Document ID: SEC-2012-2174-0001
Agency: sec
Document Type: Rule
Title: Principal Trades With Certain Advisory Clients
Posted Date: 2012-12-31T05:00Z

[Federal Register Volume 77, Number 250 (Monday, December 31, 2012)]
[Rules and Regulations]
[Pages 76854-76860]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-31221]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-3522; File No. S7-23-07]
RIN 3235-AL28

Temporary Rule Regarding Principal Trades With Certain Advisory 
Clients

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission is amending rule 
206(3)-3T under the Investment Advisers Act of 1940, a temporary rule 
that establishes an alternative means for investment advisers who are 
registered with the Commission as broker-dealers to meet the 
requirements of section 206(3) of the Investment Advisers Act when they 
act in a principal capacity in transactions with certain of their 
advisory clients. The amendment extends the date on which rule 206(3)-
3T will sunset from December 31, 2012 to December 31, 2014.

DATES: The amendments in this document are effective December 28, 2012 
and the expiration date for 17 CFR 275.206(3)-3T is extended to 
December 31, 2014.

FOR FURTHER INFORMATION CONTACT: Melissa S. Gainor, Attorney-Adviser, 
Vanessa M. Meeks, Attorney-Adviser, Sarah A. Buescher, Branch Chief, or 
Daniel S. Kahl, Assistant Director, at (202) 551-6787 or 
IArules@sec.gov, Office of Investment Adviser Regulation, Division of 
Investment Management, U.S. Securities and Exchange Commission, 100 F 
Street NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission is 
adopting an amendment to temporary rule 206(3)-3T [17 CFR 275.206(3)-
3T] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] that 
extends the date on which the rule will sunset from December 31, 2012 
to December 31, 2014. Note that previous related releases used RIN 
3235-AJ96. (See Temporary Rule Regarding Principal Trades with Certain 
Advisory Clients, Investment Advisers Act Release No. 2653 (Sep. 24, 
2007) [72 FR 55022 (Sep. 28, 2007)]; Temporary Rule Regarding Principal 
Trades with Certain Advisory Clients, Investment Advisers Act Release 
No. 2965 (Dec. 23, 2009) [74 FR 69009 (Dec. 30, 2009)]; Temporary Rule 
Regarding Principal Trades with Certain Advisory Clients, Investment 
Advisers Act Release No. 2965A (Dec. 31, 2009) [75 FR 742 (Jan. 6, 
2010)]; Temporary Rule Regarding Principal Trades with Certain Advisory 
Clients, Investment Advisers Act Release No. 3118 (Dec. 1, 2010) [75 FR 
75650 (Dec. 6, 2010)]; Temporary Rule Regarding Principal Trades with 
Certain Advisory Clients, Investment Advisers Act Release No. 3128 
(Dec. 28, 2010) [75 FR 82236 (Dec. 30, 2010)]; Temporary Rule Regarding 
Principal Trades with Certain Advisory Clients, Investment Advisers Act 
Release No. 3483 (October 9, 2012), [77 FR 62185 (October 12, 2012)].)

I. Background

    On September 24, 2007, we adopted, on an interim final basis, rule 
206(3)-3T, a temporary rule under the Investment Advisers Act of 1940 
(the ``Advisers Act'') that provides an alternative means for 
investment advisers that are registered with us as broker-dealers to 
meet the requirements of section 206(3) of the Advisers Act when they 
act in a principal capacity in transactions with certain of their 
advisory clients.\1\ In December 2009, we extended the rule's sunset 
date by one year to December 31, 2010.\2\ In December 2010, we further 
extended the rule's sunset date by two years to December 31, 2012.\3\ 
We deferred final action on rule 206(3)-3T at that time in

[[Page 76855]]

order to complete a study required by section 913 of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank Act'') 
\4\ and to consider more broadly the regulatory requirements applicable 
to broker-dealers and investment advisers, including whether rule 
206(3)-3T should be substantively modified, supplanted, or permitted to 
sunset.\5\
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    \1\ Rule 206(3)-3T [17 CFR 275.206(3)-3T]. All references to 
rule 206(3)-3T and the various sections thereof in this release are 
to 17 CFR 275.206(3)-3T and its corresponding sections. See also 
Temporary Rule Regarding Principal Trades with Certain Advisory 
Clients, Investment Advisers Act Release No. 2653 (Sep. 24, 2007) 
[72 FR 55022 (Sep. 28, 2007)] (``2007 Principal Trade Rule 
Release'').
    \2\ See Temporary Rule Regarding Principal Trades with Certain 
Advisory Clients, Investment Advisers Act Release No. 2965 (Dec. 23, 
2009) [74 FR 69009 (Dec. 30, 2009)] (``2009 Extension Release''); 
Temporary Rule Regarding Principal Trades with Certain Advisory 
Clients, Investment Advisers Act Release No. 2965A (Dec. 31, 2009) 
[75 FR 742 (Jan. 6, 2010)] (making a technical correction to the 
2009 Extension Release).
    \3\ See Temporary Rule Regarding Principal Trades with Certain 
Advisory Clients, Investment Advisers Act Release No. 3118 (Dec. 1, 
2010) [75 FR 75650 (Dec. 6, 2010)] (proposing a two-year extension 
of rule 206(3)-3T's sunset date) (``2010 Extension Proposing 
Release''); Temporary Rule Regarding Principal Trades with Certain 
Advisory Clients, Investment Advisers Act Release No. 3128 (Dec. 28, 
2010) [75 FR 82236 (Dec. 30, 2010)] (``2010 Extension Release'').
    \4\ Public Law 111-203, 124 Stat. 1376 (2010). Under section 913 
of the Dodd-Frank Act, we were required to conduct a study and 
provide a report to Congress concerning the obligations of broker-
dealers and investment advisers, including standards of care 
applicable to those intermediaries and their associated persons. 
Section 913 also provides that we may commence a rulemaking 
concerning the legal or regulatory standards of care for broker-
dealers, investment advisers, and persons associated with these 
intermediaries for providing personalized investment advice about 
securities to retail customers, taking into account the findings, 
conclusions, and recommendations of the study.
    \5\ See 2010 Extension Release, Section II.
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    The study mandated by section 913 of the Dodd-Frank Act was 
prepared by the staff and delivered to Congress on January 21, 2011.\6\ 
Since that time, we have considered the findings, conclusions, and 
recommendations of the 913 Study in order to determine whether to 
promulgate rules concerning the legal or regulatory standards of care 
for broker-dealers and investment advisers. In addition, since issuing 
the 913 Study, Commissioners and the staff have held numerous meetings 
with interested parties on the study and related matters.\7\
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    \6\ See Study on Investment Advisers and Broker-Dealers (``913 
Study'') (Jan. 21, 2011), available at http://www.sec.gov/news/studies/2011/913studyfinal.pdf. For a discussion regarding principal 
trading, see section IV.C.1.(b) of the 913 Study. See also 
Commissioners Kathleen L. Casey and Troy A. Paredes, Statement by 
SEC Commissioners: Statement Regarding Study on Investment Advisers 
and Broker-Dealers (Jan. 21, 2011), available at http://www.sec.gov/news/speech/2011/spch012211klctap.htm.
    \7\ See Comments on Study Regarding Obligations of Brokers, 
Dealers, and Investment Advisers, File No. 4-606, available at 
http://sec.gov/comments/4-606/4-606.shtml.
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    On October 9, 2012, we proposed to extend the date on which rule 
206(3)-3T will sunset for a limited amount of time, from December 31, 
2012 to December 31, 2014.\8\ We received five comment letters 
addressing our proposal.\9\ Four of these commenters generally 
supported extending rule 206(3)-3T for at least two years,\10\ and one 
opposed a two-year extension.\11\ The comments we received on our 
proposal are discussed below. After considering each of the comments, 
we are extending the rule's sunset date by two years to December 31, 
2014, as proposed.
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    \8\ See Temporary Rule Regarding Principal Trades with Certain 
Advisory Clients, Investment Advisers Act Release No. 3483 (October 
9, 2012), [77 FR 62185 (October 12, 2012)] (``Proposing Release'').
    \9\ See Comment Letter of Chris Barnard (Oct. 26, 2012) 
(``Barnard Letter''); Comment Letter of fi360, Inc. (Nov. 13, 2012) 
(``fi360 Letter''); Comment Letter of the Financial Services 
Institute (Nov. 5, 2012) (``FSI Letter''); Comment Letter of the 
Securities Industry and Financial Markets Association (Nov. 13, 
2012) (``SIFMA Letter''); Comment Letter of Wells Fargo Advisors 
(Nov. 13, 2012) (``Wells Fargo Letter'').
    \10\ See Barnard Letter; FSI Letter; SIFMA Letter; Wells Fargo 
Letter.
    \11\ See fi360 Letter.
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II. Discussion

    We are amending rule 206(3)-3T only to extend the rule's sunset 
date by two additional years.\12\ We are not adopting any substantive 
amendments to the rule at this time. Absent further action by the 
Commission, the rule would sunset on December 31, 2012. We are adopting 
this extension because, as we discussed in the Proposing Release, we 
continue to believe that the issues raised by principal trading, 
including the restrictions in section 206(3) of the Advisers Act and 
our experiences with, and observations regarding, the operation of rule 
206(3)-3T, should be considered as part of our broader consideration of 
the regulatory requirements applicable to broker-dealers and investment 
advisers in connection with the Dodd-Frank Act.\13\
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    \12\ The rule includes a reference to an ``investment grade debt 
security,'' which is defined as ``a non-convertible debt security 
that, at the time of sale, is rated in one of the four highest 
rating categories of at least two nationally recognized statistical 
rating organizations (as defined in section 3(a)(62) of the Exchange 
Act).'' Rule 206(3)-3T(a)(2) and (c). Section 939A of the Dodd-Frank 
Act requires that we ``review any regulation issued by [us] that 
requires the use of an assessment of the credit-worthiness of a 
security or money market instrument; and any references to or 
requirements in such regulations regarding credit ratings.'' Once we 
have completed that review, the statute provides that we modify any 
regulations identified in our review to ``remove any reference to or 
requirement of reliance on credit ratings and to substitute in such 
regulations such standard of credit-worthiness'' as we determine 
appropriate. We believe that the credit rating requirement in the 
temporary rule would be better addressed after the Commission 
completes its review of the regulatory standards of care that apply 
to broker-dealers and investment advisers. One commenter addressed 
credit ratings and agreed with us that the issue would be better 
addressed after the Commission completes its review. See SIFMA 
Letter. We are not adopting any substantive amendments to the rule 
at this time. See generally Report on Review of Reliance on Credit 
Ratings (July 21, 2011), available at http://www.sec.gov/news/studies/2011/939astudy.pdf (staff study reviewing the use of credit 
ratings in Commission regulations).
    \13\ See Proposing Release, Section II. The 913 Study is one of 
several studies relevant to the regulation of broker-dealers and 
investment advisers mandated by the Dodd-Frank Act. See, e.g., Study 
on Enhancing Investment Adviser Examinations (Jan. 19, 2011), 
available at http://sec.gov/news/studies/2011/914studyfinal.pdf 
(staff study required by section 914 of the Dodd-Frank Act, which 
directed the Commission to review and analyze the need for enhanced 
examination and enforcement resources for investment advisers); 
Commissioner Elisse B. Walter, Statement on Study Enhancing 
Investment Adviser Examinations (Required by Section 914 of Title IV 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act) 
(Jan. 19, 2011), available at http://sec.gov/news/speech/2011/spch011911ebw.pdf. See also Study and Recommendations on Improved 
Investor Access to Registration Information About Investment 
Advisers and Broker-Dealers (Jan. 26, 2011), available at http://sec.gov/news/studies/2011/919bstudy.pdf (staff study required by 
section 919B of the Dodd-Frank Act that directed the Commission to 
complete a study, including recommendations (some of which have been 
implemented) of ways to improve investor access to registration 
information about investment advisers and broker-dealers, and their 
associated persons); United States Government Accountability Office 
Report to Congressional Committees on Private Fund Advisers (July 
11, 2011), available at http://www.gao.gov/new.items/d11623.pdf 
(study required by section 416 of the Dodd-Frank Act, which directed 
the Comptroller General of the United States to study the 
feasibility of forming a self-regulatory organization to oversee 
private funds).
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    Section 913 of the Dodd-Frank Act provides that we may commence a 
rulemaking concerning, among other things, the legal or regulatory 
standards of care for broker-dealers, investment advisers, and persons 
associated with these intermediaries when providing personalized 
investment advice about securities to retail customers. Since the 
completion of the 913 Study in 2011, we have been considering the 
findings, conclusions, and recommendations of the study and the 
comments we have received from interested parties.\14\ In addition, our 
staff has been working to obtain data and economic analysis related to 
standards of conduct and enhanced regulatory harmonization of broker-
dealers and investment advisers to inform the Commission as it 
considers any future rulemaking. At this time, our consideration of the 
regulatory requirements applicable to broker-dealers and investment 
advisers and the recommendations from the 913 Study is ongoing. We will 
not complete our consideration of these issues before December 31, 
2012, the current sunset date for rule 206(3)-3T.
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    \14\ Section 913(f) of the Dodd-Frank Act requires us to 
consider the 913 Study in any rulemaking authorized by that section 
of the Dodd-Frank Act. See also Comments on Study Regarding 
Obligations of Brokers, Dealers, and Investment Advisers, File No. 
4-606, available at http://sec.gov/comments/4-606/4-606.shtml.
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    If we permit rule 206(3)-3T to sunset on December 31, 2012, after 
that date investment advisers registered with us as broker-dealers that 
currently rely on rule 206(3)-3T would be required to comply with 
section 206(3)'s transaction-by-transaction written disclosure and 
consent requirements without the benefit of the alternative means of 
complying with these requirements currently provided by rule 206(3)-3T. 
This could limit the access of non-discretionary advisory clients of

[[Page 76856]]

advisory firms that are registered with us as broker-dealers to certain 
securities.\15\ In addition, firms would be required to make 
substantial changes to their disclosure documents, client agreements, 
procedures, and systems.
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    \15\ For a discussion of the costs and benefits underlying rule 
206(3)-3T, see 2007 Principal Trade Rule Release, Section VI.C.
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    As noted above, four commenters generally supported our proposal to 
amend rule 206(3)-3T to extend it,\16\ and one commenter opposed the 
two-year extension.\17\ Commenters who supported the extension cited 
the disruption to investors that would occur if the rule expired at 
this time, asserting that investors would lose access to the securities 
currently offered through principal trades, receive less favorable 
pricing on such securities, or be forced to buy such securities through 
brokerage accounts.\18\ These commenters further explained that, if the 
rule were allowed to expire, firms relying on the rule would be 
required to make considerable changes to their operations, client 
relationships, systems, policies and procedures at substantial expense, 
without substantial benefits to investors.\19\ One commenter described 
a recent survey it conducted that indicated reliance on rule 206(3)-3T 
by dual registrants in order to engage in principal trades.\20\ In 
addition, two commenters specifically addressed Commission 
consideration of requests for exemptive orders as an alternative means 
of compliance with section 206(3). Both commenters strongly supported 
the two-year extension instead of Commission consideration of requests 
for exemptive orders.\21\ One commenter expressed concern about the 
potential inefficiency and uncertainty created by the need to submit 
individual requests for exemptive relief.\22\ Commenters supporting the 
extension agreed that extending the rule while the Commission conducted 
its review of the obligations of broker-dealers and investment 
advisers, as mandated by the Dodd-Frank Act, would be the least 
disruptive option.\23\
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    \16\ See Barnard Letter; FSI Letter; SIFMA Letter; Wells Fargo 
Letter.
    \17\ See fi360 Letter.
    \18\ See FSI Letter; SIFMA Letter (noting that of seven advisory 
firms that responded to a recent SIFMA survey, two firms indicated 
that they would not be able to elicit customer consent in accordance 
with section 206(3) of the Advisers Act, and the other five firms 
indicated that although they would be able to elicit customer 
consent in accordance with section 206(3), they would nonetheless 
significantly limit their volume of principal trading); Wells Fargo 
Letter.
    \19\ See FSI Letter; SIFMA Letter; Wells Fargo Letter.
    \20\ See SIFMA Letter (SIFMA noted responses from seven dual-
registrant firms that, in the aggregate, manage over $325 billion of 
assets in over 1.1 million non-discretionary advisory accounts. The 
firms indicated that 459,507 of these accounts with aggregate assets 
of over $125 billion are eligible to engage in principal trading in 
reliance on rule 206(3)-3T. These firms also indicated that, during 
the previous two years, they engaged in principal trades in reliance 
on rule 206(3)-3T with 106,682 accounts and executed an average of 
12,009 principal trades per month in reliance on the rule.)
    \21\ See SIFMA Letter; Wells Fargo Letter.
    \22\ See SIFMA Letter.
    \23\ See Barnard Letter; SIFMA Letter; Wells Fargo Letter.
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    One commenter opposed extending the rule for more than a limited 
period of time (no more than six months) and questioned maintaining 
investor choice as a rationale for extending rule 206(3)-3T.\24\ This 
commenter also noted that although instances of ``dumping'' have not 
been discovered, the staff has observed related compliance problems in 
the past. The commenter asserted that a more detailed analysis of 
principal trades executed in reliance on rule 206(3)-3T, including 
spreads paid by investors and investment returns, be conducted and 
suggested that the Commission extend rule 206(3)-3T for no more than 
six months to conduct such an assessment.\25\ The commenter also 
expressed concern about the open-ended nature of extending this 
temporary rule.\26\
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    \24\ See fi360 Letter. This commenter also raised concerns 
regarding the effectiveness of disclosure generally, including the 
disclosures required by the temporary rule. Such concerns are beyond 
the scope of this rulemaking.
    \25\ See fi360 Letter.
    \26\ Id.
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    On balance, and after careful consideration of these comments, we 
conclude that extending the rule for two years is the most appropriate 
course of action at this time. First, with respect to investors, we 
agree with commenters that permitting the rule to sunset before we 
complete our consideration of the regulatory requirements applicable to 
broker-dealers and investment advisers could produce substantial 
disruption for investors with advisory accounts serviced by firms 
relying on the rule.\27\ These investors might lose access to 
securities available through principal transactions and be forced to 
convert their accounts in the interim, only to face the possibility of 
future change--and the costs and uncertainty such additional change may 
entail.\28\ We believe that the rule benefits investors because it 
provides them with greater access to a wider range of securities and 
includes provisions designed to protect them.
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    \27\ See Barnard Letter; SIFMA Letter; Wells Fargo Letter.
    \28\ As discussed in each of the 2007 Principal Trade Rule 
Release, 2009 Extension Release and 2010 Extension Release, firms 
have explained that they may refrain from engaging in principal 
trading with their advisory clients in the absence of the rule given 
the practical difficulties of complying with section 206(3), and 
thus may not offer principal trades through advisory accounts. See 
2007 Principal Trade Rule Release, Section I.B; 2009 Extension 
Release, Section I; 2010 Extension Release, Section II. See also 
SIFMA Letter.
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    Second, with respect to firms, the letters submitted by three 
commenters demonstrate that firms in fact do rely on the rule, and that 
those firms will be faced with uncertainty and disruption of operations 
should the rule expire just as the Commission is engaging in a 
comprehensive review process that may ultimately produce different 
regulatory requirements.\29\ One commenter that represents securities 
firms provided data showing that a substantial number of accounts and 
volume of trades would be affected by a change in the rule.\30\ This 
disruption will be avoided if the rule remains available while we 
engage in our broader consideration of the regulatory requirements 
applicable to broker-dealers and investment advisers.
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    \29\ See FSI Letter; SIFMA Letter; Wells Fargo Letter.
    \30\ See SIFMA Letter.
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    We believe that the requirements of rule 206(3)-3T, coupled with 
regulatory oversight, will adequately protect advisory clients for an 
additional limited period of time while we consider more broadly the 
regulatory requirements applicable to broker-dealers and investment 
advisers.\31\ In the 2010 Extension Proposing Release, we discussed 
certain compliance issues identified by the Office of Compliance, 
Inspections and Examinations.\32\ One matter identified in the staff's 
review resulted in a settlement of an enforcement proceeding and other 
matters continue to be reviewed by the staff.\33\ We are sensitive to 
the concerns regarding compliance issues with respect to rule 206(3)-3T 
raised by one commenter.\34\ Since 2010 and throughout the period of 
the extension,

[[Page 76857]]

the staff has and will continue to examine firms that engage in 
principal transactions and will take appropriate action to help ensure 
that firms are complying with section 206(3) or rule 206(3)-3T (as 
applicable), including possible enforcement action.
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    \31\ In addition, rule 206(3)-3T(b) provides that the rule does 
not relieve an investment adviser from acting in the best interests 
of its clients, or from any obligation that may be imposed by 
sections 206(1) or (2) of the Advisers Act or any other applicable 
provisions of the federal securities laws.
    \32\ See 2010 Extension Proposing Release, Section II 
(discussing certain compliance issues identified by the Office of 
Compliance Inspections and Examinations with respect to the 
requirements of section 206(3) or rule 206(3)-3T and noting that the 
staff did not identify any instances of ``dumping'' as part of its 
review).
    \33\ See In the Matter of Feltl & Company, Inc., Investment 
Advisers Act Release No. 3325 (Nov. 28, 2011) (settled order 
finding, among other things, violations of section 206(3) of the 
Advisers Act for certain principal transactions and section 206(4) 
of the Advisers Act and rule 206(4)-7 thereunder for failure to 
adopt written policies and procedures reasonably designed to prevent 
violations of the Advisers Act and its rules).
    \34\ See fi360 Letter.
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    We received four comment letters specifically addressing the 
duration of our proposed extension of rule 206(3)-3T.\35\ Three of 
these commenters expressed support for extending the rule for an 
additional two years, although two of these commenters suggested that 
an extension of five years would be more appropriate.\36\ One commenter 
opposed extending the rule for more than a six-month period, during 
which the rule's effectiveness could be further assessed.\37\
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    \35\ See fi360 Letter; FSI Letter; SIFMA Letter; Wells Fargo 
Letter.
    \36\ See FSI Letter; SIFMA Letter; Wells Fargo Letter. Two of 
these commenters also recommended that the rule should ultimately be 
made permanent. See FSI Letter; SIFMA Letter.
    \37\ See fi360 Letter.
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    As we noted in the Proposing Release, we believe that the rule's 
sunset date should be extended only for a limited amount of time.\38\ 
That period of time, however, must be long enough to permit us to 
engage in any rulemaking prompted by our broader review of regulatory 
requirements applicable to investment advisers and broker-dealers. We 
do not believe that six months is long enough to engage in this 
process, and we do not believe that it is appropriate at this time to 
extend the temporary rule for an additional five years. We are 
sensitive to comments regarding the duration of the extension and the 
uncertainty caused by extending a temporary rule, but we believe that a 
two-year extension is necessary to provide investors uninterrupted 
access to securities available through principal trades and to provide 
us adequate time to engage in any rulemaking or other process.
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    \38\ See Proposing Release, Section II.
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    Three commenters addressed the question of whether we should 
consider changing the requirements for adviser disclosures to have 
registered advisers provide more information to us and their clients 
about whether they are relying on rule 206(3)-3T.\39\ Each of these 
commenters asserted that additional requirements for adviser 
disclosures are unnecessary, noting that certain additional disclosures 
may be redundant, and that current disclosures appear to be 
adequate.\40\ We are not adopting amendments requiring additional 
adviser disclosures at this time, but will consider the need for such 
disclosures in future rulemakings or other processes as necessary.\41\
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    \39\ See FSI Letter; SIFMA Letter; Wells Fargo Letter. See also 
Proposing Release, Section III (requesting comment on whether we 
should consider changing the requirements in Form ADV for adviser 
disclosures to have registered advisers provide more information to 
us and their clients about whether they are relying on the rule).
    \40\ See FSI Letter; SIFMA Letter; Wells Fargo Letter.
    \41\ See supra note 25.
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    As noted above, one commenter suggested that there be a more 
detailed analysis of data, including spreads paid and investor 
returns.\42\ These factors are relevant to principal trades in general, 
and are not specific to rule 206(3)-3T. This commenter also raised the 
concern that the Commission may ultimately apply a ``uniform'' 
fiduciary standard to broker-dealers and investment advisers in two 
different ways.\43\ These comments pertain to our broader consideration 
of the regulatory requirements applicable to broker-dealers and 
investment advisers, and we will consider these comments in conducting 
this broader review.
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    \42\ See fi360 Letter.
    \43\ See fi360 Letter. We note that the standard of care to 
which advisers are subject and the duties they owe clients are in no 
way diminished by their reliance on rule 206(3)-3T. See supra note 
30.
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III. Certain Administrative Law Matters

    The amendment to rule 206(3)-3T is effective on December 28, 2012. 
The Administrative Procedure Act generally requires that an agency 
publish a final rule in the Federal Register not less than 30 days 
before its effective date.\44\ However, this requirement does not apply 
if the rule is a substantive rule which grants or recognizes an 
exemption or relieves a restriction, or if the rule is 
interpretive.\45\ Rule 206(3)-3T is a rule that recognizes an exemption 
and relieves a restriction and in part has interpretive aspects.
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    \44\ 5 U.S.C. 553(d).
    \45\ Id.
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IV. Paperwork Reduction Act

    Rule 206(3)-3T contains ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995.\46\ The 
Office of Management and Budget (``OMB'') last approved the collection 
of information with an expiration date of May 31, 2014. An agency may 
not conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a currently valid OMB 
control number. The title for the collection of information is: 
``Temporary rule for principal trades with certain advisory clients, 
rule 206(3)-3T'' and the OMB control number for the collection of 
information is 3235-0630. The Proposing Release solicited comments on 
our PRA estimates, but we did not receive comment on them.\47\
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    \46\ 44 U.S.C. 3501 et seq.
    \47\ See Proposing Release, Section IV.
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    The amendment to the rule we are adopting today--to extend rule 
206(3)-3T's sunset date for two years--does not affect the current 
annual aggregate estimated hour burden of 378,992 hours.\48\ Therefore, 
we are not revising the Paperwork Reduction Act burden and cost 
estimates submitted to OMB as a result of this amendment.
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    \48\ See Proposed Collection; Comment Request, 75 FR 82416 (Dec. 
30, 2010); Submission for OMB Review; Comment Request, 76 FR 13002 
(Mar. 9, 2011).
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V. Economic Analysis

A. Introduction

    We are sensitive to the costs and benefits of our rules. The 
discussion below addresses the costs and benefits of extending rule 
206(3)-3T's sunset date for two years, as well as the effect of the 
extension on the promotion of efficiency, competition, and capital 
formation as required by section 202(c) of the Advisers Act.\49\
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    \49\ 15 U.S.C. 80b-2(c). Section 202(c) of the Advisers Act 
mandates that the Commission, when engaging in rulemaking that 
requires it to consider or determine whether an action is necessary 
or appropriate in the public interest, consider, in addition to the 
protection of investors, whether the action will promote efficiency, 
competition, and capital formation.
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    Rule 206(3)-3T provides an alternative means for investment 
advisers that are registered with the Commission as broker-dealers to 
meet the requirements of section 206(3) of the Advisers Act when they 
act in a principal capacity in transactions with their non-
discretionary advisory clients. Other than extending the rule's sunset 
date for two additional years, we are not modifying the rule from its 
current form. We previously considered and discussed the economic 
analysis of rule 206(3)-3T in its current form in the 2007 Principal 
Trade Rule Release, the 2009 Extension Release, and the 2010 Extension 
Release.\50\
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    \50\ See 2007 Principal Trade Rule Release, Sections VI-VII; 
2009 Extension Release, Sections V-VI; 2010 Extension Release, 
Sections V-VI.
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    The baseline for the following analysis of the benefits and costs 
of the amendment is the situation in existence today, in which 
investment advisers that are registered with us as broker-dealers can 
choose to use rule 206(3)-3T as an alternative means to comply with 
section 206(3) of the Advisers Act when engaging in principal 
transactions with their non-discretionary advisory clients. The 
amendment, which will extend rule 206(3)-3T's sunset date by

[[Page 76858]]

two additional years, will affect investment advisers that are 
registered with us as broker-dealers and engage in, or may consider 
engaging in, principal transactions with non-discretionary advisory 
clients, as well as the non-discretionary advisory clients of these 
firms that engage in, or may consider engaging in, principal 
transactions. The extent to which firms currently rely on the rule is 
unknown.\51\ Past comment letters have indicated that since its 
implementation in 2007, both large and small advisers have relied upon 
the rule.\52\ A recent letter submitted by one commenter describes 
survey results of several of its members that rely on the rule.\53\
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    \51\ As of November 1, 2012, we estimate that there are 
491registered investment advisers that also are registered broker-
dealers. Based on IARD data as of November 1, 2012, we estimate that 
there are approximately 100 registered advisers that also are 
registered as broker-dealers that have non-discretionary advisory 
accounts and that engage in principal transactions.
    \52\ See Comment Letter of Securities Industry and Financial 
Markets Association (Dec. 20, 2010); Comment Letter of Winslow, 
Evans & Crocker (Dec. 8, 2009) (``Winslow, Evans & Crocker 
Letter''); Comment Letter of Bank of America Corporation (Dec. 20, 
2010) (``Bank of America Letter'').
    \53\ See supra notes 18, 20.
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B. Benefits and Costs of Rule 206(3)-3T

    As stated in previous releases, we believe the principal benefit of 
rule 206(3)-3T is that it maintains investor choice among different 
types of accounts and protects the interests of investors. Rule 206(3)-
3T also provides a lower cost and more efficient alternative for an 
adviser that is registered with us as a broker-dealer to comply with 
the requirements of section 206(3) of the Advisers Act. This, in turn, 
may provide non-discretionary advisory clients greater access to a 
wider range of securities. Non-discretionary advisory clients also 
benefit from the protections of the sales practice rules of the 
Securities Exchange Act of 1934 (the ``Exchange Act'') and the relevant 
self-regulatory organization(s) and the fiduciary duties and other 
obligations imposed by the Advisers Act. Greater access to a wider 
range of securities may also allow non-discretionary advisory clients 
to better allocate capital. In the long term, the more efficient 
allocation of capital may lead to an increase in capital formation.
    We received one comment on our economic analysis.\54\ The commenter 
questioned the importance of investor choice as the principal benefit 
of rule 206(3)-3T.\55\ We continue to believe that providing non-
discretionary advisory clients with greater access to a wider range of 
securities is beneficial. As we have previously stated, many clients 
wish to access the securities inventory of a diversified broker-dealer 
through their non-discretionary advisory accounts.\56\ We believe that 
it is appropriate to preserve investors' access to the securities 
available through principal transactions made in reliance on rule 
206(3)-3T while consideration of the regulatory requirements applicable 
to broker-dealers and investment advisers is ongoing.
---------------------------------------------------------------------------

    \54\ See fi360 Letter.
    \55\ Id.
    \56\ See 2007 Principal Trade Rule Release, Section I.B.
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    Also, in connection with the 2010 extension of the rule, one 
commenter had disagreed with a number of the benefits of rule 206(3)-3T 
described above, but did not provide any specific data, analysis, or 
other information in support of its comment.\57\ That commenter argued 
that rule 206(3)-3T would impede, rather than promote, capital 
formation because it would lead to ``more numerous and more severe 
violations * * * of the trust placed by individual investors in their 
trusted investment adviser.'' \58\ While we understand the view that 
numerous and severe violations of trust could impede capital formation, 
we have not seen any evidence that rule 206(3)-3T has caused this 
result. The staff has not identified instances where an adviser has 
used the temporary rule to ``dump'' unmarketable securities or 
securities that the adviser believes may decline in value into an 
advisory account, a harm that section 206(3) and the conditions and 
limitations of rule 206(3)-3T are designed to redress.\59\ No commenter 
provided any substantive or specific evidence to contradict our 
previous conclusion that the rule benefits investors, and we continue 
to believe that the rule provides those benefits.\60\
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    \57\ See Comment Letter of the National Association of Personal 
Financial Advisors (Dec. 20, 2010) (``NAPFA Letter'') (questioning 
the benefits of the rule in: (1) Providing protections of the sales 
practice rules of the Exchange Act and the relevant self-regulatory 
organizations; (2) allowing non-discretionary advisory clients of 
advisory firms that are also registered as broker-dealers to have 
easier access to a wider range of securities which, in turn, should 
continue to lead to increased liquidity in the markets for these 
securities; (3) maintaining investor choice; and (4) promoting 
capital formation).
    \58\ See id.
    \59\ See supra note 32.
    \60\ See 2007 Principal Trade Rule Release, Section VI.C; 2009 
Extension Release, Section V; 2010 Extension Release, Section V.
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    We also received comments on the 2007 Principal Trade Rule Release 
from commenters who opposed the limitation of the temporary rule to 
investment advisers that are registered with us as broker-dealers, as 
well as to accounts that are subject to both the Advisers Act and 
Exchange Act as providing a competitive advantage to investment 
advisers that are registered with us as broker-dealers.\61\ Based on 
our experience with the rule to date, and as we noted in previous 
releases, we have no reason to believe that broker-dealers (or 
affiliated but separate investment advisers and broker-dealers) are put 
at a competitive disadvantage to advisers that are themselves also 
registered as broker-dealers.\62\ Commenters on the Proposing Release 
did not address this specific issue, but we intend to continue to 
evaluate the effects of the rule on efficiency, competition, and 
capital formation in connection with our broader consideration of the 
regulatory requirements applicable to broker-dealers and investment 
advisers.
---------------------------------------------------------------------------

    \61\ See Comment Letter of the Financial Planning Association 
(Nov. 30, 2007); Comment Letter of the American Bar Association, 
section of Business Law's Committee on Federal Regulation of 
Securities (Apr. 18, 2008). See also 2009 Extension Release, Section 
VI.
    \62\ See 2009 Extension Release, Section VI; 2010 Extension 
Release, Section VI.
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    As we discussed in previous releases, there are also several costs 
associated with rule 206(3)-3T, including the operational costs 
associated with complying with the rule.\63\ In the 2007 Principal 
Trade Rule Release, we presented estimates of the costs of each of the 
rule's disclosure elements, including: prospective disclosure and 
consent; transaction-by-transaction disclosure and consent; 
transaction-by-transaction confirmations; and the annual report of 
principal transactions. We also provided estimates for the following 
related costs of compliance with rule 206(3)-3T: (i) The initial 
distribution of prospective disclosure and collection of consents; (ii) 
systems programming costs to ensure that trade confirmations contain 
all of the information required by the rule; and (iii) systems 
programming costs to aggregate already-collected information to 
generate compliant principal transactions reports. Although one 
commenter noted that the Commission's cost analysis had remained 
unchanged, we do not believe the extension we are adopting today 
materially affects the cost estimates associated with the rule.\64\ The 
commenter did not provide supporting data discrediting the cost

[[Page 76859]]

analysis we presented in the 2007 Principal Trade Rule Release.\65\
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    \63\ See supra note 50.
    \64\ See 2007 Principal Trade Rule Release, Section VI.D. In the 
2007 Principal Trade Rule Release, we estimated the total overall 
costs, including estimated costs for all eligible advisers and 
eligible accounts, relating to compliance with rule 206(3)-3T to be 
$37,205,569.
    \65\ See fi360 Letter.
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C. Benefits and Costs of the Extension

    In addition to the benefits of rule 206(3)-3T described above and 
in previous releases, we believe there are benefits to extending the 
rule's sunset date for an additional two years. The temporary extension 
of rule 206(3)-3T will have the benefit of providing the Commission 
with additional time to consider principal trading as part of the 
broader consideration of the regulatory requirements applicable to 
broker-dealers and investment advisers without causing disruption to 
the firms and clients relying on the rule.
    One alternative to the extension of the rule's sunset date would be 
to let the temporary rule sunset on its current sunset date, and so 
preclude investment advisers from engaging in principal transactions 
with their advisory clients unless in compliance with the requirements 
of section 206(3) of the Advisers Act. As explained in the 2010 
Extension Release, if we did not extend rule 206(3)-3T's sunset date, 
firms currently relying on the rule would be required to restructure 
their operations and client relationships on or before the rule's 
current expiration date--potentially only to have to do so again later 
(first when the rule sunsets or is modified, and again if we adopt a 
new approach in connection with our broader consideration of the 
regulatory requirements applicable to broker-dealers and investment 
advisers).\66\ As a result of the two-year extension of the rule's 
sunset date, firms relying on the rule will continue to be able to 
offer clients and prospective clients the same level of access to 
certain securities on a principal basis and will not need to incur the 
cost of adjusting to a new set of rules or abandoning the systems 
established to comply with the current rule during this two-year 
period. The extension of the rule will also permit non-discretionary 
advisory clients who have had greater access to certain securities 
because of their advisers' reliance on the rule to trade on a principal 
basis to continue to have the same level of access to those securities 
without disruption.
---------------------------------------------------------------------------

    \66\ See 2010 Extension Release, Section V.
---------------------------------------------------------------------------

    Although we did not receive any comments on the rule's compliance 
costs, we recognize that, as a result of our amendment, firms relying 
on the rule will incur the costs associated with complying with the 
rule for two additional years. We also recognize that a temporary rule, 
by nature, creates long-term uncertainty, which in turn, may result in 
a reduced ability of firms to coordinate and plan future business 
activities.\67\ However, we believe that it would be premature to allow 
the rule to sunset or to adopt the rule on a permanent basis while 
consideration of the regulatory requirements applicable to broker-
dealers and investment advisers is ongoing. We also considered 
extending the rule's sunset date for a period other than two years. Two 
commenters suggested an extension of five years, noting that this 
period of time would provide greater certainty for firms and more ample 
time for the Commission to consider its broader regulation of broker-
dealers and investment advisers.\68\ Another commenter stated that the 
rule should be extended for no more than six months.\69\ We do not 
believe that six months is long enough to engage in a review of the 
regulatory obligations of broker-dealers and investment advisers, and 
we do not believe that it is appropriate at this time to extend the 
temporary rule for an additional five years. Should our consideration 
of the fiduciary obligations and other regulatory requirements 
applicable to broker-dealers and investment advisers extend beyond the 
sunset date of the temporary rule, a longer period may be appropriate. 
On balance, however, we continue to believe that the two-year extension 
of rule 206(3)-3T appropriately addresses the needs of firms and 
clients relying on the rule while preserving the Commission's ability 
to address principal trading as part of its broader consideration of 
the standards applicable to investment advisers and broker-dealers. We 
will continue to assess the rule's operation and impact along with 
intervening developments during the period of the extension.
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    \67\ One of the two commenters who argued that the rule should 
eventually be made permanent specifically noted the uncertainty 
caused by the need for additional extensions in the future. See 
SIFMA Letter. We also received several comments in connection with 
prior extensions of the rule urging us to make the rule permanent to 
avoid such uncertainty. See e.g., Winslow, Evans & Crocker Letter; 
Bank of America Letter.
    \68\ See SIFMA Letter; Wells Fargo Letter.
    \69\ See fi360 Letter.
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VI. Final Regulatory Flexibility Act Analysis

    The Commission has prepared the following Final Regulatory 
Flexibility Analysis (``FRFA'') regarding the amendment to rule 206(3)-
3T in accordance with 5 U.S.C. 604. We prepared and included an Initial 
Regulatory Flexibility Analysis (``IRFA'') in the Proposing 
Release.\70\
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    \70\ See Proposing Release, Section VII.
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A. Need for the Rule Amendment

    We are adopting an amendment to extend rule 206(3)-3T's sunset date 
for two years because we believe that it would be premature to require 
firms relying on the rule to restructure their operations and client 
relationships before we complete our broader consideration of the 
regulatory requirements applicable to broker-dealers and investment 
advisers. The objective of the amendment to rule 206(3)-3T, as 
discussed above, is to permit firms currently relying on rule 206(3)-3T 
to limit the need to modify their operations and relationships on 
multiple occasions before we complete our broader consideration of the 
regulatory requirements applicable to broker-dealers and investment 
advisers. Absent further action by the Commission, the rule will sunset 
on December 31, 2012.
    We are amending rule 206(3)-3T pursuant to sections 206A and 211(a) 
of the Advisers Act [15 U.S.C. 80b-6a and 15 U.S.C. 80b-11(a)].

B. Significant Issues Raised by Public Comments

    We did not receive any comment letters related to our IRFA.

C. Small Entities Subject to the Rule

    Rule 206(3)-3T is an alternative method of complying with Advisers 
Act section 206(3) and is available to all investment advisers that: 
(i) Are registered as broker-dealers under the Exchange Act; and (ii) 
effect trades with clients directly or indirectly through a broker-
dealer controlling, controlled by or under common control with the 
investment adviser, including small entities. Under Advisers Act rule 
0-7, for purposes of the Regulatory Flexibility Act an investment 
adviser generally is a small entity if it: (i) Has assets under 
management of less than $25 million; (ii) did not have total assets of 
$5 million or more on the last day of its most recent fiscal year; and 
(iii) does not control, is not controlled by, and is not under common 
control with another investment adviser that has assets under 
management of $25 million or more, or any person (other than a natural 
person) that had total assets of $5 million or more on the last day of 
its most recent fiscal year.\71\
---------------------------------------------------------------------------

    \71\ See 17 CFR 275.0-7.
---------------------------------------------------------------------------

    As noted in the Proposing Release, we estimated that as of August 
1, 2012, 547 SEC-registered investment advisers were

[[Page 76860]]

small entities.\72\ As discussed in the 2007 Principal Trade Rule 
Release, we opted not to make the relief provided by rule 206(3)-3T 
available to all investment advisers, and instead have restricted it to 
investment advisers that also are registered as broker-dealers under 
the Exchange Act.\73\ We therefore estimated for purposes of the IRFA 
that 7 of these small entities (those that are both investment advisers 
and registered broker-dealers) could rely on rule 206(3)-3T.\74\ We did 
not receive any comments on these estimates.
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    \72\ IARD data as of August 1, 2012. As of November 1, 2012, 
based on IARD data, we estimate that 502 SEC-registered investment 
advisers were small entities.
    \73\ See 2007 Principal Trade Rule Release, Section VIII.B.
    \74\ IARD data as of August 1, 2012. As of November 1, 2012, 
based on IARD data, we estimate that 6 of these small entities could 
rely on rule 206(3)-3T.
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D. Projected Reporting, Recordkeeping, and other Compliance 
Requirements

    The provisions of rule 206(3)-3T impose certain reporting or 
recordkeeping requirements and our amendment will extend the imposition 
of these requirements for an additional two years. The two-year 
extension will not alter these requirements.
    Rule 206(3)-3T is designed to provide an alternative means of 
compliance with the requirements of section 206(3) of the Advisers Act. 
Investment advisers taking advantage of the rule with respect to non-
discretionary advisory accounts are required to make certain 
disclosures to clients on a prospective, transaction-by-transaction and 
annual basis.
    Specifically, rule 206(3)-3T permits an adviser, with respect to a 
non-discretionary advisory account, to comply with section 206(3) of 
the Advisers Act by, among other things: (i) Making certain written 
disclosures; (ii) obtaining written, revocable consent from the client 
prospectively authorizing the adviser to enter into principal trades; 
(iii) making oral or written disclosure and obtaining the client's 
consent orally or in writing prior to the execution of each principal 
transaction; (iv) sending to the client a confirmation statement for 
each principal trade that discloses the capacity in which the adviser 
has acted and indicating that the client consented to the transaction; 
and (v) delivering to the client an annual report itemizing the 
principal transactions. Advisers are already required to communicate 
the content of many of the disclosures pursuant to their fiduciary 
obligations to clients. Other disclosures are already required by rules 
applicable to broker-dealers.
    Our amendment will only extend the rule's sunset date for two years 
in its current form. Advisers currently relying on the rule already 
should be making the disclosures described above.

E. Agency Action To Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objective, while 
minimizing any significant adverse impact on small entities.\75\ 
Alternatives in this category would include: (i) Establishing different 
compliance or reporting standards or timetables that take into account 
the resources available to small entities; (ii) clarifying, 
consolidating, or simplifying compliance requirements under the rule 
for small entities; (iii) using performance rather than design 
standards; and (iv) exempting small entities from coverage of the rule, 
or any part of the rule.
---------------------------------------------------------------------------

    \75\ See 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    We believe that special compliance or reporting requirements or 
timetables for small entities, or an exemption from coverage for small 
entities, may create the risk that the investors who are advised by and 
effect securities transactions through such small entities would not 
receive adequate disclosure. Moreover, different disclosure 
requirements could create investor confusion if it creates the 
impression that small investment advisers have different conflicts of 
interest with their advisory clients in connection with principal 
trading than larger investment advisers. We believe, therefore, that it 
is important for the disclosure protections required by the rule to be 
provided to advisory clients by all advisers, not just those that are 
not considered small entities. Further consolidation or simplification 
of the proposals for investment advisers that are small entities would 
be inconsistent with our goal of fostering investor protection.
    We have endeavored through rule 206(3)-3T to minimize the 
regulatory burden on all investment advisers eligible to rely on the 
rule, including small entities, while meeting our regulatory 
objectives. It was our goal to ensure that eligible small entities may 
benefit from our approach to the rule to the same degree as other 
eligible advisers. The condition that advisers seeking to rely on the 
rule must also be registered with us as broker-dealers and that each 
account with respect to which an adviser seeks to rely on the rule must 
be a brokerage account subject to the Exchange Act, and the rules 
thereunder, and the rules of the self-regulatory organization(s) of 
which the broker dealer is a member, reflect what we believe is an 
important element of our balancing between easing regulatory burdens 
(by affording advisers an alternative means of compliance with section 
206(3) of the Act) and meeting our investor protection objectives.\76\ 
Finally, we do not consider using performance rather than design 
standards to be consistent with our statutory mandate of investor 
protection in the present context.
---------------------------------------------------------------------------

    \76\ See 2007 Principal Trade Rule Release, Section II.B.7 
(noting commenters that objected to this condition as disadvantaging 
small broker-dealers (or affiliated but separate investment advisers 
and broker-dealers)).
---------------------------------------------------------------------------

VII. Statutory Authority

    The Commission is amending rule 206(3)-3T pursuant to sections 206A 
and 211(a) of the Advisers Act [15 U.S.C. 80b-6a and 80b-11(a)].

List of Subjects in 17 CFR Part 275

    Investment advisers, Reporting and recordkeeping requirements.

Text of Rule Amendment

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

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

0
1. The authority citation for Part 275 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless 
otherwise noted.
* * * * *

Sec.  275.206(3)-3T  [Amended]

0
2. In Sec.  275.206(3)-3T, amend paragraph (d) by removing the words 
``December 31, 2012'' and adding in their place ``December 31, 2014.''

    Dated: December 20, 2012.

    By the Commission.

Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-31221 Filed 12-28-12; 8:45 am]
BILLING CODE 8011-01-P