
concerned that such restrictions may preclude the program from relying 
on the safe harbor.
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    \58\ This commenter suggested that providing the right to pledge 
securities in the account of a retirement plan could cause the plan 
to lose its status as a qualified plan under the Internal Revenue 
Code. In general, a qualified plan must provide that benefits under 
the plan may not be anticipated, assigned, alienated, or subject to 
attachment, garnishment, levy, execution, or other legal process. 
See Internal Revenue Code (``IRC'') Section 401(a)(13) [26 U.S.C. 
401(a)(13)]; Treas. Reg. Sec. 1.401(a)-13 (as amended by T.D. 8219, 
53 FR 31837 (Aug. 22, 1988)). In addition, the IRC imposes an 
additional tax of 10% on early distributions from a qualified 
retirement plan. See IRC Section 72(t)(1) [26 U.S.C. 72(t)(1)].
---------------------------------------------------------------------------

    Paragraph (a)(5) of rule 3a-4 contemplates only that the program 
does not impose additional restrictions or limitations on client 
ownership of securities held in program accounts, and that a client's 
participation in the program will not alter his or her ability to 
exercise the ownership rights enumerated in the rule.<SUP>59 The 
language of the rule has been modified to clarify this standard.<SUP>60
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    \59\ Similarly, paragraph (a)(5) would not prohibit a client 
from being charged reasonable fees for services in connection with 
the ownership of securities held in the program, provided such fees 
could be charged if the client held the securities outside the 
program. Of course, all fees must be permissible under applicable 
state and federal law and must be adequately disclosed. See Item 7 
of Schedule H of Form ADV.
    \60\ Paragraph (a)(5) of rule 3a-4, as adopted. The rule's text 
also has been changed to clarify that the rule provides for the 
retention of only the rights of ownership specified in the rule. Of 
course, nothing in the rule is intended to prevent clients from 
retaining other rights of ownership, if permitted by the program.
---------------------------------------------------------------------------

1. Ability to Withdraw and Pledge Securities
    The revised proposed rule would have provided that clients be able 
to withdraw securities or cash from their accounts. In addition, 
revised proposed rule 3a-4 also would have specified that clients be 
able to pledge the securities in their accounts. The July Release 
stated that investment advisory programs relying on the safe harbor 
could require a client to withdraw securities from his or her account 
before using them as collateral.<SUP>61
---------------------------------------------------------------------------

    \61\ July Release, supra note 5, at Section II.A.3.i.
---------------------------------------------------------------------------

    A number of commenters maintained that the retention by clients of 
the right to pledge securities should be eliminated from the final 
rule. One of these commenters asserted that, because clients may be 
forced to withdraw their securities before pledging them, the provision 
of the revised proposed rule regarding the right to pledge securities 
is unnecessary if the client has the right to withdraw them. The 
Commission agrees, and has modified the rule text to remove this 
provision.<SUP>62
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    \62\ The Commission regards a client's ability to pledge 
securities in his or her account directly without first withdrawing 
them as an additional attribute of the client's ownership of the 
securities. While the absence of a right to pledge would not cause a 
program to fall outside of rule 3a-4, a client's right to pledge 
securities may be relevant to determining whether a program that is 
not relying on the safe harbor would be considered to be an 
investment company.
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2. Right to Vote Securities and Receive Certain Documents as 
Securityholders
    The revised proposed rule would have provided that the client have 
the right to vote the securities in his or her account. This provision 
would have permitted clients to delegate the authority to vote 
securities to another person, such as the portfolio manager or other 
fiduciary, so long as the client retained the right to revoke the 
delegation at any time. The Commission indicated that the right to vote 
proxies implied that the client would receive proxy materials in 
sufficient time to permit the client to consider how to vote and to 
submit the proxies.<SUP>63 The Commission is clarifying that, if a 
client delegates voting rights to another person, the proxies, proxy 
materials, and, if applicable, annual reports, need be furnished only 
to the party exercising the delegated voting authority.<SUP>64
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    \63\ July Release, supra note 5, at Section II.A.3.ii.
    \64\ See infra Section II.D.3. Rule 3a-4, as adopted, is in no 
way intended to indicate the instances under which a client's right 
to vote proxies may be delegated to another person. Whether the 
right can be delegated depends on applicable state and federal law. 
An employee benefit plan subject to the Employee Retirement Income 
Security Act of 1974 (``ERISA''), for example, may provide that the 
plan's named fiduciary may delegate asset management, including the 
authority to vote proxies, to an ``investment manager'' for the 
plan, as that term is defined in Section 3(38) of ERISA. See, e.g., 
Sections 402-405 of ERISA [29 U.S.C. Secs. 1102-1105]; Letter from 
Alan D. Lebowitz, Deputy Assistant Secretary for Program Operations, 
U.S. Department of Labor, to Robert A.G. Monks, Institutional 
Shareholder Services, Inc. (Jan. 23, 1990), 1990 ERISA LEXIS 66. 
Certain provisions of the federal securities laws also contemplate 
that clients can delegate their right to vote proxies. Under the 
Commission's proxy rules, the term ``beneficial owner,'' the person 
who must receive proxy materials, includes an investment adviser 
that has the power to vote, or to direct the voting of, a security 
pursuant to an agreement with the client. See Securities Exchange 
Act Rule 14b-2(a)(2) [17 CFR Sec. 240.14b-2]. Rules adopted by the 
New York Stock Exchange (``NYSE''), the National Association of 
Securities Dealers, Inc. (``NASD'') and the American Stock Exchange, 
Inc. (``AMEX'') permit a securityholder to designate a registered 
investment adviser who has discretion over the management of the 
client's account to receive and vote proxies on his or her behalf. 
See NYSE Guide, Rules of Board, Rules 450, 451, 452 and 465; NASD 
Conduct Rules, Rule 2260; AMEX Rules 575, 576, 577 and 585.

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[[Page 15106]]

    Revised proposed rule 3a-4 contemplated that the client (or the 
client's agent) would be provided with documents that the client (or 
agent) would have received had the same securities been owned by the 
client outside the program. These documents may include prospectuses, 
periodic shareholder reports, proxy materials, and any other 
information and disclosure required by applicable laws or regulations.
    Some commenters suggested that clients be permitted to waive 
receipt of the documents generally required to be provided to 
securityholders, as they could have waived receipt of immediate 
confirmations under the revised proposed rule.<SUP>65 Rule 3a-4 does 
not limit a client's right to waive receipt of these documents. Nor 
does rule 3a-4 prohibit a client from making an informed designation of 
another person, including a financial planner or registered broker-
dealer, to receive such documents on the client's behalf.<SUP>66 
Whether a client in an investment advisory program may waive receipt of 
documents or designate another person to receive documents depends upon 
whether the client would have been able to do so under applicable 
federal or state law if the securities were owned directly.
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    \65\ See infra Section II.D.3.
    \66\ In the revised proposed rule, the paragraph regarding 
receipt of documents specifically referred to receipt by the 
client's agent. Paragraph (a)(5)(iv) of revised proposed rule 3a-4; 
July Release, supra note 5, at Section II.A.3.iii. In connection 
with modifying the rule text to effect the changes discussed above, 
supra Section II.D, the reference to the client's agent has been 
deleted as a conforming change. These changes in the rule text are 
not intended to indicate that a client in an investment advisory 
program may not designate another person to receive documents that 
must be provided to securityholders by law.
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3. Right to Receive Trade Confirmations
    The revised proposed rule contained a provision under which a 
client would have the right to receive in a timely manner confirmations 
of securities transactions of the type required by rule 10b-10 under 
the Securities Exchange Act of 1934.<SUP>67 Two commenters objected to 
the provision of the rule that the confirmations be ``of the type 
required by rule 10b-10.'' These commenters asserted that this 
provision was burdensome, particularly with respect to banks and trust 
companies that are not subject to rule 10b-10. The Commission has 
decided that the confirmation provision, like the other indicia of 
ownership specified in the rule, should apply only to the extent that 
the client would have a right to receive confirmations from the person 
executing the transaction if he or she traded the securities through 
that person outside the program. Therefore, the Commission has revised 
the provision of the rule addressing confirmations to delete the 
reference to rule 10b-10. As revised, this provision would state that a 
client in an investment advisory program must receive confirmations 
that the person executing the transaction is required to send under the 
laws regulating that person's activities. This provision of the rule 
also provides that the confirmations must include the information 
specified by the applicable law governing such content.<SUP>68
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    \67\ 17 CFR 240.10b-10.
    \68\ Paragraph (a)(6) of rule 3a-4, as adopted. Banks that 
execute securities transactions for customers generally are subject 
to confirmation requirements under the banking laws. See, e.g., 12 
CFR 12.4-12.5 (Office of the Comptroller of the Currency (``OCC'') 
confirmation requirements for national banks). The OCC recently 
proposed amendments to these rules that would make their 
confirmation requirements more closely reflect the requirements of 
rule 10b-10. OCC, Recordkeeping and Confirmation Requirements for 
Securities Transactions (Dec. 7, 1995), 60 FR 66517 (Dec. 22, 1995). 
In addition, the Federal Deposit Insurance Corporation (``FDIC'') 
recently considered when and how to amend its regulations governing 
recordkeeping and confirmation requirements for securities 
transactions by state nonmember banks (12 CFR part 344). FDIC, 
Recordkeeping and Confirmation Requirements for Securities 
Transactions (May 14, 1996), 61 FR 26135 (May 24, 1996).
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    As discussed in the July Release, rule 10b-10 permits customers of 
registered broker-dealers to waive receipt of individual confirmations 
in certain circumstances.<SUP>69 A client in an investment advisory 
program whose transactions are executed by a registered broker-dealer 
effectively has the option to receive either individual confirmations 
for each transaction or periodic statements, delivered no less 
frequently than quarterly, that include the information required by 
rule 10b-10 with respect to all transactions that occurred within the 
period covered by the statement.<SUP>70 Two commenters suggested that 
the Commission clarify that an entity that is not required to be 
registered with the Commission as a broker-dealer could rely on the 
safe harbor if it sent quarterly statements to clients who waived their 
rights to receive individual confirmations. As discussed above, the 
confirmation provision in rule 3a-4 applies only to the extent that the 
client would have a right to receive confirmations if he or she traded 
the securities outside the program. A client's ability to waive receipt 
of confirmations will not be altered because securities are held in a 
program account. Whether a client whose transactions are not executed 
by a registered broker-dealer may waive receipt of confirmations or 
other transaction notifications must be determined by reference to the 
laws that govern the relationship.<SUP>71
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    \69\ July Release, supra note 5, at n.60 and accompanying text, 
citing Securities Exchange Act Release No. 34962 (Nov. 10, 1994), 59 
FR 59612 (Nov. 17, 1994) (``Exchange Act Release 34962'').
    \70\ Although a client may waive his or her right to receive the 
immediate confirmation, the client may not waive his or her right to 
receive the periodic statement. Exchange Act Release 34962, supra 
note 68, at nn.34-36 and accompanying text.
    \71\ One commenter observed that a person executing transactions 
on behalf of a client whose shares are held in nominee name may not 
know the identity of the client, and asked the Commission to clarify 
how a program relying on the safe harbor could comply with the 
confirmation provision with respect to such a client. In the case of 
transactions effected by a registered broker-dealer, the Division of 
Market Regulation has expressed the view that a good faith effort 
should be made in these circumstances to obtain the information 
necessary to send the confirmation required by rule 10b-10 directly 
to the client. If these efforts are not successful, then the 
confirmation should be sent, in accordance with certain procedures, 
to the client's custodian or a fiduciary authorized to manage the 
account. See Letter from Catherine McGuire, Chief Counsel, Division 
of Market Regulation, U.S. Securities and Exchange Commission, to 
George P. Miller, Vice President and Associate General Counsel, 
Public Securities Association (Sept. 29, 1995).
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4. Legal Rights as Securityholders
    Revised proposed rule 3a-4 would have provided that the client 
retain the right to proceed directly against an issuer of securities in 
a client's account without joining any other person involved in the 
program. The July Release indicated that underlying this provision 
(which was based on representations made in several no-action letters) 
<SUP>72 was the view that a key element of providing individualized 
advisory services is that a client have the same rights as a person 
holding the securities outside an investment advisory program.
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    \72\ See, e.g., Westfield Consultants Group, supra note 3; 
Manning & Napier Advisors, Inc., supra note 12; Jeffries & Company, 
supra note 12; Rauscher Pierce Refsnes, Inc., supra note 3.
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    Certain commenters suggested that this provision of the revised 
proposed rule may be problematic with respect to client securities that 
are held in nominee or street name, or by a trustee. These commenters 
stated that the nominee or trustee might be considered an indispensable 
party in any action against the issuer, and that nominal joinder of the 
nominee or trustee might be required. These comments have been 
addressed by the revision discussed above regarding restrictions on the 
exercise of ownership rights that are

[[Page 15107]]

external to the program.<SUP>73 Otherwise, the Commission is adopting 
this provision as proposed.<SUP>74
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    \73\ See supra Section II.D.
    \74\ Paragraph (a)(5)(iv) of rule 3a-4, as adopted.
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E. Policies and Procedures and Form N-3a4

    Paragraph (a)(6) of revised proposed rule 3a-4 contemplated the 
establishment by a program's sponsor of written procedures and 
agreements governing the operation of the program, and the maintenance 
of records relating to the program. Paragraph (a)(6) would have 
provided that the sponsor must: (1) Establish and effect written 
policies and procedures that are reasonably designed to ensure that 
each of the provisions of the rule are implemented; (2) maintain and 
preserve all written policies, procedures and certain other documents 
relating to the program for specified periods of time; (3) enter into 
written agreements with other persons that the sponsor designates to 
retain records pertaining to the program; and (4) furnish to the 
Commission upon demand copies of the policies, procedures and other 
documents created pursuant to these policies and procedures. Paragraph 
(a)(7) of the revised proposed rule would have provided that the 
sponsor of an investment advisory program intending to rely on the safe 
harbor file Form N-3a4 with the Commission.
    In the July Release, the Commission specifically requested comment 
whether any of the provisions under paragraph (a)(6) of the rule could 
be ``eliminated, consolidated, or otherwise made less burdensome 
without compromising investor protection.'' <SUP>75 Most commenters 
addressing this aspect of the revised proposed rule viewed the 
provisions as unnecessary, unduly burdensome, irrelevant to determining 
whether an investment advisory program is an investment company under 
the Investment Company Act, or as an improper attempt by the Commission 
to regulate entities--principally banks--that are excepted from the 
definition of investment adviser under the Advisers Act. A few 
commenters also suggested that provisions setting forth written 
policies and procedures would discourage sponsors from relying on the 
safe harbor. For similar reasons, most commenters also opposed any 
filing provision under the rule.
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    \75\ July Release, supra note 5, at Section II.A.4.
---------------------------------------------------------------------------

    Although the Commission does not agree with many of the comments 
pertaining to the proposed recordkeeping and other operational 
provisions, the Commission has reevaluated these provisions and 
determined not to adopt them for a number of reasons. First, the 
Commission agrees that compliance with these types of formal procedural 
provisions generally should not be determinative of an entity's status 
under the Investment Company Act. As one commenter noted, none of the 
other rules under the Investment Company Act exempting certain entities 
from investment company regulation contain similar procedural 
provisions.<SUP>76
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    \76\ See rule 3a-1 (certain prima facie investment companies); 
rule 3a-2 (transient investment companies); rule 3a-3 (certain 
investment companies owned by companies that are not investment 
companies); rule 3a-5 (exemption for subsidiaries organized to 
finance the operations of domestic or foreign companies); rule 3a-6 
(foreign banks and foreign insurance companies); and rule 3a-7 
(issuers of asset-backed securities).
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    Second, with respect to programs sponsored by registered investment 
advisers, the recordkeeping requirements under the Advisers Act and the 
Commission's authority to examine registered investment advisers should 
be sufficient to enable the Commission to detect violations of the 
Investment Company Act. Most, if not all, of the records that would 
have been covered by the revised proposed rule currently are required 
to be maintained under rule 204-2 under the Advisers Act.<SUP>77
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    \77\ For instance, paragraph (a)(7) of rule 204-2 [17 CFR 
275.204-2(a)(7)] generally requires a registered adviser to maintain 
originals of all written communications received and copies of all 
written communication sent by the adviser relating to the adviser's 
advice or recommendations. Under section 204 of the Advisers Act, 
records maintained under rule 204-2 must be made available to 
Commission examiners.
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    With respect to those investment advisory programs sponsored by 
banks that are not subject to the Advisers Act, the Commission staff 
intends to consult and work closely with the relevant banking agencies 
so that these programs will be subject to oversight designed to 
determine whether the programs are being operated as unregistered 
investment companies. Further, to the extent these programs include 
registered investment companies as investment vehicles for their 
clients, or that registered investment advisers serve as subadvisers in 
a program sponsored by a bank, the Commission will have access to 
certain records relating to the programs through its authority to 
examine such registered entities.
    Despite its determination not to include in rule 3a-4 a provision 
pertaining to written policies and procedures, the Commission continues 
to believe that it is important for the sponsor of an investment 
advisory program to monitor the program's compliance with the rule. 
Each person relying on rule 3a-4 is responsible for demonstrating its 
compliance with the rule's provisions. A sponsor that establishes and 
implements written policies and procedures designed to ensure adherence 
to the provisions of rule 3a-4 would greatly reduce the chance that the 
program will fail to operate in the manner specified in the rule. 
Moreover, the implementation of such procedures by an investment 
adviser may serve to protect the adviser in certain instances from 
liability for violating, or aiding and abetting violations of, the 
Investment Company Act and/or the Securities Act, or failing to 
supervise a person under the adviser's supervision who violates those 
Acts.<SUP>78 The Commission, therefore, strongly recommends that a 
sponsor of an advisory program seeking to rely on rule 3a-4 establish 
and implement written policies and procedures, and a system for 
applying such procedures, that are reasonably designed to ensure that 
the program operates in the manner contemplated by the rule.
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    \78\ Section 203(e)(5) of the Advisers Act [15 U.S.C. 80b-
3(e)(5)] provides that no person will be deemed to have failed to 
supervise another person subject to his or her supervision if: (1) 
the person has established procedures that would reasonably be 
expected to prevent or detect the other person's violation, and a 
system for applying such procedures; and (2) the supervisor 
reasonably discharged his or her duties under the procedures and 
system and did not have reasonable cause to believe that such 
procedures were not being complied with.
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    The Commission also believes that it would be advisable for a 
person seeking to rely on rule 3a-4 to maintain the records necessary 
to evidence compliance with the rule, even if the person is not subject 
to rule 204-2 under the Advisers Act or certain of the records are not 
required by that rule. As noted above, a person seeking to rely on rule 
3a-4 must be able to establish compliance with each of the rule's 
provisions. Compliance with many of these provisions, including those 
relating to client contact, the delivery of documents to clients, and 
the opportunity of clients to place reasonable restrictions on the 
management of their accounts, would be difficult, if not impossible, to 
demonstrate without contemporaneous recordkeeping.

F. Investment Advisers Act Issues Raised by Investment Advisory 
Programs

    The Commission noted in the July Release that wrap fee and other 
investment advisory programs raise, in addition to the Investment 
Company

[[Page 15108]]

Act issues addressed in the release, a number of issues under the 
Advisers Act. The Commission requested comment on certain of these 
issues and indicated the possible publication of an interpretive 
release that would address them. <SUP>79 The Commission received few 
comments in response to this request, and the comments that were 
received suggested that investment advisory programs did not raise 
unique issues under the Advisers Act, but simply presented issues under 
the Act in a specific factual context. The Commission, therefore, has 
decided not to publish an interpretive release at this time. The staff 
of the Division will entertain requests for no-action or interpretive 
guidance with respect to the application of the Advisers Act in the 
context of investment advisory programs.
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    \79\ July Release, supra note 5, at Section II.C.
---------------------------------------------------------------------------

III. Cost/Benefit Analysis

    Rule 3a-4 under the Investment Company Act provides a nonexclusive 
safe harbor from the definition of investment company for investment 
advisory programs. Programs that are organized and operated in the 
manner described in the rule are not required to register under the 
Investment Company Act or to comply with the Act's substantive 
provisions. The rule is intended to provide guidance to persons 
operating investment advisory programs regarding the status of these 
programs under the Investment Company Act, and help to ensure that such 
programs do not operate as investment companies without clients of the 
programs benefitting from the Act's protections.
    The Commission anticipates that the cost of compliance with rule 
3a-4 will be small. In addition, the Commission does not believe that 
compliance with any of the provisions will be unduly burdensome. 
Furthermore, because the rule is based principally on long-standing 
staff positions, the Commission believes that it will not substantially 
alter current industry practice or the costs associated therewith.
    Section 2(c) of the Investment Company Act provides that whenever 
the Commission is engaged in rulemaking under the Investment Company 
Act and is required to consider or determine whether an action is 
consistent with the public interest, the Commission also must consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation. The Commission 
has considered rule 3a-4 in light of these standards and believes that, 
by removing uncertainty with respect to the status of certain 
investment advisory programs under the Investment Company Act, the rule 
is consistent with the public interest, and will promote efficiency and 
the competition among sponsors of such programs. In addition, the rule 
will have no adverse effect on capital formation, nor be unduly 
burdensome to those sponsors wishing to comply with the rule.

IV. Paperwork Reduction Act

    An investment advisory program structured to take advantage of the 
safe harbor contained in rule 3a-4 will provide for each client in the 
program receiving a statement quarterly describing all activities in 
the client's account during the preceding quarter. Such a provision 
constitutes a ``collection of information'' requirement within the 
meaning of the Paperwork Reduction Act of 1995 (44 U.S.C. 3501, et 
seq.), <SUP>80 because providing the quarterly statements is necessary 
to meet the provisions of the safe harbor. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information without display of a valid OMB control number. Accordingly, 
the Commission submitted the revised proposed rule to the Office of 
Management and Budget (``OMB'') pursuant to 44 U.S.C. 3507 and received 
approval of the rule's ``collection of information'' requirement (OMB 
control number 3235-0459). Because the collection of information 
requires disclosure to third parties (the client accountholders), 
assurance of confidentiality is not an issue.
---------------------------------------------------------------------------

    \80\ See supra Section II.C.4.
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    As noted above, the Commission has determined not to adopt the 
other collection of information requirements it proposed, including the 
establishment of written procedures and agreements governing the 
operation of the program, the maintenance of records relating to the 
program, and the filing of Form N-3a4 with the Commission.<SUP>81 Due 
to this decision, as well as a revision to the Commission's estimate of 
the amount of assets presently in investment advisory programs, the 
Commission has revised its estimate of the paperwork burden. The total 
aggregate estimated annual reporting burden associated with the rule's 
requirements has been reduced by 152,724.5 hours. The potential 
respondents are the approximately 53 sponsors of investment advisory 
programs. The Commission now estimates that there are 1,016,000 clients 
of investment advisory programs, and the reporting burden imposed by 
rule 3a-4 is one hour per client, for a total aggregate annual 
reporting burden of 1,016,000 hours. On average, the annual reporting 
burden for each respondent is estimated to be 19,169.8 hours. The 
Commission notes that many sponsors already may provide quarterly 
statements to clients and the burden under paragraph (a)(4) of rule 3a-
4 is likely to be less for such sponsors.
---------------------------------------------------------------------------

    \81\ See supra Section II.E.
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V. Final Regulatory Flexibility Analysis

    A summary of the Initial Regulatory Flexibility Analysis regarding 
revised proposed rule 3a-4 was published in the July Release. No 
comments were received on the Initial Regulatory Flexibility Analysis, 
and no comments were received with respect to the effect of the rule on 
small entities. The Commission has prepared a Final Regulatory 
Flexibility Analysis in accordance with 5 U.S.C. 604 regarding rule 3a-
4.
    The analysis states that the rule is intended to provide a 
nonexclusive safe harbor from the definition of investment company for 
certain programs under which investment advisory services are provided 
to clients. The analysis notes that the objective of rule 3a-4 is to 
help ensure that investment advisory programs do not operate as de 
facto investment companies by clarifying the Commission's views 
regarding the status of investment advisory programs under the federal 
securities laws. The conditions of the rule are designed to describe 
certain basic attributes that can differentiate an investment advisory 
program from an investment company. As discussed more fully in the 
analysis, because the rule is a nonexclusive safe harbor, no entity, 
either large or small, is required to operate in accordance with its 
terms, and notes that a program that is a small entity and that does 
not operate in the manner contemplated by the rule is not presumed to 
be an investment company.
    As discussed in the analysis, the Commission estimates that of the 
53 sponsors offering investment advisory programs in 1995, 
approximately 6 programs met the Commission's definition of small 
entity for purposes of the Investment Company Act (i.e., an investment 
company with net assets of $50 million or less as of its most recent 
fiscal year [17 CFR 270.0-10]).
    The analysis states that the rule does not impose any reporting or 
recordkeeping requirements with the exception of one condition which 
requires programs relying on the rule to furnish its clients a 
statement, at least quarterly, describing activity in the client's 
account. This condition reflects representations in several no-action

[[Page 15109]]

letters and is consistent with industry practice. In addition, the 
analysis notes that the Commission has attempted to minimize the rule's 
burden on all persons, not just small entities, particularly by 
eliminating provisions included in the Revised Proposed Rule relating 
to the creation and maintenance of books and records to facilitate and 
support a program's reliance on the rule, and to the filing of a form 
with the Commission. The analysis also notes that alternatives for 
providing different means of compliance for small entities were 
considered, but that the rule is crafted in a manner designed to permit 
program sponsors considerable flexibility as to how they comply with 
the safe harbor's conditions. Furthermore, the analysis states that 
exempting small entities from the conditions of the rule would be 
inconsistent with the Commission's statutory authority to protect 
investors. Cost/benefit information reflected in the ``Cost/Benefit 
Analysis'' section of this Release also is reflected in the analysis.
    A copy of the Final Regulatory Flexibility Analysis may be obtained 
by contacting Rochelle Kauffman Plesset, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Mail Stop 10-6, Washington, D.C. 
20549.

VI. Effective Date

    Rule 3a-4 is effective upon publication in the Federal Register. 
Pursuant to 5 U.S.C. 553(d)(1), immediate effectiveness is appropriate 
because rule 3a-4 is purely exemptive in nature. It provides a 
nonexclusive safe harbor from the definition of investment company for 
certain programs under which investment advisory services are provided 
to advisory clients. Under the rule, programs that are organized and 
operated in the manner described in the rule are not required to 
register under the Investment Company Act or to comply with the Act's 
requirements. The benefits of the rule should be available at the 
earliest possible time.

VII. Statutory Authority

    The Commission is adopting rule 3a-4 pursuant to the authority set 
forth in sections 6(c) and 38(a) of the Investment Company Act [15 
U.S.C. 80a-6(c), -37(a)].

Text of Rule

List of Subjects in 17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

    For the reasons set out in the preamble, title 17, chapter II of 
the Code of Federal Regulations is amended as follows:

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

    1. 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-39 unless 
otherwise noted;
* * * * *
    2. By adding Sec. 270.3a-4 to read as follows:


Sec. 270.3a-4  Status of investment advisory programs.

    Note: This section is a nonexclusive safe harbor from the 
definition of investment company for programs that provide 
discretionary investment advisory services to clients. There is no 
registration requirement under section 5 of the Securities Act of 
1933 [15 U.S.C. 77e] with respect to programs that are organized and 
operated in the manner described in Sec. 270.3a-4. The section is 
not intended, however, to create any presumption about a program 
that is not organized and operated in the manner contemplated by the 
section.

    (a) Any program under which discretionary investment advisory 
services are provided to clients that has the following characteristics 
will not be deemed to be an investment company within the meaning of 
the Act [15 U.S.C. 80a, et seq.]:
    (1) Each client's account in the program is managed on the basis of 
the client's financial situation and investment objectives and in 
accordance with any reasonable restrictions imposed by the client on 
the management of the account.
    (2)(i) At the opening of the account, the sponsor or another person 
designated by the sponsor obtains information from the client regarding 
the client's financial situation and investment objectives, and gives 
the client the opportunity to impose reasonable restrictions on the 
management of the account;
    (ii) At least annually, the sponsor or another person designated by 
the sponsor contacts the client to determine whether there have been 
any changes in the client's financial situation or investment 
objectives, and whether the client wishes to impose any reasonable 
restrictions on the management of the account or reasonably modify 
existing restrictions;
    (iii) At least quarterly, the sponsor or another person designated 
by the sponsor notifies the client in writing to contact the sponsor or 
such other person if there have been any changes in the client's 
financial situation or investment objectives, or if the client wishes 
to impose any reasonable restrictions on the management of the client's 
account or reasonably modify existing restrictions, and provides the 
client with a means through which such contact may be made; and
    (iv) The sponsor and personnel of the manager of the client's 
account who are knowledgeable about the account and its management are 
reasonably available to the client for consultation.
    (3) Each client has the ability to impose reasonable restrictions 
on the management of the client's account, including the designation of 
particular securities or types of securities that should not be 
purchased for the account, or that should be sold if held in the 
account; Provided, however, that nothing in this section requires that 
a client have the ability to require that particular securities or 
types of securities be purchased for the account.
    (4) The sponsor or person designated by the sponsor provides each 
client with a statement, at least quarterly, containing a description 
of all activity in the client's account during the preceding period, 
including all transactions made on behalf of the account, all 
contributions and withdrawals made by the client, all fees and expenses 
charged to the account, and the value of the account at the beginning 
and end of the period.
    (5) Each client retains, with respect to all securities and funds 
in the account, to the same extent as if the client held the securities 
and funds outside the program, the right to:
    (i) Withdraw securities or cash;
    (ii) Vote securities, or delegate the authority to vote securities 
to another person;
    (iii) Be provided in a timely manner with a written confirmation or 
other notification of each securities transaction, and all other 
documents required by law to be provided to security holders; and
    (iv) Proceed directly as a security holder against the issuer of 
any security in the client's account and not be obligated to join any 
person involved in the operation of the program, or any other client of 
the program, as a condition precedent to initiating such proceeding.
    (b) As used in this section, the term sponsor refers to any person 
who receives compensation for sponsoring, organizing or administering 
the program, or for selecting, or providing advice to clients regarding 
the selection of, persons responsible for managing the client's account 
in the program. If a program has more than one sponsor, one person 
shall be designated the principal sponsor, and such person shall be

[[Page 15110]]

considered the sponsor of the program under this section.

    By the Commission.

    Dated: March 24, 1997.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-8075 Filed 3-28-97; 8:45 am]
BILLING CODE 8010-01-P