Document ID: SEC-2009-1844-0001
Agency: sec
Document Type: Rule
Title: Temporary Rule Regarding Principal Trades With Certain Advisory Clients
Posted Date: 2009-12-30T05:00Z

[Federal Register: December 30, 2009 (Volume 74, Number 249)]
[Rules and Regulations]               
[Page 69009-69015]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30de09-3]                         

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-2965; File No. S7-23-07]
RIN 3235-AJ96

 
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 adopting as final 
Rule 206(3)-3T under the Investment Advisers Act of 1940, the interim 
final 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. As adopted, the only change to the 
rule is the expiration date. Rule 206(3)-3T will sunset on December 31, 
2010.

DATES:  Effective Date: December 30, 2009.

FOR FURTHER INFORMATION CONTACT: Sarah A. Bessin, Assistant Director, 
Daniel S. Kahl, Branch Chief, or Matthew N. Goldin, Senior Counsel, at 
(202) 551-6787 or IArules@sec.gov, Office of Investment Adviser 
Regulation, Division of Investment Management, Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549-5041.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission is 
adopting as final temporary Rule 206(3)-3T [17 CFR 275.206(3)-3T] under 
the Investment Advisers Act of 1940 [15 U.S.C. 80b].

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 who 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 District of 
Columbia 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 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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    The rule vacated in the FPA Decision had allowed broker-dealers to 
offer fee-based accounts without complying with the Advisers Act, 
including the requirements of Section 206(3). Section 206(3) makes is 
unlawful for any investment adviser, directly or indirectly, ``acting 
as a principal for his own account, knowingly to sell any security to 
or to purchase any security from a client * * *, without disclosing to 
such client in writing before the completion of such transaction the

[[Page 69010]]

capacity in which he is acting and obtaining the consent of the client 
to such transaction.'' \5\ Prior to our adoption of Rule 206(3)-3T, 
several firms that had offered fee-based brokerage accounts informed 
our staff that the written disclosure and the client consent 
requirements of Section 206(3) act as an operational barrier to their 
ability to engage in principal trades with their clients. Most informed 
us that they planned to discontinue fee-based brokerage accounts as a 
result of the FPA decision. They explained that they planned to do so 
because of the application of the Advisers Act and that, unless they 
were provided an exemption from (or an alternative means of complying 
with) Section 206(3), they would be unable to provide the same range of 
services to those fee-based brokerage customers who elected to become 
advisory clients and would expect few to elect to do so.
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    \5\ 15 U.S.C. 80b-6(3) (emphasis added). See also 2007 Principal 
Trade Rule Release, Section II.A.
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    Rule 206(3)-3T was designed to continue to provide the protection 
of transaction-by-transaction disclosure and consent \6\ to advisory 
clients when investment advisers seek to trade with them on a principal 
basis, subject to several conditions.\7\ Specifically, Rule 206(3)-3(T) 
permits an adviser, with respect to non-discretionary advisory 
accounts,\8\ to comply with Section 206(3) of the Advisers Act by, 
among other things, meeting the following conditions:
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    \6\ Rule 206(3)-3T(a)(4). See also 2007 Principal Trade Rule 
Release, Section II.B.4.
    \7\ For a discussion of Section 206(3) of the Advisers Act, its 
legislative history and our past interpretations of it, see the 2007 
Principal Trade Rule Release, Section II.A.
    \8\ For purposes of the rule, the term ``investment discretion'' 
has the same meaning as in Section 3(a)(35) of the Exchange Act [15 
U.S.C. 78c(a)(35)], except that it excludes investment discretion 
granted by a customer on a temporary or limited basis. Rule 206(3)-
3T(a)(1). See also 2007 Principal Trade Rule Release at n. 31.
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    (i) Providing written, prospective disclosure regarding the 
conflicts arising from principal trades; \9\
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    \9\ Rule 206(3)-3T(a)(3). See also 2007 Principal Trade Rule 
Release, Section II.B.3.
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    (ii) Obtaining written, revocable consent from the client 
prospectively authorizing the adviser to enter into principal 
transactions; \10\
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    \10\ Rule 206(3)-3T(a)(3). Rule 206(3)-3T also requires an 
adviser seeking to rely on the rule to include with each written 
disclosure required by the rule a conspicuous, plain English 
statement that the client may revoke the prospective, written 
consent without penalty at any time by written notice to the 
investment adviser. Rule 206(3)-3T(a)(8). See also 2007 Principal 
Trade Rule Release, Section II.B.3.
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    (iii) Making certain disclosures, either orally or in writing, and 
obtaining the client's consent before each principal transaction; \11\
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    \11\ Rule 206(3)-3T(a)(4). See also 2007 Principal Trade Rule 
Release, Section II.B.4.
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    (iv) Sending to the client confirmation statements disclosing the 
capacity in which the adviser has acted and disclosing that the adviser 
informed the client that it may act in a principal capacity and that 
the client authorized the transaction; \12\ and
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    \12\ Rule 206(3)-3T(a)(5). See also 2007 Principal Trade Rule 
Release, Section II.B.5.
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    (v) Delivering to the client an annual report itemizing the 
principal transactions made during the year.\13\
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    \13\ Rule 206(3)-3T(a)(6). See also 2007 Principal Trade Rule 
Release, Section II.B.6.
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    The rule also requires that the investment adviser be registered as 
a broker-dealer under Section 15 of the Securities Exchange Act of 1934 
(the ``Exchange Act'') [15 U.S.C. 78o] and that each account for which 
the adviser relies on the rule be a brokerage account subject to the 
Exchange Act, and the rules thereunder, and the rules of the self-
regulatory organization(s) (``SRO'') of which it is a member.\14\ The 
rule is not available for principal trades of securities if the 
investment adviser or a person who controls, is controlled by, or is 
under common control with the adviser (``control person'') is the 
issuer or is an underwriter of the security.\15\ The rule includes one 
exception--an adviser may rely on the rule for trades in which the 
adviser or a control person is an underwriter of non-convertible 
investment-grade debt securities.\16\ Rule 206(3)-3T(b) clarifies that 
the rule does not relieve in any way an investment adviser from its 
obligation to act in the best interests of each of its advisory 
clients, including fulfilling the duty with respect to the best price 
and execution for a particular transaction for the advisory client.\17\ 
Rule 206(3)-3T was set to expire on December 31, 2009, approximately 27 
months after its adoption.\18\
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    \14\ Rule 206(3)-3T(a)(7). See also 2007 Principal Trade Rule 
Release, Section II.B.7.
    \15\ Rule 206(3)-3T(a)(2). See also 2007 Principal Trade Rule 
Release, Section II.B.2.
    \16\ Rule 206(3)-3T(a)(2). See also 2007 Principal Trade Rule 
Release, Section II.B.2. A separate Commission rulemaking may have 
an impact on the rule's definition of ``non-convertible investment 
grade debt securities.'' See note 34 below.
    \17\ Rule 206(3)-3T(b). See also 2007 Principal Trade Rule 
Release, Section II.B.8.
    \18\ Rule 206(3)-3T(d). See also 2007 Principal Trade Rule 
Release, Section II.B.9.
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II. Discussion

    We are adopting Rule 206(3)-3T in the same form in which we adopted 
it on an interim final basis in 2007, except that the sunset period of 
the rule will end one year later (on December 31, 2010). Absent further 
action by the Commission, Rule 206(3)-3T will expire on December 31, 
2010. As we continue to assess the operation of the rule along with 
intervening developments, we believe that the substantive provisions of 
Rule 206(3)-3T as it was adopted on an interim final basis provide 
sufficient protections to advisory clients to warrant its continued 
operation for an additional limited period of time. We will use that 
time to consider whether to propose to continue the rule beyond the 
revised sunset date and, if so, what if any modifications should be 
made to the rule.

a. Comments on the Scope and Conditions of the Rule

    We received comment letters from eight commenters on the interim 
final rule.\19\ Several favored narrowing the scope of the exemption 
provided by the rule or opposed its expansion.\20\ Others, however, 
urged us to expand the rule's exemption to cover additional 
securities.\21\ Some commenters suggested that an adviser be prohibited 
from relying on the rule when trading any securities underwritten or 
issued by the adviser or any of its affiliates (i.e., that we exclude 
underwritten non-convertible investment grade debt securities).\22\ 
Others asked that we allow advisers, in reliance on the rule, to engage 
in principal trades with clients in various types of securities the 
adviser or an affiliate underwrote that are highly liquid and for which 
ascertainable prices are readily available.\23\
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    \19\ The comment letters are available at http://www.sec.gov/
comments/s7-23-07/s72307.shtml. However, one additional comment 
letter was submitted in connection with our proposed Interpretive 
Rule under the Advisers Act Affecting Broker-Dealers, Investment 
Advisers Act Release No. 2652 (Sep. 24, 2007). International 
Association of Small Broker Dealers and Advisers (Oct. 25, 2007) 
(``IASBDA Letter.'') The IASBDA Letter addresses one particular 
aspect of the rule, as noted below, and is available at http://
www.sec.gov/comments/s7-22-07/s72207-3.pdf.
    \20\ See, e.g., Comment Letter of the Financial Planning 
Association (Nov. 30, 2007) (``FPA Letter I''); Comment Letter of 
the National Association of Personal Financial Advisors (Nov. 30, 
2007) (``NAPFA Letter'').
    \21\ See, e.g., Comment Letter of the Securities Industry and 
Financial Markets Association (Nov. 30, 2007) (``SIFMA Letter I''); 
Comment Letter of Davis Polk & Wardwell (Dec. 4, 2007) (``DPW 
Letter'').
    \22\ See, e.g., Comment Letter of Fund Democracy and the 
Consumer Federation of America (Nov. 30, 2007) (``FD/CFA Letter'').
    \23\ See, e.g., SIFMA Letter I.
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    Some commenters generally viewed the protections afforded to 
clients under the rule as inadequate,\24\ while others urged us to 
modify the rule to make it easier for advisers to effect principal

[[Page 69011]]

transactions with their clients.\25\ For example, one commenter urged 
us to limit the rule's relief to principal transactions with 
sophisticated or wealthy investors who are in a position to protect 
themselves.\26\ Another suggested the rule expressly require firms to 
develop policies and procedures that are specifically designed to 
detect, deter and prevent disadvantageous principal transactions.\27\ 
And others suggested that we require that the disclosure supporting the 
initial client authorization for principal trades be in a separately 
executed, stand-alone document and not permit it to be incorporated 
directly into an account opening agreement.\28\ Some commenters 
asserted, however, that the disclosure requirements--in particular, 
requiring transaction-by-transaction disclosures for principal trades 
with sophisticated investors--were too restrictive,\29\ while others 
argued that they did not go far enough.\30\ Some commenters suggested 
we impose additional disclosures or disclosure-related 
requirements.\31\ One commenter questioned the rule's overall focus on 
disclosure and urged us to consider instead requiring affirmative 
measures designed to prevent principal trading abuses.\32\
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    \24\ See, e.g., NAPFA Letter.
    \25\ See, e.g., DPW Letter.
    \26\ FPA Letter I.
    \27\ FD/CFA Letter.
    \28\ See, e.g., FD/CFA Letter; NAPFA Letter; FPA Letter I.
    \29\ See, e.g., DPW Letter (although supporting the rule, 
commenting that the Commission should provide more relief from the 
restrictions of Section 206(3) to permit affirmative waiver of the 
transaction-by-transaction disclosure and consent requirements with 
respect to transactions with financially sophisticated investors 
involving certain ``readily marketable'' securities).
    \30\ See, e.g., Comment Letter of the Investment Advisers 
Association (Nov. 30, 2007) (``IAA Letter'') (expressing strong 
opposition to any expansion of the relief provided in the rule, or 
relaxation of the rule's conditions, and emphasizing the importance 
of monitoring the rule in practice before making further changes); 
FPA Letter I (expressing concern about the risks attendant to 
principal trades); NAPFA Letter (arguing that any expansion of the 
scope of the rule would be inappropriate because of the potential 
risks associated with principal trades).
    \31\ See, e.g., FD/CFA Letter; FPA Letter I (expressing concern 
that the transaction-specific disclosures required by the rule may 
not provide investors with enough information regarding conflicts of 
interest and suggested additional disclosures that should be 
required by the rule).
    \32\ See note 27 above and accompanying text.
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    Commenters who addressed the issue generally agreed with our view 
that principal trades in securities issued or underwritten by an 
adviser or its control persons should not be permitted under the 
rule.\33\ However, these commenters expressed differing views with 
respect to the rule's exception from the general prohibition for trades 
in which the adviser or control person is an underwriter of non-
convertible investment grade debt securities.\34\ We also received 
mixed comments on the rule's limitation of relief to investment 
advisers that are registered with the Commission as broker-dealers. 
Some commenters, generally those representing financial institutions 
that act as both advisers and broker-dealers, supported the limitation 
\35\ while others opposed it.\36\
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    \33\ See, e.g., FD/CFA Letter; FPA Letter I; SIFMA Letter I.
    \34\ Compare SIFMA Letter I (arguing that we should expand the 
exception to underwritten preferred stock, convertible debt, and 
certificates of deposit (among others)) with FPA Letter I 
(specifically urging us not to extend the exception to debt 
instruments other than investment grade municipal debt and corporate 
debt and expressing concern with price transparency of debt 
instruments, generally) and FD/CFA Letter (arguing that the 
exception should not be further expanded or that it should be 
eliminated altogether because of concerns regarding the price 
transparency of debt instruments).
    One commenter supporting a broadening of the exception also 
urged us to modify our definition of ``investment grade debt 
security'' to require that a qualifying security receive ratings 
from only one nationally recognized statistical rating organization 
(``NRSRO'') instead of two. SIFMA Letter I. We are considering more 
globally, and in a separate rulemaking, whether our inclusion of 
requirements related to credit ratings in our rules and forms as an 
indication of investment grade quality has, in effect, placed an 
``official seal of approval'' on ratings and has adversely affected 
the quality of due diligence and investment analysis. See References 
to Ratings of Nationally Recognized Statistical Rating Organizations 
in Rules Under the Investment Company Act and Investment Advisers 
Act, Investment Company Act Release No. 28327 (Jul. 1, 2008) [73 FR 
40124 (July 11, 2008)]. In conjunction with recently reopening the 
comment period for the proposal with respect to Rule 206(3)-3T, the 
Commission requested comment on whether it should substitute an 
approach that uses credit ratings as a minimum standard along with 
additional criteria that must be met with regard to evaluating 
securities. The re-opened comment period closed on December 8, 2009. 
See References to Ratings of Nationally Recognized Statistical 
Rating Organizations, Investment Company Act Release No. 28939 (Oct. 
5, 2009) [74 FR 52358 (Oct. 9, 2009)].
    \35\ See, e.g., SIFMA Letter I (arguing that the dual 
registration condition preserves important investor protections that 
were available to former fee-based brokerage customers who elected 
after the FPA Decision to convert their accounts to advisory 
accounts).
    \36\ See, e.g., FPA Letter I (urging us to eliminate the 
limitation because investors would already receive the protections 
of both the Advisers Act and the Exchange Act whether the adviser is 
itself also registered as a broker-dealer or whether it is simply 
affiliated with a broker-dealer, and further arguing that that the 
condition may have anticompetitive effects, providing an advantage 
to investment advisers that are also registered as broker-dealers); 
Comment Letter of the American Bar Association, section of Business 
Law's Committee on Federal Regulation of Securities (Apr. 18, 2008) 
(``ABA Committee Letter'') (arguing that the substantial regulatory 
burdens of applying two regulatory regimes is not offset by 
additional investor protection benefits).
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    Several commenters agreed with our decision to limit the rule to 
non-discretionary accounts.\37\ In contrast, one commenter urged us to 
expand the rule to be available to all advisory accounts, not just non-
discretionary ones.\38\ One commenter urged us to limit the scope of 
the rule so that advisers may only rely on it when they are conducting 
a principal trade with a ``qualified client,'' as defined under Rule 
205-3 [17 CFR 275.205-3] under the Advisers Act,\39\ while another 
argued that the rule should not be restricted to particular 
clients.\40\
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    \37\ See, e.g., FD/CFA Letter (arguing that discretionary 
accounts present a ``greater risk of abuse as a general matter'' and 
expressed appreciation for the protections provided by this 
limitation); IAA Letter; SIFMA Letter I (agreeing that the rule 
should apply to all non-discretionary accounts, but specifically 
noting that the rule should not be further limited in application to 
former fee-based brokerage accounts only); FPA Letter I (supporting 
the limitation as providing a critical investor protection, but 
arguing that we should consider further narrowing the non-
discretionary account limitation to include only those accounts that 
were formerly fee-based brokerage accounts).
    \38\ ABA Committee Letter (arguing that the specific exclusion 
in the rule for adviser-underwritten securities, together with an 
adviser's best execution obligations, provides investors with 
sufficient investor protections and therefore clients in 
discretionary accounts should not be precluded from the benefits of 
the relief provided by the rule).
    \39\ FPA Letter I (further arguing that institutional clients or 
natural persons who are deemed to be ``qualified clients'' for 
purposes of Rule 205-3 are better positioned to understand the 
nature of principal transactions and the potential conflicts and, 
therefore, are better able to protect themselves against potential 
abuses than are other investors). Another commenter also expressed 
general objections to the placing of any principal trades by 
investment advisers. NAPFA Letter.
    \40\ SIFMA Letter I (noting that all investors should be able to 
benefit from the greater investment choices, potentially enhanced 
executions and additional liquidity provided by the rule).
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b. Comments on Sunset Provision

    Five commenters addressed the duration of Rule 206(3)-3T.\41\ Three 
expressed support for the temporary duration of the rule, arguing that, 
in light of the substantial risks associated with principal trading 
facilitated by the rule, a temporary effectiveness period would be 
important for the Commission to assess whether the scope of relief 
provided by the rule is appropriate.\42\ Two commenters supported 
making the rule permanent at the end of the sunset provision with 
broadened relief.\43\
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    \41\ FPA Letter I; Comment Letter of the Financial Planning 
Association (Sep. 16, 2008) (``FPA Letter II''); IAA Letter; SIFMA 
Letter I; Comment Letter of the Securities Industry and Financial 
Markets Association (Aug. 21, 2009) (``SIFMA Letter II''); DPW 
Letter; NAPFA Letter.
    \42\ FPA Letter I; IAA Letter; NAPFA Letter.
    \43\ DPW Letter; SIFMA Letter I.
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    We received two subsequent letters from market participants. The 
Securities Industry and Financial Markets Association (SIFMA) urged us 
to extend

[[Page 69012]]

the temporary rule for two years in light of pending legislation that 
could address principal trading by investment advisers.\44\ The 
Financial Planning Association (FPA) also wrote recommending allowing 
the rule to expire or extending it for no more than an additional year 
while the Commission conducts a study that either substantiates a clear 
basis for adopting a permanent exemption under Section 206(3) or 
disproves the view of firms that it affords unique benefits to the 
public.\45\
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    \44\ SIFMA Letter II.
    \45\ FPA Letter II.
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c. Limited Extension of Temporary Rule

    When we adopted Rule 206(3)-3(T) on a temporary basis in September 
2007, we anticipated the two-year period would provide us with adequate 
time to evaluate the operation of the rule in the marketplace and 
determine, in conjunction with consideration of all comments received, 
whether the rule should be made permanent, modified or allowed to 
expire. At the time we adopted the interim final rule, we explained 
that we would need to take action no later than the end of the original 
duration of the temporary rule if we intended to continue the same or 
similar relief.\46\
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    \46\ See 2007 Principal Trade Rule Release, Section II.B.9.
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    We need additional time to understand how, and in what situations, 
advisers are using the rule. Fewer firms than we anticipated at the 
time we adopted the rule on an interim final basis immediately 
determined to rely on it and those that did were slower than expected 
to implement the rule. We take seriously the investor protection 
concerns raised by commenters. Consequently, we have determined to 
limit the duration of the extension to one year while we continue to 
evaluate the operation of the rule. As our staff continues to gather 
information, we will assess whether the rule is operating, and firms 
are applying it, in a manner consistent with protecting investors.
    Given the limited nature of the extension, we believe that making 
other changes to the temporary rule could cause firms relying on the 
rule to need to make adjustments to their disclosure documents, client 
agreements, procedures, or systems that, depending on whether we 
determine to propose and adopt a permanent rule in the future, may be 
applicable for only a year.
    Further evaluation will help inform our decision whether to propose 
to make the rule permanent in its current or an amended form or to 
allow it to expire.\47\ We will consider, among other things, the 
comments we received on the interim final rule in deciding whether to 
propose a permanent rule or to let the rule expire. If we decide to 
propose a permanent rule, we will also consider the comments we 
received in determining how such a rule might differ from Rule 206(3)-
T.
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    \47\ Subsequent to adopting Rule 206(3)-3T, the study prepared 
by RAND Corporation was completed. See Investor and Industry 
Perspectives on Investment Advisers and Broker-Dealers, http://
www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf. The study 
addressed two primary questions: (1) What are the current business 
practices of broker-dealers and investment advisers; and (2) do 
investors understand the differences between and relationships among 
broker-dealers and investment advisers? Several of the bills 
currently pending before Congress are designed to harmonize the 
separate regulatory regimes for investment advisers and broker-
dealers.
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    In addition, there are currently pending before both houses of 
Congress bills that may address, or otherwise have an impact on, 
principal trading activities by investment advisers and broker-dealers, 
as well as broader issues under the Advisers Act.\48\ Waiting some 
additional time for Congress to act will permit us to consider the 
impact that any of those proposals, if enacted, will have on such 
activities prior to taking further action with respect to the temporary 
rule.
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    \48\ See, e.g., Investor Protection Act of 2009, H.R. 3817, 
111th Cong. (2009); Restoring American Financial Stability Act of 
2009, S. ---- 111th Cong. (2009).
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    For the reasons discussed in this release, we have determined that 
it is necessary or appropriate in the public interest and consistent 
with the protection of investors and consistent with the purposes 
fairly intended by the policy and provisions of the Advisers Act to 
adopt Rule 206(3)-T as a final temporary rule. We are adopting Rule 
206(3)-3T in the same form in which we originally adopted it on an 
interim final basis, except that it will expire on December 31, 2010, 
one year after its original expiration date.

III. Certain Administrative Law Matters

    The amendment to Rule 206(3)-3T is effective on December 30, 2009. 
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.\49\ 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.\50\ Rule 206(3)-3T in part has interpretive aspects and 
is a rule that recognizes an exemption and relieves a restriction.
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    \49\ 5 U.S.C. 553(d).
    \50\ 5 U.S.C. 553(d)(1) and (2).
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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.\51\ The 
Office of Management and Budget (``OMB'') approved the burden estimates 
presented in the 2007 Principal Trade Rule Release,\52\ first on an 
emergency basis and subsequently on a regular basis. OMB approved the 
collection of information with an expiration date of March 31, 2011. 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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    \51\ 44 U.S.C. 3501 et seq.
    \52\ See 2007 Principal Trade Rule Release, Section V.B&C.
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    The 2007 Principal Trade Rule Release explains that, under Rule 
206(3)-3T, there are four distinct collection burdens. Our estimate of 
the burden of each of the collections reflects the fact that the 
alternative means of compliance provided by the rule is substantially 
similar to the approach advisers currently employ to comply with the 
disclosure and consent obligations of Section 206(3) of the Advisers 
Act and the approach that broker-dealers employ to comply with the 
confirmation requirements of Rule 10b-10 under the Exchange Act. The 
2007 Principal Trade Rule Release solicited comments on our PRA 
estimates,\53\ but we did not receive comment on them. The amendment to 
the rule we are adopting today--to extend the rule for twelve months--
does not affect the burden estimates contained in the 2007 Principal 
Trade Rule Release.\54\
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    \53\ See id., Section V.D.
    \54\ As discussed above, fewer firms than we anticipated at the 
time we adopted the rule on an interim final basis immediately 
determined to rely on it and those that did were slower than 
expected in implementing it. We received no comments on our estimate 
of the number of advisers or accounts and, for purposes of this 
release, are retaining those estimates.
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V. Cost-Benefit Analysis

    We are adopting, as a final temporary rule, Rule 206(3)-3T under 
the Advisers Act, which provides an alternative means for investment 
advisers that are registered with us as broker-dealers to meet the 
requirements of Section 206(3)

[[Page 69013]]

when they act in a principal capacity with respect to transactions with 
certain of their advisory clients. Other than extending the sunset 
period of the temporary rule for one year, we are not otherwise 
modifying the rule from the form in which we initially adopted it on an 
interim final basis in September 2007.
    In summary, as explained in the 2007 Principal Trade Rule 
Release,\55\ we believe the principal benefit of Rule 206(3)-3T is that 
it maintains investor choice and protects the interests of investors 
who held an estimated $300 billion in one million fee-based brokerage 
accounts. A resulting second benefit of the rule is that non-
discretionary advisory clients of advisory firms that are also 
registered as broker-dealers have easier access to a wider range of 
securities which, in turn, should lead to increased liquidity in the 
markets for these securities and promote capital formation in these 
areas. A third benefit of the rule is that it provides the protections 
of the sales practice rules of the Exchange Act and the relevant self-
regulatory organizations because an adviser relying on the rule must 
also be a registered broker-dealer. Another benefit of Rule 206(3)-3T 
is that it provides a lower cost alternative for an adviser to engage 
in principal transactions.
---------------------------------------------------------------------------

    \55\ For a complete discussion of the benefits for Rule 206(3)-
3T, see 2007 Principal Trade Rule Release, Section VI.
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    We believe there are some benefits associated with extension of the 
rule for one year. By extending the rule for one year, 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 will continue to have access to those securities 
without disruption. Firms relying on the rule will continue to be able 
to offer clients and prospective clients access to certain securities 
on a principal basis as well and will not need during this one-year 
period to incur the cost of adjusting to a new set of rules or 
abandoning the systems established to comply with the current rule. In 
other words, extension will avoid disruption to clients and firms 
during the period while we consider whether to make the rule permanent 
in its current form or in a modified form or to let it expire.
    As discussed in the 2007 Principal Trade Rule Release,\56\ we 
presented estimates of the costs of each of the rule's disclosure 
elements, including: the 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.\57\ Finally, we solicited comment on, 
and requested data to assist us in further developing, our cost and 
benefit estimates.\58\
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    \56\ See 2007 Principal Trade Rule Release, Section VI.D.
    \57\ We note that the rule provides an alternative means of 
compliance with Section 206(3) of the Advisers Act. Therefore, there 
is no requirement that any adviser rely on it. We believe that it is 
reasonable to assume that only those advisers that conclude that the 
benefits in aggregate outweigh the aggregate costs of relying on the 
rule would choose to do so.
    \58\ See 2007 Principal Trade Rule Release, Section VI.
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    We did not receive comments directly addressing with supporting 
data the cost-benefit analysis we presented in the 2007 Principal Trade 
Rule Release and we continue to believe that our estimates reflect the 
likely costs an adviser would incur to rely on the rule.\59\ Several of 
the comments described above, however, relating to the utility of 
specific disclosure provisions, along with an additional comment 
regarding the potential effect of the rule on small firms, do have 
bearing on our cost-benefit analysis of the rule. In particular, one 
commenter argued that the costs of transaction-by-transaction notice 
and consent for sophisticated investors may outweigh the benefits.\60\ 
This commenter suggested that the rule expressly permit negative 
consent for principal trading because the costs for certain clients who 
must locate and contact an authorized person to sign an affirmative 
consent on behalf of the client on a timely basis may outweigh the 
benefits.\61\ Another commenter expressed doubt that the benefit of the 
transaction-by-transaction confirmation requirement would outweigh the 
costs of revising and further burdening the standard confirmation form, 
especially given the rule's other disclosure and consent 
requirements.\62\ Another commenter argued that limiting the 
availability of the rule to advisers that also are registered as 
broker-dealers imposes substantial regulatory burdens that are not 
justified by corresponding investor protection benefits.\63\ We 
recognize these commenters' concerns and will consider them, as well as 
all the other comments we have received, if we determine to propose to 
make the rule permanent in its current or a modified form. For purposes 
of the limited extension at issue here, however, we believe the costs 
of adjustments to practices and systems that may or may not be 
continued or necessary under a potential, future permanent rule would 
not be justified at this time.\64\
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    \59\ As discussed above, fewer firms than we anticipated at the 
time we adopted the rule on an interim final basis immediately 
determined to rely on it. We received no comments on our estimate of 
the number of advisers or accounts and, for purposes of this 
release, are retaining our original estimates.
    \60\ DPW Letter.
    \61\ Id.
    \62\ FD/CFA Letter.
    \63\ ABA Committee Letter.
    \64\ See Section II.C. of this Release.
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    We acknowledge that firms relying on the rule would incur 
operational costs associated with complying with the rule for one year. 
We believe that the estimates of the costs we outlined were reasonable, 
and no commenter provided specific, alternative estimates. We believe 
that the benefits were appropriately identified. We believe that all 
the costs and benefits associated with the rule--which, as noted above, 
the purpose of which was to permit broker-dealers to sell to their non-
discretionary advisory clients 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) should be considered in aggregate. The particular 
array of disclosure requirements and limitations contained in the rule 
was tailored to safeguard investor protection and counterbalance 
investor protection concerns that might stem from the rule's allowance 
for transaction-by-transaction notice and consent to principal trades 
to be delivered orally or in written form, instead of just in written 
form. We believe that, for purposes of this one-year extension of the 
rule, these overall benefits justify the costs associated with the 
rule.

VI. Promotion of Efficiency, Competition, and Capital Formation

    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

[[Page 69014]]

action will promote efficiency, competition, and capital formation.\65\
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    \65\ 15 U.S.C. 80b-2(c).
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    As we explained in the 2007 Principal Trade Rule Release, Rule 
206(3)-3T may increase efficiency by providing an alternative means of 
compliance with Section 206(3) of the Advisers Act that we believe will 
be less costly and less burdensome.\66\ By permitting oral transaction-
by-transaction disclosure, advisers may be more willing to engage in 
principal trades with advisory clients leading advisers to provide 
access to certain securities the adviser or its affiliate has in 
inventory. As we noted in the 2007 Principal Trade Rule Release, firms 
have argued that making securities available to clients through 
principal trades could lead to faster or less expensive execution, 
advantages a client may deem to outweigh the risks presented by 
principal trading with an adviser.\67\
---------------------------------------------------------------------------

    \66\ 2007 Principal Trade Rule Release, Section VII.
    \67\ Id.
---------------------------------------------------------------------------

    We further explained our expectation that Rule 206(3)-3T will 
promote competition because it preserves investor choice for different 
types of advisory accounts and that, if Rule 206(3)-3T has any effect 
on capital formation, it is likely to be positive, although 
indirect.\68\ We also described our understanding that providing an 
alternative to the traditional requirements of transaction-by-
transaction written disclosure might serve to broaden the potential 
universe of purchasers of securities, in particular investment grade 
debt securities, for the reasons described in the 2007 Principal Trade 
Rule Release, opening the door to greater investor participation in the 
securities markets with a potential positive effect on capital 
formation.\69\
---------------------------------------------------------------------------

    \68\ Id.
    \69\ Id., Section II.B.2.
---------------------------------------------------------------------------

    Some commenters, while expressing support for the goal of affording 
investors engaged in principal transactions the protections of both the 
investment adviser regulatory regime (i.e., the Advisers Act and rules 
thereunder) and the broker-dealer regulatory regime (i.e., the Exchange 
Act and rules thereunder and the rules of applicable SROs), opposed the 
limitation of the temporary rule not only to investment advisers that 
are also registered as broker-dealers, but also to accounts that are 
subject to both the Advisers Act and Exchange Act.\70\ One of these 
commenters specifically argued that these limitations are unnecessary, 
contending they provide no additional protection for investors engaging 
in principal transactions because any principal trades conducted for an 
advisory account would be subject to the Exchange Act and SRO rules 
anyway.\71\ This commenter concluded that the limitation instead merely 
provides a competitive advantage to investment advisers that are also 
registered broker-dealers.\72\
---------------------------------------------------------------------------

    \70\ See, e.g., FPA Letter I; ABA Committee Letter; SIFMA Letter 
I. Another commenter commented upon potential anti-competitive 
aspects of the rule, in particular as it relates to a proposed (but 
not adopted) interpretive rule that was proposed on the same day 
Rule 206(3)-3T was adopted on an interim final basis. IASBDA Letter. 
See also note 19 above. Because those comments relate more directly 
to the proposed interpretive rule, they will be considered in 
conjunction with that interpretive rulemaking.
    \71\ FPA Letter I (arguing that a client engaging in a principal 
trade enjoys the benefits of two regulatory regimes regardless of 
whether the client's adviser is itself both an investment adviser 
and a broker-dealer for purposes of the Federal securities laws or 
instead affiliated with a separate broker-dealer with which the 
client engages in the trade on a principal basis because, in the 
first instance, a single firm is responsible for meeting all 
regulatory requirements (including those of the Commission and the 
relevant SRO) and in the second, one firm holds the broad fiduciary 
duties of an adviser (and is subject to Commission oversight), while 
the affiliated broker-dealer must still comply with the Commission's 
and relevant SRO's sales practice and best execution requirements).
    \72\ Id.
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    We intend to continue to evaluate the effects of the rule on 
efficiency, competition and capital formation as we consider whether to 
propose to extend or modify the rule or allow it to expire. As 
discussed above, we have no reason to believe, based on our experience 
with the rule to date, that small broker-dealers (or affiliated but 
separate investment advisers and broker-dealers) are put at a 
competitive disadvantage to larger advisers that are themselves also 
registered as broker-dealers. We believe that the effects on 
efficiency, competition and capital formation of Rule 206(3)-3T as it 
was adopted on an interim final basis warrant its continued operation 
for the additional limited period of time. We anticipate no new effects 
on efficiency, competition and capital formation as a result of the 
one-year extension. During that time, we will continue to assess the 
rule's operation and impact along with intervening developments.

VII. Final Regulatory Flexibility Act Analysis

    A final regulatory flexibility analysis (``FRFA'') was prepared in 
accordance with 5 U.S.C. 603 when Rule 206(3)-3T was adopted in 
September 2007. In the 2007 Principal Trade Rule Release, we analyzed: 
(i) The need for and objectives of the rule; (ii) an estimate of small 
entities subject to the rule; (iii) the rule's projected reporting, 
recordkeeping and other compliance requirements; (iv) agency action to 
minimize the effect on small entities; (v) duplicative, overlapping or 
conflicting Federal rules; and (vi) significant alternatives. We sought 
comment on each of these aspects of our FRFA.
    As discussed above, several commenters objected to the condition 
that advisers seeking to rely on the rule must also be registered as 
broker-dealers and that each account must be subject to both the 
Advisers Act and the Exchange Act (and applicable SRO rules). Some 
contended that the burdens of requiring application of both regulatory 
regimes do not outweigh the benefits.\73\ Others essentially argued 
that limiting the availability of the relief under the rule to advisers 
also registered as broker-dealers might be anti-competitive.\74\ With 
respect to small entities in particular, one commenter suggested that 
the alternative means of compliance with the Advisers Act's principal 
trading restrictions made available by Rule 206(3)-3T (in particular, 
when considered in conjunction with the interpretive rule proposed on 
the same day),\75\ would disadvantage small broker-dealers because they 
are less likely to also be registered as an investment adviser, and as 
a result would have to form an adviser to take advantage of the 
benefits of the rule.\76\
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    \73\ See notes 35-36 and accompanying text above
    \74\ See notes 70-72 and accompanying text above.
    \75\ See note 19 above.
    \76\ IASBDA Letter.
---------------------------------------------------------------------------

    We specifically considered and discussed these issues in the final 
regulatory flexibility analysis in the 2007 Principal Trade Rule 
Release and believe that it is appropriate to continue this condition 
of the rule for the limited extension. As explained above, however, we 
expect to continue to consider these comments in conjunction with data 
our staff gathers on the operation of the rule in the marketplace, no 
later than the end of the rule's revised termination date if the 
Commission intends to propose to continue the same or similar relief.

VIII. Statutory Authority

    The Commission is adopting Rule 206(3)-3T pursuant to Sections 206A 
and 211(a) of the Advisers Act.

Text of Rule

List of Subjects in 17 CFR Part 275

    Investment advisers, Reporting and recordkeeping requirements.

0
For the reasons set out in the preamble, Title 17, Chapter II of the

[[Page 69015]]

Code of Federal Regulations is amended as follows:

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

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

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

* * * * *

0
2. Section 275.206(3)-3T(d) is revised to read as follows:

Sec.  275.206(3)-3T  Temporary rule for principal trades with certain 
advisory clients.

    (d) This section will expire and no longer be effective on December 
31, 2010.

    Dated: December 23, 2009.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-30877 Filed 12-29-09; 8:45 am]

BILLING CODE 8011-01-P