[Federal Register Volume 77, Number 198 (Friday, October 12, 2012)]
[Proposed Rules]
[Pages 62185-62191]
[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<EMAIL_ADDRESS>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<PHONE_NUMBER> or
<EMAIL_ADDRESS>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\

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

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

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

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

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-

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