Document ID: SEC-2012-1668-0001
Agency: sec
Document Type: Proposed Rule
Title: Principal Trades with Certain Advisory Clients
Posted Date: 2012-10-12T04:00Z

[Federal Register Volume 77, Number 198 (Friday, October 12, 2012)]
[Proposed Rules]
[Pages 62185-62191]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-25116]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-3483; File No. S7-23-07]
RIN 3235-AJ96

Temporary Rule Regarding Principal Trades With Certain Advisory 
Clients

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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

DATES: Comments must be received on or before November 13, 2012.

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

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number S7-23-07 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

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

All submissions should refer to File Number S7-23-07. This file number 
should be included on the subject line if email is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE., Washington, DC 
20549, on official business days between the hours of 10:00 a.m. and 
3:00 p.m. All comments received will be posted without change; we do 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: 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 
proposing an amendment to temporary rule 206(3)-3T [17 CFR 275.206(3)-
3T] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] that 
would extend the date on which the rule will sunset from December 31, 
2012 to December 31, 2014.

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\ The purpose of the rule was to permit broker-
dealers to sell to their advisory clients, in the wake of Financial 
Planning Association v. SEC (the ``FPA Decision''),\2\ certain 
securities held in the proprietary accounts of their firms that might 
not be available on an agency basis--or might be available on an agency 
basis only on less attractive terms \3\--while protecting clients from 
conflicts of interest as a result of such transactions.\4\
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    \1\ Rule 206(3)-3T [17 CFR 275.206(3)-3T]. All references to 
rule 206(3)-3T and the various sections thereof in this release are 
to 17 CFR 275.206(3)-3T and its corresponding sections. See also 
Temporary Rule Regarding Principal Trades with Certain Advisory 
Clients, Investment Advisers Act Release No. 2653 (Sep. 24, 2007) 
[72 FR 55022 (Sep. 28, 2007)] (``2007 Principal Trade Rule 
Release'').
    \2\ 482 F.3d 481 (D.C. Cir. 2007). In the FPA Decision, handed 
down on March 30, 2007, the Court of Appeals for the D.C. Circuit 
vacated (subject to a subsequent stay until October 1, 2007) rule 
202(a)(11)-1 under the Advisers Act. Rule 202(a)(11)-1 provided, 
among other things, that fee-based brokerage accounts were not 
advisory accounts and were thus not subject to the Advisers Act. For 
further discussion of fee-based brokerage accounts, see 2007 
Principal Trade Rule Release, Section I.
    \3\ See 2007 Principal Trade Rule Release at nn.19-20 and 
Section VI.C.
    \4\ As a consequence of the FPA Decision, broker-dealers 
offering fee-based brokerage accounts with an advisory component 
became subject to the Advisers Act with respect to those accounts, 
and the client relationship became fully subject to the Advisers 
Act. These broker-dealers--to the extent they wanted to continue to 
offer fee-based accounts and met the requirements for registration--
had to: register as investment advisers, if they had not done so 
already; act as fiduciaries with respect to those clients; disclose 
all material conflicts of interest; and otherwise fully comply with 
the Advisers Act, including the restrictions on principal trading 
contained in section 206(3) of the Act. See 2007 Principal Trade 
Rule Release, Section I.
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    As initially adopted on an interim final basis, rule 206(3)-3T was 
set to sunset on December 31, 2009. In December 2009, however, we 
adopted rule 206(3)-3T as a final rule in the same form in which it was 
adopted on an interim final basis in 2007, except that we extended the 
rule's sunset date by one year to December 31, 2010.\5\ We deferred 
final action on rule 206(3)-3T in December 2009 because we needed 
additional time to understand how, and in what situations, the rule was 
being used.\6\
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    \5\ See Temporary Rule Regarding Principal Trades with Certain 
Advisory Clients, Investment Advisers Act Release No. 2965 (Dec. 23, 
2009) [74 FR 69009 (Dec. 30, 2009)] (``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).
    \6\ See 2009 Extension Release, Section II.c.
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    In December 2010, we further extended the rule's sunset date by two 
years to December 31, 2012.\7\ We deferred final action on rule 206(3)-
3T at that time in order to complete a study required by section 913 of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (the 
``Dodd-Frank Act'') \8\

[[Page 62186]]

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.\9\
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    \7\ 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 provision) (``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'').
    \8\ 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 authorizes us to promulgate rules 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.
    \9\ 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.\10\ 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.\11\
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    \10\ 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.
    \11\ 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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II. Discussion

    We are proposing to amend rule 206(3)-3T only to extend the rule's 
sunset date by two additional years.\12\ Absent further action by the 
Commission, the rule will sunset on December 31, 2012. We are proposing 
this extension because 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 to 
be 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. Therefore, we are not 
proposing 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\ 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 an self-
regulatory organization to oversee private funds).
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    As discussed in the 2010 Extension Release, section 913 of the 
Dodd-Frank Act authorizes us to promulgate rules concerning, among 
other things, the legal or regulatory standards of care for broker-
dealers, investment advisers, and persons associated with these 
intermediaries 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 
advisory firms that are registered with us as broker-dealers to certain 
securities.\15\ In addition, firms may 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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    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.\16\ In the 2010 Extension Proposing Release, we discussed 
certain compliance issues identified by the Office of Compliance, 
Inspections and Examinations.\17\ 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.\18\ Since 2010 and 
throughout the

[[Page 62187]]

period of the proposed extension, the staff has and would 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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    \16\ 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.
    \17\ 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).
    \18\ 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).
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    In light of these considerations, we believe that it would be 
premature to require firms currently relying on the rule to restructure 
their operations and client relationships before we complete our 
consideration of the standards of conduct and regulatory requirements 
applicable to broker-dealers and investment advisers. To the extent our 
consideration of these issues leads to new rules concerning principal 
trading, these firms would be required to restructure their operations 
and client relationships, potentially at substantial expense.
    As part of our broader consideration of the regulatory requirements 
applicable to broker-dealers and investment advisers, we intend to 
carefully consider principal trading by advisers, including whether 
rule 206(3)-3T should be substantively modified, supplanted, or 
permitted to sunset. In making these determinations, we will consider, 
among other things, the 913 Study, relevant comments received in 
connection with the 913 Study and any rulemaking that may follow, the 
results of our staff's evaluation of the operation of rule 206(3)-3T, 
and comments we receive on rule 206(3)-3T in connection with this 
proposed extension.

III. Request for Comment

    We request comment on our proposal to extend rule 206(3)-3T's 
sunset date for two additional years.
     Should we allow the rule to sunset?
     If so, what costs would advisers that currently rely on 
the rule incur? What would be the impact on their clients?
     If we allow the rule to sunset, should we consider 
requests from investment advisers that are registered with us as 
broker-dealers for exemptive orders providing an alternative means of 
compliance with section 206(3)?
     If we extend the rule's sunset date, is two years an 
appropriate period of time to extend the sunset date? Or should we 
extend the rule's sunset date for a different period of time? If so, 
for how long?
     Is it appropriate to extend rule 206(3)-3T's sunset date 
for a limited period of time in its current form while we complete our 
broader consideration of the regulatory requirements applicable to 
broker-dealers and investment advisers?
     Should we 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 the rule? For 
example, should we amend Part 1A of Form ADV to require advisers to 
disclose whether they rely on rule 206(3)-3T for certain principal 
transactions? Should we amend Part 2A of Form ADV to require advisers 
who rely on rule 206(3)-3T to provide a description to clients of the 
policies and procedures they have adopted to ensure compliance with the 
rule?
     Why do advisers eligible to rely on the temporary rule not 
rely on it?

IV. Paperwork Reduction Act

    Rule 206(3)-3T contains ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995.\19\ 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.
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    \19\ 44 U.S.C. 3501 et seq.
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    The amendment to the rule we are proposing 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.\20\ Therefore, 
we are not revising the Paperwork Reduction Act burden and cost 
estimates submitted to OMB as a result of this proposed amendment.
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    \20\ 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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    We request comment on whether the estimates continue to be 
reasonable. Have circumstances changed such that these estimates (or 
the underlying assumptions embedded in these estimates) should be 
modified or revised? Persons submitting comments should direct the 
comments to the Office of Management and Budget, Attention: Desk 
Officer for the Securities and Exchange Commission, Office of 
Information and Regulatory Affairs, Washington, DC 20503, and should 
send a copy to Elizabeth M. Murphy, Secretary, Securities and Exchange 
Commission, 100 F Street NE., Washington, DC 20549-1090, with reference 
to File No. S7-23-07.

V. Economic Analysis

A. Introduction

    The Commission is sensitive to the costs and benefits of its 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 
proposed extension on the promotion of efficiency, competition, and 
capital formation as required by section 202(c) of the Advisers 
Act.\21\
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    \21\ 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 proposing to extend rule 
206(3)-3T's sunset date for two years, we are not otherwise proposing 
to modify 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.\22\
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    \22\ 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 proposed rule 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 
proposed amendment, which will extend rule 206(3)-3T's sunset date by 
an additional two 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

[[Page 62188]]

the rule is unknown.\23\ Past comment letters have indicated that since 
its implementation in 2007, both large and small advisers have relied 
upon the rule.\24\
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    \23\ Based on IARD data as of August 1, 2012, we estimate that 
there are less than 100 registered advisers that are also registered 
as broker-dealers that have non-discretionary advisory accounts and 
that engage in principal transactions.
    \24\ 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'').
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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 and protects the 
interests of investors. Rule 206(3)-3T also provides non-discretionary 
advisory clients easier access to a wider range of securities by 
providing 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. Non-discretionary 
advisory clients also benefit from the protections of the sales 
practice rules of the Exchange Act and the relevant self-regulatory 
organization(s), and the fiduciary duties and other obligations imposed 
by the Advisers Act. The rule also may promote a more efficient 
allocation of capital by increasing access of non-discretionary 
advisory clients to a wider range of securities. In the long term, the 
more efficient allocation of capital may lead to an increase in capital 
formation.
    A commenter disagreed with a number of the benefits of rule 206(3)-
3T described above in connection with the 2010 extension of the rule, 
but did not provide any specific data, analysis, or other information 
in support of its comment.\25\ This commenter also 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.'' \26\ 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.\27\ No commenter provided any substantive or 
specific evidence to contradict the Commission's previous conclusion 
that the rule benefits investors, and the Commission continues to 
believe that the rule provides those benefits.\28\
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    \25\ 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).
    \26\ See id.
    \27\ See supra n.17.
    \28\ 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.\29\ 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.\30\ 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.
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    \29\ 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.
    \30\ 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.\31\ 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. We did not receive 
comments directly addressing with supporting data the cost analysis we 
presented in the 2007 Principal Trade Rule Release. We do not believe 
the extension we are proposing today would materially affect the cost 
estimates associated with the rule.\32\ We request comment on whether 
the proposed extension would impact our previous estimates.
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    \31\ See supra n. 22.
    \32\ In the 2007 Principal Trade Rule Release, we estimated the 
total overall costs, including estimated costs for all eligible 
advisers and eligible accounts, relating to compliance with rule 
206(3)-3T to be $37,205,569. See 2007 Principal Trade Rule Release, 
Section VI.D.
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C. Benefits and Costs of the Proposed 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. A temporary extension 
of rule 206(3)-3T would 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 proposed 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 do 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).\33\ On the other hand, if the rule's sunset date

[[Page 62189]]

is extended for two years, firms relying on the rule would continue to 
be able to offer clients and prospective clients access to certain 
securities on a principal basis and would 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. An 
extension of the rule would also permit non-discretionary advisory 
clients who have had access to certain securities because of their 
advisers' reliance on the rule to trade on a principal basis to 
continue to have access to those securities without disruption.
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    \33\ See 2010 Extension Release, Section V.
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    We recognize that if this proposal is adopted, firms relying on the 
rule would continue to 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.\34\ 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. The Commission also 
considered extending the rule's sunset date for a period other than two 
years. Should our consideration of the fiduciary obligations and other 
regulatory requirements applicable to broker-dealers and investment 
advisers extend beyond the proposed sunset date of the temporary rule, 
a longer period may be appropriate. On balance, however, we believe 
that the proposed two-year extension of rule 206(3)-3T appropriately 
addresses the concerns 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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    \34\ We 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.
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D. Request for Comment

    We request comment on all aspects of the economic analysis, 
including the accuracy of the potential costs and benefits identified 
and assessed in this Release and the prior releases, any other costs or 
benefits that may result from the proposal, and whether the proposal, 
if adopted, would promote efficiency, competition, and capital 
formation. Commenters are requested to provide empirical data to 
support their views.

VII. Initial Regulatory Flexibility Act Analysis

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

    We are proposing to extend rule 206(3)-3T'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.

B. Objectives and Legal Basis

    The objective of the proposed amendment to rule 206(3)-3T, as 
discussed above, is to permit firms currently relying on rule 206(3)-3T 
to limit the need to modify their operations and relationships on 
multiple occasions, both before and potentially after we complete any 
regulatory actions stemming from the 913 Study.
    We are proposing to amend rule 206(3)-3T pursuant to sections 206A 
and 211(a) of the Advisers Act [15 U.S.C. 80b-6a and 15 U.S.C. 80b-
11(a)].

C. Small Entities Subject to the Rule

    Rule 206(3)-3T is an alternative method of complying with Advisers 
Act section 206(3) and is available to all investment advisers that: 
(i) Are registered as broker-dealers under the Exchange Act; and (ii) 
effect trades with clients directly or indirectly through a broker-
dealer controlling, controlled by or under common control with the 
investment adviser, including small entities. Under Advisers Act rule 
0-7, for purposes of the Regulatory Flexibility Act an investment 
adviser generally is a small entity if it: (i) Has assets under 
management 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.\36\
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    \36\ See 17 CFR 275.0-7.
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    We estimate that as of August 1, 2012, 547 SEC-registered 
investment advisers were small entities.\37\ As discussed in the 2007 
Principal Trade Rule Release, we opted not to make the relief provided 
by rule 206(3)-3T available to all investment advisers, and instead 
have restricted it to investment advisers that are registered as 
broker-dealers under the Exchange Act.\38\ We therefore estimate for 
purposes of this IRFA that 7 of these small entities (those that are 
both investment advisers and registered broker-dealers) could rely on 
rule 206(3)-3T.\39\
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    \37\ IARD data as of August 1, 2012.
    \38\ See 2007 Principal Trade Rule Release, Section VIII.B.
    \39\ IARD data as of August 1, 2012.
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D. Reporting, Recordkeeping, and other Compliance Requirements

    The provisions of rule 206(3)-3T impose certain reporting or 
recordkeeping requirements, and our proposal, if adopted, would extend 
the imposition of these requirements for an additional two years. We do 
not, however, expect that the proposed two-year extension of the rule's 
sunset date would alter these requirements.
    Rule 206(3)-3T is designed to provide an alternative means of 
compliance with the requirements of section 206(3) of the Advisers Act. 
Investment advisers taking advantage of the rule with respect to non-
discretionary advisory accounts would be required to make certain 
disclosures to clients on a prospective, transaction-by-transaction and 
annual basis.
    Specifically, rule 206(3)-3T permits an adviser, with respect to a 
non-discretionary advisory account, to comply with section 206(3) of 
the Advisers Act by, among other things: (i) Making certain written 
disclosures; (ii) obtaining written, revocable consent from the client 
prospectively authorizing the adviser to enter into principal trades; 
(iii) making oral or written disclosure and obtaining the client's 
consent orally or in writing prior to the execution of each principal 
transaction; (iv) sending to the client 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

[[Page 62190]]

clients. Other disclosures are already required by rules applicable to 
broker-dealers.
    Our proposed amendment, if adopted, only would extend the rule's 
sunset date for two years. Advisers currently relying on the rule 
already should be making the disclosures described above.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    We believe that there are no rules that duplicate or conflict with 
rule 206(3)-3T, which presents an alternative means of compliance with 
the procedural requirements of section 206(3) of the Advisers Act that 
relate to principal transactions.
    We note, however, that rule 10b-10 under the Exchange Act is a 
separate confirmation rule that requires broker-dealers to provide 
certain information to their customers regarding the transactions they 
effect, including whether the broker or dealer is acting as an agent or 
as a principal for its own account in a given transaction. Furthermore, 
FINRA rule 2232 requires broker-dealers that are members of FINRA to 
deliver a written notification in conformity with rule 10b-10 under the 
Exchange Act containing certain information. Rule G-15 of the Municipal 
Securities Rulemaking Board also contains a separate confirmation rule 
that governs transactions in municipal securities, and requires 
brokers, dealers and municipal securities dealers to disclose, among 
other things, the capacity in which the firm effected a transaction 
(i.e., as an agent or principal). In addition, investment advisers that 
are qualified custodians for purposes of rule 206(4)-2 under the 
Advisers Act and that maintain custody of their advisory clients' 
assets must send quarterly account statements to their clients pursuant 
to rule 206(4)-2(a)(3) under the Advisers Act.
    These rules overlap with certain elements of rule 206(3)-3T, but we 
designed the temporary rule to work efficiently together with existing 
rules by permitting firms to incorporate the required disclosure into 
one confirmation statement.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objective, while 
minimizing any significant adverse impact on small entities.\40\ 
Alternatives in this category would include: (i) Establishing different 
compliance or reporting standards or timetables that take into account 
the resources available to small entities; (ii) clarifying, 
consolidating, or simplifying compliance requirements under the rule 
for small entities; (iii) using performance rather than design 
standards; and (iv) exempting small entities from coverage of the rule, 
or any part of the rule.
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    \40\ See 5 U.S.C. 603(c).
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    We believe that special compliance or reporting requirements or 
timetables for small entities, or an exemption from coverage for small 
entities, may create the risk that the investors who are advised by and 
effect securities transactions through such small entities would not 
receive adequate disclosure. Moreover, different disclosure 
requirements could create investor confusion if it creates the 
impression that small investment advisers have different conflicts of 
interest with their advisory clients in connection with principal 
trading than larger investment advisers. We believe, therefore, that it 
is important for the disclosure protections required by the rule to be 
provided to advisory clients by all advisers, not just those that are 
not considered small entities. Further consolidation or simplification 
of the proposals for investment advisers that are small entities would 
be inconsistent with the Commission's goals of fostering investor 
protection.
    We have endeavored through rule 206(3)-3T to minimize the 
regulatory burden on all investment advisers eligible to rely on the 
rule, including small entities, while meeting our regulatory 
objectives. It was our goal to ensure that eligible small entities may 
benefit from the Commission's approach to the 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.\41\ 
Finally, we do not consider using performance rather than design 
standards to be consistent with our statutory mandate of investor 
protection in the present context.
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    \41\ See 2007 Principal Trade Rule Release, Section II.B.7 
(noting commenters that objected to this condition as disadvantaging 
small broker-dealers (or affiliated but separate investment advisers 
and broker-dealers)).
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G. Solicitation of Comments

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

VIII. Consideration of Impact on the Economy

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

IX. Statutory Authority

    The Commission is proposing to amend rule 206(3)-3T pursuant to 
sections 206A and 211(a) of the Advisers Act [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 Proposed Rule Amendment

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

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

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

    Authority:  15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-

[[Page 62191]]

4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *

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

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

    By the Commission.

    Dated: October 9, 2012.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-25116 Filed 10-11-12; 8:45 am]
BILLING CODE 8011-01-P