[Federal Register Volume 60, Number 148 (Wednesday, August 2, 1995)]
[Proposed Rules]
[Pages 39574-39584]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-18891]
[[Page 39573]]
_______________________________________________________________________
Part III
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Parts 270 and 274
Status of Investment Advisory Programs Under the Investment Company Act
of 1940; Proposed Rules
Federal Register / Vol. 60, No. 148 / Wednesday, August 2, 1995 /
Proposed Rules
[[Page 39574]]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 270 and 274
[Release No. IC-21260; IA-1510; S7-24-95]
RIN 3235-AG07
Status of Investment Advisory Programs Under the Investment
Company Act of 1940
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule and form; request for comment.
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SUMMARY: The Commission is publishing for public comment revised
proposed rule 3a-4 under the Investment Company Act of 1940, which
would provide a nonexclusive safe harbor from the definition of
investment company for certain programs under which investment advisory
services are provided to clients. Programs that are organized and
operated in a manner consistent with the rule's conditions would not be
required to register under the Investment Company Act or to comply with
the Act's substantive requirements. The Commission also is proposing
Form N-3a4 under the Investment Company Act, which would be filed with
the Commission by sponsors of programs intending to rely on rule 3a-4.
The rule and form are intended to provide guidance regarding the status
of investment advisory programs under the Investment Company Act, and
to facilitate Commission examination of persons involved in the
operation of these programs. Finally, in connection with the
preparation of an interpretive release, the Commission is requesting
comment regarding the application of certain provisions of the
Investment Advisers Act of 1940 to investment advisers participating in
investment advisory programs.
DATES: Comments on the revised proposed rule and the proposed form
should be received on or before October 2, 1995.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street
NW., Washington, DC 20549. All comment letters should refer to File No.
S7-24-95. All comments received will be available for public inspection
and copying in the Commission's Public Reference Room, 450 Fifth
Street, N.W., Washington, D.C. 20549.
FOR FURTHER INFORMATION CONTACT: Rochelle Kauffman Plesset, Senior
Counsel, or Eric C. Freed, Special Counsel, (202) 942-0660, Office of
Chief Counsel, Division of Investment Management, 450 Fifth Street NW.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission
(``Commission'') is publishing for comment revised proposed rule 3a-4
[17 CFR 270.3a-4] under the Investment Company Act of 1940 [15 U.S.C.
80a-1 et seq.] (the ``Investment Company Act''). Rule 3a-4 would
provide a nonexclusive safe harbor from the definition of investment
company for certain programs under which investment advisory services
are provided to clients (``investment advisory programs''). The
Commission also is proposing new Form N-3a4 [17 CFR 274.222] under the
Investment Company Act, which would be filed by sponsors of investment
advisory programs that intend to rely on rule 3a-4. Finally, the
Commission is requesting comment with respect to certain issues that
investment advisory programs raise under the Investment Advisers Act of
1940 (the ``Advisers Act'').
TABLE OF CONTENTS
Executive Summary
I. Background
II. Discussion
A. Revised Proposed Rule 3a-4
1. Role of the Sponsor
2. Individualized Treatment
i. Management of Client Accounts
ii. Client Contact--Initial and Ongoing
iii. Reasonable Management Restrictions
iv. Quarterly Account Statements
v. Minimum Account Size
3. Indicia of Ownership
i. Ability to Withdraw and Pledge Securities
ii. Right to Vote Securities
iii. Right to Receive Confirmations and Other Documents
iv. Rights as Securityholders
4. Written Procedures and Agreements
B. Form N-3a4
C. Advisers Act Issues Raised by Investment Advisory Programs
III. Cost/Benefit Analysis
IV. Summary of Initial Regulatory Flexibility Analysis
V. Statutory Authority
Text of Revised Proposed Rule and Proposed Form
Executive Summary
The Commission is publishing for public comment revised proposed
rule 3a-4 under the Investment Company Act to provide a nonexclusive
safe harbor from the definition of investment company for certain
investment advisory programs. Investment advisory programs typically
are designed to provide the same or similar professional portfolio
management services on a discretionary basis to a large number of
individual clients.
Revised proposed rule 3a-4 would exclude any investment advisory
program from the definition of investment company provided that the
program is organized and operated in compliance with the rule's
conditions.1 The revised proposed rule would require that: (i)
Each client's account be managed on the basis of the client's financial
situation, investment objectives, and instructions; (ii) the sponsor of
the program obtain information from each client that is necessary to
manage the client's account individually; (iii) the sponsor and
portfolio manager be reasonably available to consult with clients; (iv)
each client have the ability to impose reasonable restrictions on the
management of the account; (v) each client be provided with a quarterly
statement containing a description of all activity in the client's
account; (vi) each client retain the indicia of ownership of all
securities and funds in the account; (vii) the sponsor establish and
effect written procedures that are reasonably designed to ensure that
each of the conditions of rule 3a-4 is met; (viii) if the sponsor
designates another person to perform certain obligations under the
rule, the sponsor obtain from that person a written agreement to
perform those obligations; (ix) the sponsor maintain and preserve the
policies, procedures, agreements and other documents relating to the
program in the manner set forth in the rule; and (x) the sponsor
furnish to the Commission upon demand copies of specified documents.
The conditions of the revised proposed rule are based on the conditions
of a previously proposed rule, as modified and interpreted in a series
of no-action letters issued by the Commission staff over the past
thirteen years.
\1\ If revised proposed rule 3a-4 is adopted, interests in
investment advisory programs that are organized and operated in
compliance with the conditions of the rule would not require
registration under section 5 of the Securities Act of 1933 (15
U.S.C. 77e).
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Programs that are organized and operated in a manner consistent
with the rule would not be required to register under the Investment
Company Act or be subject to that Act's provisions. The rule is
intended to be a nonexclusive safe harbor; it is not intended to create
any presumption about a program that is not organized and operated in
compliance with the rule.
The Commission also is proposing Form N-3a4 under the Investment
[[Page 39575]]
Company Act. Revised proposed rule 3a-4 would require Form N-3a4 to be
filed by sponsors of programs intending to rely on the rule.
Finally, the Commission is requesting comment with respect to the
application of certain provisions of the Advisers Act to investment
advisers participating in investment advisory programs. These comments
will be considered in the preparation of an interpretive release
dealing with certain issues raised under the Advisers Act by investment
advisory programs.
I. Background
In recent years, there has been a proliferation of investment
advisory programs that typically are designed to provide professional
portfolio management services to a large number of individual clients.
These programs have historically been marketed to clients who are
investing an amount of money less than the amount otherwise required by
portfolio managers but more than the minimum account size of most
mutual funds.
Investment advisory programs typically are organized and
administered by a sponsor, which provides, or arranges for the
provision of, asset allocation advice and administrative
services.2 In some programs, the sponsor or its employees also
provide portfolio management services, including the selection of
particular securities, to the program's clients. In other programs, the
sponsor selects, or provides advice to clients regarding the selection
of, a portfolio manager (which may or may not be affiliated with the
sponsor).3 In these programs, the sponsor generally is responsible
for continuously monitoring the portfolio manager selected and its
management of client accounts. The sponsor, rather than the portfolio
manager, often serves as the primary contact for the client in
connection with the program.4 The sponsor and the portfolio
managers usually meet the definition of ``investment adviser'' under
the Advisers Act 5 and are required to register under that
Act,6 unless they are excepted from the definition of investment
adviser 7 or exempted from registration.8
\2\ The sponsor is often a broker-dealer or mutual fund adviser
or, in some instances, a bank or money management firm. See, e.g.,
Wall Street Preferred Money Managers, Inc. (pub. avail. Apr. 10,
1992) (broker-dealer); Strategic Advisers Inc. (pub. avail. Dec. 13,
1988) (mutual fund adviser); Atlantic Bank of New York (pub. avail.
June 7, 1991) (bank). The sponsor also may execute some or all of
the transactions in client accounts.
\3\ More than one portfolio manager may manage the client's
assets, depending on the program, the client's investment
objectives, and the size of the client's account. See, e.g.,
Westfield Consultants Group (pub. avail. Dec. 13, 1991); Rauscher
Pierce Refsnes, Inc. (pub. avail. Apr. 10, 1992); Wall Street
Preferred Money Managers, Inc., supra note .
\4\ Some investment advisory programs, however, are marketed by
the sponsor through unaffiliated investment advisers, such as small
financial planners. In some of these programs, the unaffiliated
investment adviser rather than the sponsor may serve as the primary
contact for its clients that participate in the program. See, e.g.,
Westfield Consultants Group, supra note .
\5\ 15 U.S.C. 80b-1 et seq.
\6\ Section 203(a) of the Advisers Act (15 U.S.C. 80b-3(a))
requires any person who meets the definition of investment adviser
and is not otherwise exempt from registration to register with the
Commission. Section 202(a)(11) of the Advisers Act (15 U.S.C. 80b-
2(a)(11)) defines ``investment adviser'' as ``any person who, for
compensation, engages in the business of advising others, either
directly or through publications or writings, as to the value of
securities or as to the advisability of investing in, purchasing, or
selling securities, or who, for compensation and as part of a
regular business, issues or promulgates analyses or reports
concerning securities . . . .''
\7\ See section 202(a)(11)(A)-(F) of the Advisers Act (15 U.S.C.
80b-2(a)(11)(A)-(F)) (persons excepted from the definition of
investment adviser). A sponsor of an investment advisory program
that is a broker-dealer or a registered representative of a broker-
dealer generally cannot rely on the exception from the definition of
investment adviser for broker-dealers in section 202(a)(11)(C) of
the Advisers Act. See, e.g., National Regulatory Services, Inc.
(pub. avail. Dec. 2, 1992). That exception is available only to a
broker-dealer that provides investment advice that is ``solely
incidental'' to its brokerage business and that does not receive
special compensation for the investment advice. Id. The staff is of
the view that an investment advisory program generally is not
incidental to a sponsor's broker-dealer business and, at least in a
wrap fee program, the sponsor's portion of the wrap fee is special
compensation. Id.
\8\ See section 203(b) of the Advisers Act (15 U.S.C. 80b-3(b))
(persons exempted from registration). Unlike a person excepted from
the definition of investment adviser, a person that meets the
definition but is exempted from registration remains subject to the
Advisers Act's antifraud provision, section 206 (15 U.S.C. 80b-6).
The exemption from registration provided in section 203(b)(3) of the
Advisers Act would not be available as a general matter to the
sponsor or portfolio manager of an investment advisory program
because participation in the program would cause the sponsor or
portfolio manager to be holding itself out to the public as an
investment adviser. See, e.g., Resource Bank & Trust (pub. avail.
Mar. 29, 1991).
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Included among these investment advisory programs are those
commonly referred to as ``wrap fee programs.'' In a wrap fee program,
the client is typically provided with portfolio management, execution
of transactions, asset allocation, and administrative services for a
single fee based on assets under management.9 As of year-end 1994,
assets in wrap fee programs totaled approximately $116.8 billion, an
increase of 42 percent over a two-year period.10
\9\ See paragraph (g)(4) of rule 204-3 under the Advisers Act
(17 CFR 275.204-3(g)(4)) (defining wrap fee program for purposes of
wrap fee brochure requirement).
\10\ The Cerulli Report, The State of the Wrap Account Industry
3 (1995). According to this report, assets in mutual fund wrap
programs, also called mutual fund asset allocation programs,
represented 11% of total assets in wrap fee programs as of year-end
1994. These programs differ from traditional wrap fee programs, in
part, in that a client's assets are allocated only among specified
mutual funds.
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Under wrap fee and other investment advisory programs, a client's
account typically is managed on a discretionary basis in accordance
with pre-selected investment objectives. Clients with similar
investment objectives often receive the same investment advice and may
hold the same or substantially the same securities in their accounts.
In light of this similarity of management, some of these investment
advisory programs meet the definition of investment company under the
Investment Company Act, and can be deemed to be issuing securities for
purposes of the Securities Act of 1933 (``Securities Act'').11
\11\ 15 U.S.C. 77a et seq. See In the Matter of Clarke Lanzen
Skalla Investment Firm, Inc., Investment Company Act Release No.
21140 (June 16, 1995); SEC v. First National City Bank, Litigation
Release No. 4534 [1969-1970 Transfer Binder] Fed. Sec. L. Rep. (CCH)
para. 92592 (Feb. 6, 1970).
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Section 3(a)(1) of the Investment Company Act defines the term
investment company generally to include any ``issuer'' which is engaged
primarily in the business of investing, reinvesting, or trading in
securities.12 The definition of issuer includes any organized
group of persons, whether or not incorporated, that issues or proposes
to issue any security.13 An investment advisory program could be
considered to be an issuer because the client accounts in the program,
taken together, could be considered to be an organized group of
persons.14 Investors in the program could be viewed as purchasing
securities in the form of investment contracts.15 If an investment
advisory
[[Page 39576]]
program is deemed to be an ``issuer,'' it also would be deemed to be an
investment company because it is engaged in the business of investing,
reinvesting, or trading in securities.
\12\ 15 U.S.C. 80a-3(a)(1).
\13\ Section 2(a)(22) of the Investment Company Act defines
issuer generally to include any person who issues any security (15
U.S.C. 80a-2(a)(22)). Under section 2(a)(28), a person includes a
company, and under section 2(a)(8), a company includes any organized
group of persons, whether incorporated or not (15 U.S.C. 80a-
2(a)(28), 2(a)(8)).
\14\ The accounts managed by a particular portfolio manager also
can be considered an organized group of persons under certain
circumstances. The legislative history of the Investment Company Act
explained that one type of investment company involves ``an agency
relationship between the individual contributors to the fund and the
management upon whom they confer substantially a power of attorney
to act as agent in the investment of the moneys contributed. The
group of individual investors is not a legal entity but rather
constitutes in essence a combination of distinct individual
interests.'' H.R. Doc. No. 707, 75th Cong., 3rd Sess. 24 (1939). In
Prudential Insurance Co. of America v. SEC, the court, citing this
legislative history, found that an organized group of persons does
not refer only to identifiable business entities. 326 F.2d 383 (3rd
Cir.), cert. denied, 377 U.S. 953 (1964).
\15\ The definition of security in both section 2(a)(36) of the
Investment Company Act (15 U.S.C. 80a-2(a)(36)) and section 2(1) of
the Securities Act (15 U.S.C. 77b(1)) includes an ``investment
contract.'' The Supreme Court, in SEC v. W.J. Howey Co., defined an
investment contract for purposes of the Securities Act as a scheme
that ``involves an investment of money in a common enterprise with
profits to come solely from the efforts of others.'' 328 U.S. 293,
301 (1946). The Commission has taken the view that an investment
advisory program could satisfy the common enterprise element of the
Howey test if the accounts are discretionary, the investors receive
the same or substantially overlapping investment advice, and the
investment advice is not ``individualized.'' See Individualized
Investment Management Services, Investment Company Act Release No.
11391 (Oct. 10, 1980), 45 FR 69479 (Oct. 21, 1980) (``Release
11391''). See also In the Matter of Clarke Lanzen Skalla Investment
Firm Inc., supra note ; SEC v. First National City Bank, supra note.
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The status of investment advisory programs under the Investment
Company Act and the Securities Act has been a subject of debate for
twenty-five years. In 1972, the Commission established the Advisory
Committee on Investment Management Services for Individual Investors
(``Advisory Committee'') to assist the Commission in developing
policies regarding these programs.16 The Advisory Committee
published a report generally concluding that an investment advisory
program should not be required to register under the Investment Company
Act as long as the program's clients maintain all indicia of ownership
of the securities in their accounts, thereby avoiding the ``pooling''
of client assets.17
\16\ The Advisory Committee was established after the Commission
instituted an enforcement action against an investment adviser and
broker-dealer for operating an unregistered investment company in
the form of an investment advisory program. While the program was
advertised as offering individualized advice, the adviser invested
client funds in a virtually identical manner and made investment
decisions in a generally uniform manner to all clients. SEC v. First
National City Bank, supra note . The Division subsequently denied
no-action relief to similar investment advisory programs. See, e.g.,
Wheat & Co., Inc. (pub. avail. July 9, 1971); Finanswer America/
Investments, Inc. (pub. avail. Apr. 26, 1971); Jacobs Persinger &
Parker (pub. avail. Mar. 8, 1971).
\17\ Advisory Committee on Investment Management Services for
Individual Investors, Small Account Investment Management Services
(Jan. 1973). The Advisory Committee also concluded that the
interests in the program (i.e., the client accounts) should not be
required to be registered as securities under the Securities Act if
the program provides each client with individualized treatment.
In 1980, the Commission proposed rule 3a-4 under the Investment
Company Act, which would have provided a safe harbor from the
definition of investment company for investment advisory programs
meeting the conditions of the rule.18 The proposed rule would have
required that: (i) The client receive continuous advice based on its
individual needs; (ii) the persons authorized to make investment
decisions have significant contact with the client, as described in the
rule; (iii) each client maintain all indicia of ownership of the
securities in its account; and (iv) each client have the opportunity
and authority to instruct the person managing its account to refrain
from purchasing particular securities that otherwise might be
purchased. The Commission expressed the view that when an investment
manager provides each client with individualized treatment, the
likelihood of a common enterprise existing among a group of advisory
clients is substantially reduced and no investment company is
created.19
\18\ See Release 11391, supra note . Release 11391 also stated
that the Commission's Division of Corporation Finance had indicated
that if rule 3a-4 was adopted, that Division would not recommend
that the Commission take enforcement action under the Securities Act
with respect to the interests in an investment advisory program
operated in accordance with the proposed rule's requirements. Id. at
n.15.
\19\ Id. at note and accompanying text. Although the statements
in the Release 11391 focused on the necessity for each client to be
provided with individualized treatment, the proposed rule also would
have included conditions designed to avoid the ``pooling'' of client
assets.
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Commenters generally opposed the proposed rule, arguing, among
other things, that the rule's conditions were burdensome, would cause
unnecessary changes in industry practice, and were too detailed for
purposes of a safe harbor rule.20 In contrast, one commenter
argued that the proposed rule would have permitted programs that are de
facto investment companies to be excluded from regulation under the
Investment Company Act merely by meeting ``mechanistic and ritualistic
conditions,'' the performance of which is not indicative of
individualized investment advice being provided.21 The proposed
rule was never adopted.
\20\ E.g., Letter from the American Bar Association to George A.
Fitzsimmons, Secretary, SEC 1-2, 4 (Jan. 9, 1981), File No. S7-854;
Letter from the Investment Counsel Association of America, Inc. to
George A. Fitzsimmons, Secretary, SEC 3-4 (Jan. 9, 1981), File No.
S7-854; Letter from Neuberger and Berman to George A. Fitzsimmons,
Secretary, SEC 2 (Jan. 12, 1981), File No. S7-854.
\21\ Letter from the Investment Company Institute to George A.
Fitzsimmons, Secretary, SEC 2, 4 (Jan. 9, 1981), File No. S7-854.
This commenter also pointed out that the proposed rule would have
permitted commercial banks, which are excepted from regulation under
the Advisers Act, to sponsor investment advisory programs without
being subject to the Advisers Act's prohibitions against conflicts
of interest, the Act's brochure requirements, and inspection by
Commission staff. Id. at 2.
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Since the proposal of rule 3a-4, the Division of Investment
Management (``Division'') has responded to numerous inquiries with
respect to the status of wrap fee and other types of investment
advisory programs under the Investment Company Act. The Division has
issued over 20 letters to persons requesting assurance that the
Division would not recommend that the Commission bring enforcement
action with respect to investment advisory programs that are not
registered under the Investment Company Act (the ``no-action
letters'').22 Each of these letters was conditioned on
representations that were based primarily on the terms of proposed rule
3a-4.23
\22\ In each case, the Division of Corporation Finance also has
granted no-action relief with respect to registration of interests
in the programs under the Securities Act.
\23\ See, e.g., Wall Street Preferred Money Managers, Inc.,
supra note ; Rauscher Pierce Refsnes, Inc., supra note .
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II. Discussion
The investment advisory program industry has developed and matured
since the original proposal of rule 3a-4 in 1980. During this time
period, the Commission has acquired substantial experience with the
organization and operation of investment advisory programs. This
experience has come from the review of numerous requests for no-action
relief, as well as from examinations of sponsors and other registered
investment advisers that are involved with operating these programs.
For many of these programs, registration and regulation under the
Investment Company Act would not appear to be necessary.24
Nevertheless, that the law in this area has been defined and redefined
principally through a series of no-action letters has created some
uncertainty regarding the status of these programs under the federal
securities laws. While counsel can (and frequently does) offer advice
and issue opinions based on the no-action letters, those letters do not
provide the same degree of certainty that would be provided by a
Commission rule and may not be as readily accessible. The Commission is
therefore publishing for comment revised proposed rule 3a-4 to provide
a regulatory safe harbor from investment company regulation for
programs that satisfy certain conditions. The Commission also is
proposing new Form N-3a4, which would be filed with the Commission by
sponsors of
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investment advisory programs intending to rely on rule 3a-4.25
\24\ The Commission, however, recently brought an enforcement
action against a sponsor of an investment advisory program that was
operating as an unregistered investment company. In the Matter of
Clarke Lanzen Skalla Investment Firm, Inc., supra note .
\25\ The Commission previously has adopted amendments to rule
204-3 (17 CFR 275.204-3) and Form ADV under the Advisers Act to
require sponsors of wrap fee programs to provide prospective clients
of these programs with specified information. Disclosure by
Investment Advisers Act Regarding Wrap Fee Programs, Investment
Advisers Release No. 1411 (Apr. 19, 1994), 59 FR 21657 (Apr. 26,
1994).
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A. Revised Proposed Rule 3a-4
Revised proposed rule 3a-4 would provide a nonexclusive safe harbor
from the definition of investment company for investment advisory
programs that are organized and operated in a manner consistent with
the rule's conditions.26 The revised proposed rule would include a
number of conditions intended to ensure that clients in programs that
rely on the rule receive individualized treatment. While the Commission
believes that an investment advisory program that meets the rule's
conditions need not be regulated as an investment company, the
Commission acknowledges that there may be investment advisory programs
that do not comply with all of the rule's conditions and yet also
should not be regulated as investment companies. Thus, revised proposed
rule 3a-4 is intended to be a nonexclusive safe harbor, and is not
intended to create any presumption about a program that is not
organized and operated in compliance with the rule's
requirements.27
\26\ If revised proposed rule 3a-4 is adopted, interests in
investment advisory programs that are organized and operated in
compliance with the conditions of the rule would not require
registration under the Securities Act. See Preliminary Note to
revised proposed rule 3a-4.
\27\ Id. In addition, adoption of revised proposed rule 3a-4
would not affect the status of no-action letters previously issued
by the Division with respect to investment advisory programs.
Therefore, investment advisory programs that operate in a manner
consistent with these letters would not be required to register
under the Investment Company Act. If rule 3a-4 is adopted, the
Division as a general matter will not consider requests for no-
action or exemptive relief with respect to programs that do not
comply with the rule.
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1. Role of the Sponsor
Generally, the rule would require the ``sponsor'' of the program or
another person designated by the sponsor to perform the duties and
responsibilities set forth in the rule. Under paragraph (b),
``sponsor'' would be defined as any person who receives compensation
for sponsoring, organizing, or administering the program, or for
selecting, or providing advice to clients regarding the selection of,
persons responsible for managing the client's account in the program.
This definition is the same as the definition of sponsor used in
paragraph (f) of rule 204-3 under the Advisers Act, which sets forth a
separate brochure requirement for sponsors of wrap fee programs.28
The definition of sponsor is broad, and, in some investment advisory
programs, more than one person performing services for the program may
meet the definition. Accordingly, paragraph (b) would provide that if a
program has more than one sponsor, the sponsors must designate one
person as the principal sponsor, and that person would be responsible
for carrying out the sponsor's duties and responsibilities under the
rule.29
\28\ The sponsor of an investment advisory program usually is
required to register under the Advisers Act and comply with the
substantive provisions of that Act and the rules thereunder. See
supra notes--and accompanying text. Revised proposed rule 3a-4 would
be available to any sponsor of investment advisory programs, even if
the sponsor is excepted from the definition of investment adviser
under the Act (e.g., banks) or is exempt from registration. Persons
wishing to rely on the revised proposed rule, however, would be
required, among other things, regardless of their status under the
Advisers Act, to furnish certain specified records to the Commission
upon demand. See infra section II.A.4. (Written Procedures and
Agreements).
\29\ Paragraph (b) would not specify which sponsor must be
designated as the principal sponsor. However, the principal sponsor
would be responsible for carrying out the duties of the sponsor
under the rule, which would include establishing and effecting
written procedures and entering into agreements with other persons.
See infra section II.A.4. (Written Procedures and Agreements).
Typically the principal sponsor would be the person or entity that
is responsible for the overall organization and operation of the
program. The person designated as the principal sponsor would be the
person whose name appears on the program's Form N-3a4. See infra
section II.B. (Form N-3a4).
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2. Individualized Treatment
Revised proposed rule 3a-4 would contain four provisions that are
intended to ensure that clients of investment advisory programs that
are organized and operated in reliance on the rule receive
individualized treatment. These provisions are based on provisions of
rule 3a-4 as originally proposed, as those conditions were applied in
the no-action letters.
i. Management of Client Accounts. Paragraph (a)(1) would require
that each client's account be managed on the basis of the client's
financial situation, investment objectives, and instructions.\30\ This
paragraph is derived from a provision in the originally proposed rule
that would have required each client to be furnished with continuous
advice as to the investment of funds on the basis of the client's
individual needs.\31\
\30\ Under paragraph (a)(1), a sponsor or portfolio manager
would have to comply with any instructions given by a client
concerning the management of the client's account in an investment
advisory program, unless the instructions are so extensive or
burdensome to the management of the account as to be unreasonable,
or the sponsor or portfolio manager believes that the instructions
are inappropriate for the client. See infra section II.A.2.iii.
(Reasonable Management Restrictions). In these cases, the sponsor or
portfolio manager must notify the client that, unless the
instructions are modified, the client will not be permitted to
participate in the program.
\31\ See proposed paragraph (a)(1).
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Paragraph (a)(1) is intended to delineate one of the key
differences between clients of investment advisers and investors in
investment companies. Each client of an investment adviser typically is
provided with individualized advice regarding the management of the
client's account that is based on the client's financial situation and
investment objectives. The investment adviser of an investment company,
on the other hand, need not consider the individual needs of the
company's shareholders when making investment decisions regarding the
company's portfolio, and has no obligation to ensure that each security
purchased for the company's portfolio is an appropriate investment for
each shareholder. Thus, the clients of an investment advisory program
complying with paragraph (a)(1) would receive individualized advice of
a type not typically provided to investment company shareholders.
Unlike the originally proposed rule, paragraph (a)(1) of the
revised proposed rule would not require a portfolio manager to make
separate determinations regarding the appropriateness of each
transaction for each client prior to effecting the transaction.32
The revised proposed rule also would modify the Commission's prior view
that the use of model portfolios is ``presumptively inconsistent with
individualized treatment.'' 33 The Commission believes that an
investment advisory program in which clients with similar investment
objectives hold substantially the same securities in their accounts in
accordance with the portfolio manager's model does not necessarily
indicate that the clients in the program have not received
individualized treatment, particularly if the program is operated in a
manner consistent with revised proposed rule 3a-4.34
\32\ See Release 11391, supra note 15, at text accompanying
n.18.
\33\ See id., at text following n.18.
\34\ The Division has issued no-action letters with respect to
programs that allocate client assets in accordance with computerized
investment allocation models. See, e.g., Qualivest Capital
Management Inc. (pub. avail. July 30, 1990) (sponsor will use
computerized investment allocation model to allocate and reallocate
client assets among money managers); Atlantic Bank of New York,
supra note 2 (sponsor's asset allocation recommendation will be
based on client's investment needs and sponsor's model portfolios).
[[Page 39578]]
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ii. Client Contact--Initial and Ongoing
Paragraph (a)(2) would contain four requirements that generally are
intended to ensure that the sponsor has sufficient contact with each
client to be able to obtain the information necessary to manage the
client's account in accordance with paragraph (a)(1). Paragraph
(a)(2)(i) would require that, at the opening of the account, the
sponsor or a person designated by the sponsor 35 obtain
information from the client concerning the client's financial situation
and investment objectives. The client must at that time also be asked
to provide specific instructions, if any, concerning the management of
the account. The provision permits the sponsor (or its designee) to
obtain this information through interviews (either in person or by
telephone) and/or through questionnaires that clients must complete and
return prior to the opening of the account.36
\35\ See infra note 63.
\36\ See, e.g., Rauscher Pierce Refsnes, Inc., supra note 3
(prospective client will be interviewed and client will complete
questionnaire during interview); Strategic Advisers, Inc., supra
note 2 (prospective client will be interviewed over the telephone);
Manning & Napier Advisors, Inc. (Apr. 24, 1990) (prospective client
initially will submit written questionnaire followed by interview
over telephone).
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Paragraph (a)(2)(ii) would require that, at least annually, the
sponsor or a person designated by the sponsor contact the client to
determine whether there have been any changes in the client's financial
situation, investment objectives, or instructions. This contact need
not be made in any particular way and could be made, for example, in
person, by telephone, or by letter requesting the client to provide the
information.37 The provision would require sponsors to request
current information about clients of the program that is necessary for
the individualized management of a client's account.
\37\ The Commission recognizes that in some circumstances the
sponsor or designated person may be unable to reach the client. The
Commission would not take any enforcement action under this
provision if the sponsor or designated person is unsuccessful in
obtaining this information from the client, provided the sponsor or
designated person makes reasonable efforts to contact the client and
documents these efforts. Sponsors may wish to include the procedures
for contacting clients and documenting these efforts in the
procedures enacted pursuant to paragraph (a)(6)(i) of the rule. See
infra section II.A.4. (Written Procedures and Agreements).
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Paragraph (a)(2)(iii) would require that, at least quarterly, the
sponsor or a person designated by the sponsor notify the client in
writing that the sponsor or designated person should be contacted if
there have been any changes in the client's financial situation,
investment objectives or instructions.38 The paragraph also
requires the sponsor or designated person to provide the client with a
means in which such contact is to be made (e.g., by giving a telephone
number or an address). Like paragraph (a)(2)(ii), this provision is
intended to provide a procedure by which sponsors can obtain current
information about clients of the program. However, unlike paragraph
(a)(2)(ii), paragraph (a)(2)(iii) would require the sponsor or
designated person only to remind the client to contact the sponsor or
designated person if any changes have occurred in the client's
financial situation, investment objectives, or instructions. The client
would be responsible for contacting the sponsor or designated person if
changes had occurred.39
\38\ The notice need not be included as a separate piece of
paper, but could be included on another mailing sent to the client.
For example, the notification could appear in the quarterly
statement that would be sent to clients in accordance with proposed
paragraph (a)(4). See infra section II.A.2.iv. (Quarterly Account
Statements). The notice also could be delivered to the client by e-
mail or other electronic means consented to by the client.
\39\ See, e.g., Scudder, Stevens & Clark Ltd. (pub. avail Aug.
17, 1988) (quarterly statement will include a reminder that client
should contract sponsor if client needs or objectives change);
Qualivest Capital Management, Inc. supra note 34 (client will be
sent reminders to notify sponsor of any change in client's financial
situation or investment objectives).
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Paragraphs (a)(2)(i)-(iii) would place the obligations to contact
or notify the client on the sponsor or a person designated by the
sponsor. In contrast, the originally proposed rule would have required
the portfolio manager to contact the client.40 The revised
proposed rule recognizes that, in many investment advisory programs,
the sponsor is the person primarily responsible for client
contact.41 The revised proposed rule, however, would permit a
person other than the sponsor to fulfill these obligations, so long as
the sponsor specifically designated the person to do so.42
\40\ Paragraph (b) of proposed rule 3a-4.
\41\ See, e.g., Strategic Advisers, Inc., supra note (sponsor
primarily responsible); Wall Street Preferred Money Managers, Inc.,
supra note (same).
\42\ The revised proposed rule would permit persons such as
portfolio managers or advisers that refer clients to the program to
be primarily responsible for client contact. Paragraph (a)(6)(i)
would require the sponsor to obtain from each designated person an
agreement in writing to perform these duties. In addition, paragraph
(a)(6)(i) would require the sponsor to establish written procedures
that are reasonably designed to ensure that each of the conditions
of the rule is met. The procedures might, for example, describe in
detail the manner in which paragraphs (a)(2)(i)-(iii) are to be
effectuated, specify the persons primarily responsible for client
contact, and include provisions designed to monitor and record the
actions taken by such persons. See infra section II.A.4. (Written
Procedures and Agreements).
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Regardless of the person responsible for contacting the client and
obtaining the information necessary to manage the client's account, the
Commission expects that, in most cases, the information obtained would
be provided to the client's portfolio manager. If such information is
not provided to the portfolio manager, the manager may not be able to
manage the client's account on the basis of the client's financial
situation, investment objectives, and instructions, as would be
required under paragraph (a)(1). The Commission, however, requests
comment whether the sponsor or designated person should be explicitly
required by rule 3a-4 to convey this information to the portfolio
manager.
Paragraph (a)(2)(iv) would require the sponsor and the client's
portfolio manager to be reasonably available to consult with the client
concerning the management of the client's account. This provision is
intended to provide for reasonable client access to the sponsor and the
portfolio manager to ask questions or to seek additional information
about an investment advisory program. Even if a program's sponsor
serves as the primary contact for clients in the program, a procedure
must be provided by which the client has reasonable access to the
portfolio manager.43 Individualized treatment would not be
provided if a program's procedures do not provide an opportunity for
reasonable availability of the portfolio manager.44
\43\ See, e.g., Rauscher Pierce Refsnes, Inc., supra note 3 (the
portfolio manager, when necessary, will be available to discuss more
complex questions regarding the client's account); Westfield
Consultants Group, supra note 3 (client will be furnished the name
and direct telephone number of manager, who will be reasonably
available during business hours). In one no-action request, a
representation was made that the client would be able to contact an
unaffiliated adviser, the sponsor or the portfolio manager to obtain
information or assistance during normal business hours, but the
client might be charged hourly fees whenever the client requests the
services of investment officers to answer specific questions
regarding investment strategies with respect to its account. Manning
& Napier Advisors, Inc., supra note 36. Sponsors of programs
complying with revised proposed rule 3a-4 may impose similar
procedures, provided the client is informed prior to entering the
program that such fees may be charged.
\44\ Whether a sponsor or portfolio manager is ``reasonably
available'' would depend on an analysis of the facts and
circumstances. The procedures required under paragraph (a)(6)(i) may
include provisions detailing the manner in which the sponsor and the
portfolio manager intend to meet this requirement. Such procedures
could, for example, describe the manner in which the sponsor and
portfolio manager will be reasonably available to clients while
still allowing for time to perform their duties. However, a sponsor
or portfolio manager would not be ``reasonably available,'' for
example, if a client's contact with the sponsor or portfolio manager
were limited to viewing or listening to recorded interviews.
[[Page 39579]]
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iii. Reasonable Management Restrictions
Paragraph (a)(3) would require each client to have the ability to
impose reasonable restrictions on the management of its account. These
restrictions could include, for example, the designation of particular
securities or types of securities that should not be purchased for the
client's account.
The originally proposed rule would have required that each client
have the ability to instruct its portfolio manager to refrain from
purchasing particular securities that otherwise might be
purchased.45 Under the revised proposal, the client must be able
to impose reasonable restrictions on the management of its account. The
revised proposal specifically states that restrictions may include
prohibitions with respect to the purchase or sale of particular
securities or types of securities.
\45\ Proposed paragraph (d). The no-action letters involving
investment advisory programs typically have included representations
that were based on the proposed provision. See, e.g., Rauscher
Pierce Refsnes, Inc, supra note; 3.
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Whether a particular restriction is reasonable would depend on an
analysis of relevant facts and circumstances, including the nature of
the restriction and the portfolio manager's investment strategy.\46\
For example, the exclusion of individual stocks, stocks of an industry
group, or stocks from a specific country generally would be considered
to be reasonable restrictions. A restriction would not be unreasonable
simply because it placed administrative burdens on the manager or could
affect the performance of the accounts. Nonetheless, a restriction
would be unreasonable if it was clearly contradictory to the adviser's
investment philosophy or strategies. For example, it may be
unreasonable for a client to instruct a portfolio manager whose
investment strategy is to achieve long-term capital appreciation
through investments in equity securities to purchase only short-term
debt securities. Restrictions also may be deemed unreasonable if the
client changes the restrictions on the account with such frequency that
it interferes with the orderly management of the account. This may be
true even if each individual restriction, taken alone, would be
reasonable.\47\
\46\ The procedures required by paragraph (a)(6)(i) may define
what restrictions are considered unreasonable. To the extent that
the ``unreasonableness'' of restrictions is a matter of judgment,
the procedures, for example, may identify the person or persons
responsible for this determination and specify the factors to be
considered by those persons. See infra section II.A.4. (Written
Procedures and Agreements).
\47\ If particular restrictions sought to be imposed by a client
are found to be unreasonable, the client should be notified and
given a chance to restate the restriction more reasonably. If unable
or unwilling to do so, the client may be removed from the program.
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The ability of clients of a program to place restrictions is a
critical factor in determining whether individualized treatment is
provided under that program. This ability is a crucial difference
between a client receiving investment advisory services and an investor
in an investment company.48
\48\ Under paragraph (a)(2), a sponsor or person designated by
the sponsor would be required to ask the client for instructions
regarding the management of its account. The request for
instructions is intended, in part, to give the client the
opportunity to convey any investment restrictions it wishes to
impose on the management of its account.
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iv. Quarterly Account Statements
Paragraph (a)(4) would require that each client be provided, on a
quarterly basis, with a statement describing all activity in the
client's account during the preceding quarter, including all
transactions made on behalf of the account, all contributions and
withdrawals made by the client, and all fees and expenses charged to
the account. The statement also would be required to include the value
of the account at both the beginning and end of the quarter. The
originally proposed rule also would have required quarterly statements,
but did not specify the information to be included in such
statements.49
\49\ Proposed paragraph (b)(3). A number of the no-action
letters have specified the content of the quarterly reports. See
Westfield Consultants Group, supra note 2 (quarterly statements will
contain a review and analysis of client account); Strategic
Advisers, Inc., supra note 2 (quarterly statements will contain a
description of investments); Republic National Bank of New York
(pub. avail. Aug. 23, 1982) (quarterly statements will show
holdings, value and change in value since preceding quarter).
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v. Minimum Account Size
Like the proposed rule, the revised proposed rule would not specify
a minimum size for client accounts in the program, leaving the account
size for each program up to the sponsor of the program.50 The
conditions of the revised proposed rule should be sufficient to ensure
individualized treatment. In addition, innovations in computer
technology may permit individualized treatment to be provided to
clients, including those with relatively small accounts, with greater
efficiency and minimal costs. A requirement for a minimum account size
also could effectively deny certain investors the opportunity to
participate in investment advisory programs that may be appropriate for
them. Nonetheless, providing individualized advice to a large number of
small accounts may be so costly and time-consuming as to render
individualized treatment impracticable.
\50\ The Division has granted no-action relief to investment
advisory programs with varying minimum account sizes. See, e.g.,
Qualivest Capital Management, Inc., supra note 34 ($5 million);
Atlantic Bank of New York, supra note 2 ($500,000); Wall Street
Preferred Money Managers, Inc., supra note 2 ($100,000); Strategic
Advisers, Inc., supra note 2 ($50,000).
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The Commission requests comment whether a minimum account size
should be required. Commenters favoring this requirement should specify
the minimum size that they believe that would be most appropriate
(e.g., $50,000, $100,000, $200,000), and address whether the minimum
amount should be required to be met only at the time the account is
opened, or whether the minimum or some lesser amount should be required
to be maintained while the client remains in the program. Commenters
favoring a requirement that a client maintain a minimum account size
while in the program also should comment whether the client should be
removed from the program if the account size fell below the initial
minimum due to investment loss rather than withdrawal. In addition,
commenters favoring a minimum size requirement should address whether
the minimum should apply to the client's aggregate investment in the
program, or to each account managed by a portfolio manager. Commenters
should also address whether any or all of the conditions of the revised
proposed rule would be rendered unnecessary by a minimum account size
requirement. Finally, commenters should address whether programs with
small account minimums should be subject to additional conditions not
imposed on programs with larger minimums, and if so, what those
conditions should be.
3. Indicia of Ownership
Paragraph (a)(5) would require that a client in an investment
advisory program retain certain indicia of ownership of all securities
and funds in the client's account. The paragraph lists specific
attributes of ownership that the client must retain.
The proposed rule would have required clients to maintain all
indicia of ownership of the funds in their accounts, and specified
certain requisite attributes of ownership.51 The revised proposed
rule would not require the client to maintain all indicia of ownership,
but would require the client
[[Page 39580]]
to maintain, at a minimum, those indicia listed. The Commission
believes that these specific indicia of ownership, which are based on
those represented as being retained by clients of programs described in
the no-action letters, provide clients with the ability to act as
owners of their securities.52
\51\ Proposed paragraph (c).
\52\ The revised proposed rule would not require the client to
be the record owner of the securities held in its account. The
Division has taken the position that an investment advisory program
would not be deemed to be an investment company solely because
securities are held in nominee or street name. The Division reasoned
that placing securities in nominee or street name is an
administrative mechanism used to record and facilitate the transfer
of ownership. In addition, requiring securities to be held in the
client's name would be inconsistent with Commission policy of
encouraging the holding of securities in nominee name to promote the
establishment of centralized clearance and settlement systems and
the elimination of certificated securities. UMB Bank, n.a. (pub.
avail. Jan. 23, 1995) (investment company securities). See, e.g.,
Manning & Napier Advisors, Inc., supra note 36 (non-investment
company securities). The recent enforcement action against Clarke
Lanzen Skalla Investment Firm, Inc., in which, among other things,
securities purchased on behalf of clients were held in nominee name,
was not inconsistent with the Division's position in the UMB Bank
no-action letter. See supra note 11.
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i. Ability to Withdraw and Pledge Securities
Paragraph (a)(5)(i) would require that the clients be able to
withdraw securities or cash from their accounts. Paragraph (a)(5)(ii)
also would specify that clients must be able to pledge the securities
in their accounts.53 Under some circumstances, programs may
require a client to withdraw the securities from his or her account
before using them as collateral. Such a requirement would be consistent
with the rule.
\53\ The proposed rule would have required that the client
maintain the right to ``hypothecate'' securities in its account.
That term is not included in the revised proposed rule because it is
generally considered to be synonymous with ``pledge.'' See Black's
Law Dictionary 669 (5th ed. 1979).
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ii. Right to Vote Securities
Paragraph (a)(5)(iii) would require that the client have the right
to vote the securities in his or her account. Implicit in this
requirement is the requirement that the client receive proxies in
sufficient time to permit the client to consider how to vote and to
submit the proxy. The provision would permit clients to delegate the
authority to vote securities to another person, such as the portfolio
manager or other fiduciary.54 However, the client must be
permitted to revoke the delegation at any time.55
\54\ Any such delegation should be contained in the investment
advisory agreement or in another document and retained with the
records relating to the program. The procedures for delegation may
also be specified in the procedures adopted under the rule.
\55\ The procedure for such revocation should be described in
the procedures for the program. See infra section II.A.4. (Written
Procedures and Agreements).
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iii. Right to Receive Confirmations and Other Documents
Paragraph (a)(5)(iv) would provide, in part, that the client must
have the right to receive in a timely manner confirmations of
securities transactions of the type required by rule 10b-10 56
under the Securities Exchange Act of 1934.57 Proposed rule 3a-4
would have required clients to receive a ``notification of each
security transaction.'' 58 In subsequent no-action letters, the
Division modified this position, permitting monthly account statements
to be provided to clients unless more frequent confirmations were
requested.59
\56\ 17 CFR 240.10b-10. If a program is structured so that each
client's securities transactions are executed by a registered
broker-dealer, rule 10b-10 would govern the delivery of
confirmations. If client transactions are executed by an entity that
is not subject to rule 10b-10, the revised proposed rule would
require the delivery of confirmations in the manner required by rule
10b-10, to the same extent as if the transactions were executed by a
registered broker-dealer.
\57\ 15 U.S.C. 78a et seq.
\58\ Proposed paragraph (c)(2).
\59\ See, e.g., Westfield Consultants Group, supra note; Manning
& Napier Advisors, Inc., supra note; Jefferies & Company (pub.
avail. June 16, 1989).
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Under the revised proposal, clients could waive receipt of
individual confirmations to the extent the waiver would otherwise be
permitted under rule 10b-10. Thus, paragraph (a)(5) effectively would
provide a client in an investment advisory program with the option to
receive either individual confirmations for each transaction or
periodic statements, delivered no less frequently than quarterly, that
include the information required by rule 10b-10 with respect to all
transactions that occurred within the period covered by the
statement.60
\60\ The Commission has taken the view that, for purposes of
complying with rule 10b-10, a broker-dealer may provide a person
whose account is managed on a discretionary basis by a fiduciary,
such as a client in an investment advisory program, with a periodic
statement (delivered no less frequently than quarterly) in lieu of
the immediate confirmation for each transaction, if the broker-
dealer obtains from the person a written agreement stating that the
immediate confirmation will be provided to the fiduciary. The
periodic statement the broker-dealer sends to the person must
contain the same information that could have been in the immediate
confirmation for each transaction. Although the person may waive his
or her right to the immediate confirmation, the person may not waive
his or her right to the periodic statement. Confirmation of
Transactions, Securities Exchange Act Release No. 34962, notes 34-36
and accompanying text (Nov. 10, 1994), 59 FR 59612 (Nov. 17, 1994).
By reference to rule 10b-10, the revised proposed rule would
incorporate this position.
Paragraph (a)(5)(iv) also would require the client (or the client's
agent) to be provided with other documents that the client (or its
agent) would receive had the same securities been owned by the client
outside the program. These documents may include prospectuses, periodic
shareholder reports, proxies, and any other information and disclosure
required by applicable laws or regulations.61
\61\ The Commission recently approved a proposed amendment of a
rule of the National Association of Securities Dealers, Inc. to
permit beneficial owners of stock to designate a registered
investment adviser to receive and vote proxies on their behalf.
Self-Regulatory Organizations; Order Approving Proposed Rule Change
by National Association of Securities Dealers, Inc. Relating to
Interpretation of the Board of Governors--Forwarding of Proxy and
Other Material Under Article III, Section 1 of the NASD Rules of
Fair Practice, Securities Exchange Act Release No. 35681 (May 5,
1995), 60 FR 25749 (May 12, 1995).
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iv. Rights as Securityholders
Paragraph (a)(5)(v) would require that a client have the right to
proceed directly as a securityholder against the issuer of any security
in the client's account without having to join any person involved in
the operation of the program or any other client of the program as a
condition precedent to proceeding against an issuer. This provision,
which is based on conditions in several no-action letters,62 is
intended to ensure that the client would have the same rights as any
person holding the same securities outside an investment advisory
program. The right to proceed against an issuer of securities in a
client's account is another important difference between a client of an
investment adviser and an investment company shareholder, as the latter
generally would not be able to proceed directly against an issuer of
securities held by the investment company.
\62\ E.g., Westfield Consultants Group, supra note 3; Manning &
Napier Advisors, Inc., supra note 36; Jefferies & Company, supra
note 59; Rauscher Pierce Refsnes, Inc., supra note 3.
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4. Written Procedures and Agreements
Paragraph (a)(6) contains four requirements regarding the
establishment of written procedures and agreements covering the
operation of the program and the maintenance of records related to
these procedures and agreements. These conditions and their purposes
are described in more detail below. The Commission, however, is
sensitive to imposing undue burdens on sponsors of investment advisory
programs. Comment is therefore requested whether any of the conditions
discussed below would impose an
[[Page 39581]]
undue burden on persons relying on the rule, or whether the burden of
any condition would outweigh its benefits. Comment is specifically
requested whether any of these conditions can be eliminated,
consolidated, or otherwise made less burdensome without compromising
investor protection.
Paragraph (a)(6)(i) would require the sponsor of the program to
establish and effect written policies and procedures that are
reasonably designed to ensure that each of the provisions of the rule
is implemented. The paragraph also would require that, to the extent
that the sponsor designates another person to carry out certain
obligations under the rule, the sponsor must obtain from that person an
agreement in writing to carry out those obligations. These provisions
are designed to require the sponsor to formalize the manner in which it
intends to comply with rule 3a-4, and, if the sponsor delegates its
responsibilities under the rule, to specifically record the delegation
and obtain from the other parties an agreement acknowledging their
responsibilities.63 The requirement that a sponsor establish and
effect written procedures detailing compliance with the conditions of
rule 3a-4 also is intended to provide the Commission with a readily
available source of information regarding the manner in which the rule
is being interpreted and applied by the investment advisory industry.
\63\ In addition, because the procedures would be reasonably
designed to ensure that the provisions of the rule are implemented,
sponsors may wish to specify in the procedures the persons other
than the principal sponsor that are involved in the operation of the
program, and each person's duties. The procedures need not, however,
specify each individual by name.
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Paragraph (a)(6)(ii)(A) would require the sponsor to maintain and
preserve all written policies, procedures and agreements that pertain
to the operation of the investment advisory program in its office for
as long as it serves as the sponsor of that program.64 The
paragraph also would require the sponsor to maintain and preserve these
documents in an easily accessible place for not less than three years
after the sponsor ceases to serve as sponsor of the program. Given the
importance of these documents, the Commission believes that the
documents must be maintained and preserved in the office of the sponsor
for as long as the sponsor acts in that capacity, so that they are
available for easy reference. These documents also must be retained in
an easily accessible place for three years after the sponsor of the
program ceases to serve as the sponsor should any questions later arise
about the operation of the program.
\64\ Because an adviser may have more than one office, paragraph
(a)(6)(ii)(A) would provide that these records should be kept ``in
an appropriate office of the sponsor.'' This language is similar to
that used in paragraph (e)(i) of rule 204-2 under the Advisers Act
(15 CFR 275.204-2), which sets forth the recordkeeping requirements
for investment advisers.
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Paragraph (a)(6)(ii)(B) would require the sponsor or another person
designated by the sponsor to maintain and preserve all documents
created pursuant to the policies and procedures governing the operation
of the program, such as client contracts, client questionnaires, and
copies of client statements, in an easily accessible place for a period
of not less than five years from the end of the fiscal year during
which the document was created. Under this provision, these documents
would be required to be maintained and preserved in a manner similar to
that required for advisory books and records under paragraph (e)(i) of
rule 204-2.65 Unlike rule 204-2, however, paragraph (a)(6)(ii)(B)
would not require the documents to be kept for the first two years in
the office of the person creating or receiving the records (i.e., the
sponsor). Rather, the paragraph would permit the sponsor to designate
another person to maintain and preserve these documents.66
\65\ See supra note 64. Revised proposed rule 3a-4 would not
require the creation of any records other than the policies,
procedures, and written agreements if the sponsor designates another
person to perform obligations under the revised proposed rule or to
maintain and preserve certain books and records. Paragraphs
(a)(6)(i), (a)(6)(iii). Paragraph (a)(6)(ii)(B), however, would
specify how records that are created pursuant to the policies and
procedures (whether or not also required by rule 204-2 under the
Advisers Act) must be maintained. If records pertaining to the
program are required to be created under rule 204-2, but not under
the policies or procedures, those records would be required to be
maintained in accordance with paragraph (e) of rule 204-2. See
National Regulatory Services, Inc., supra note (portfolio manager in
an investment advisory program must maintain records of brochure
delivery at its office, even if sponsor created such records).
\66\ However, as discussed below, the sponsor would be required
to enter into a written agreement with the designated person that
specifies that documents to be maintained by that person and that
copies of such documents would be provided to the sponsor upon
request.
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Paragraph (a)(6)(iii) would require the sponsor to enter into a
written agreement with any person designated to maintain and preserve
the books and records pertaining to the program (other than the written
policies, procedures and agreements). The paragraph also would require
that the agreement include a list of the books and records maintained
and preserved by that person and a provision obligating the person
maintaining the books and records to provide the sponsor with copies of
such books and records within a reasonable time of the sponsor's
request.
These requirements are intended to avoid duplicative recordkeeping
by allowing the sponsor to designate another person involved in the
operation of the investment advisory program to maintain copies of
books and records provided that person has a contractual obligation to
provide the records to the sponsor upon request. In addition, the
requirement that each party's recordkeeping responsibilities be
included in the party's agreement with the sponsor would help to ensure
that each person is aware of its responsibilities. Finally, since the
provision would require that the sponsor be able to request and obtain
promptly the books and records maintained by such persons, it
effectively would permit the sponsor to monitor more effectively the
person's performance of its duties under the contract, and help
facilitate Commission examinations.
Paragraph (a)(6)(iv) would require the sponsor to furnish to the
Commission upon demand copies of the policies, procedures, all
documents created pursuant to the policies and procedures, and the
written agreements with other persons involved in the operation of the
program. This provision is intended to facilitate Commission
examination of investment advisory programs relying on rule 3a-4.
As discussed above, most sponsors of investment advisory programs
are required to be registered under the Advisers Act.67 Thus,
these sponsors are already required under section 204 of the Advisers
Act to make advisory records available to the Commission upon
request.68 Revised proposed rule 3a-4, however, would be available
to all sponsors of investment advisory programs, regardless of their
status under the Advisers Act. Accordingly, paragraph (a)(6)(iv) is
intended to ensure that the Commission would have access to certain
records with respect to investment advisory programs that are sponsored
by persons that are not subject to the Advisers Act.
\67\ See supra notes 5-8 and accompanying text.
\68\ 15 U.S.C. 80b-4.
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B. Form N-3a4
Paragraph (a)(7) would require any sponsor of an investment
advisory program intending to rely on the safe harbor provided in rule
3a-4 to file with the Commission Form N-3a4.69 Form
[[Page 39582]]
N-3a4 would notify the Commission of investment advisory programs that
are intended to be organized and operated in compliance with the rule's
requirements.70 The form would assist the Commission in monitoring
the use of rule 3a-4 and facilitate Commission examination of persons
involved in investment advisory programs.
\69\ In addition, in the event that another person had
previously served as principal sponsor of, and submitted Form N-3a4
with respect to, an investment advisory program, the new principal
sponsor would be required to submit an amended Form N-3a4
identifying itself as the new sponsor and specifying the name of the
prior principal sponsor.
\70\ Paragraph (a)(7) also would require sponsors to file with
the Commission any amendments to the form. Thus, proposed Form N-3a4
also would be used to change information included in a prior filing,
to notify the Commission that the sponsor no longer intends to
operate the program in reliance on the safe harbor, or to notify the
Commission that a program operating in reliance on the safe harbor
will cease operations.
C. Advisers Act Issues Raised by Investment Advisory Programs
Wrap fee and other investment advisory programs raise, in addition
to the Investment Company Act issues addressed in this release, a
number of issues under the Advisers Act. The Commission expects to
publish an interpretive release that would address many of these
issues.
In particular, the Commission expects that the release will address
the suitability obligations of sponsors and portfolio managers to
clients of the investment advisory program, including suitability
obligations regarding client participation in the program, the
selection of portfolio managers, and the selection of investments. The
release will discuss how an adviser's obligation to seek best execution
applies in the context of wrap fee programs when brokerage commissions
are not charged separately for each transaction. In addition, the
interpretive release may discuss the application of the restrictions on
principal and agency cross transactions in section 206(3) of the
Advisers Act to investment advisory programs, including whether these
restrictions apply to transactions with a sponsor that is unaffiliated
with the portfolio manager recommending the transactions. Finally, the
release may address certain issues unique to programs under which
client assets are invested in mutual funds, including the disclosure
obligations of investment advisers regarding the various fees
associated with these programs.71
\71\ The recently adopted wrap fee disclosure requirements set
forth in Schedule H of Form ADV apply only to sponsors of wrap fee
programs and not to sponsors of mutual fund wrap programs.
---------------------------------------------------------------------------
The release will not be issued until after comments have been
received on revised proposed rule 3a-4. This timing would allow the
interpretive release to reflect, where appropriate, these comments.
Such a time schedule will also permit the consideration of comment from
members of the investment advisory program industry regarding the
issues expected to be addressed in the interpretive release. Commenters
are urged to submit such comments on these and any other issues
investment advisory programs raise under the Advisers Act. Comment is
specifically requested regarding how investment advisers participating
in investment advisory programs currently understand and comply with
their Advisers Act obligations. Commenters also are urged to suggest
specific factual situations that the release should address.
III. Cost/Benefit Analysis
Revised proposed rule 3a-4 under the Investment Company Act would
provide a nonexclusive safe harbor from the definition of investment
company for investment advisory programs. Programs that are organized
and operated in a manner consistent with the rule's conditions would
not be required to register under the Investment Company Act or comply
with the Act's substantive requirements. The revised proposed rule is
intended to provide guidance to persons operating investment advisory
programs regarding the status of these programs under the Investment
Company Act, and help to ensure that such programs do not operate as
investment companies without clients of the programs benefitting from
the Act's protections.
Proposed Form N-3a4 would be filed with the Commission by sponsors
of programs intending to rely on rule 3a-4. The proposed form would
help the Commission in monitoring the use of rule 3a-4 and facilitate
Commission examination of persons involved in these programs.
The Commission anticipates that the cost of compliance with revised
proposed rule 3a-4 and the proposed form would be small. In addition,
the Commission does not believe that compliance with any of the
proposed provisions would be unduly burdensome. Comment is requested,
however, on the costs and benefits associated with the revised proposed
rule and proposed form. Commenters should submit estimates for any
costs and benefits perceived, together with any supporting empirical
evidence available.
IV. Summary of Initial Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis in accordance with 5 U.S.C. 603 regarding revised proposed
rule 3a-4 and proposed Form N-3a4. The Analysis notes that the revised
proposed rule is intended to provide a nonexclusive safe harbor from
the definition of investment company for investment advisory programs
organized and operated in compliance with the conditions of the rule,
and that the proposed form would be filed with the Commission by
sponsors of investment advisory programs intending to rely on the rule.
The Analysis explains that the rule is intended to provide guidance
regarding the status of investment advisory programs under the
Investment Company Act, and that the rule and the form would facilitate
Commission examination of persons involved in the operation of a
program. The Analysis concludes that the rule would not be overly
costly or burdensome to sponsors of investment advisory programs that
intend to rely on the safe harbor. A copy of the Initial Regulatory
Flexibility Analysis may be obtained from Rochelle Kauffman Plesset, at
Mail Stop 10-6, Securities and Exchange Commission, 450 Fifth Street
NW., Washington, DC 20549.
V. Statutory Authority
The Commission is publishing for public comment revised proposed
rule 3a-4 and Form N-3a4 pursuant to the authority set forth in
sections 6(c) and 38(a) of the Investment Company Act [15 U.S.C. 80a-
6(c), -37(a)].
Text of Revised Proposed Rule and Proposed Form
List of Subjects in 17 CFR Parts 270 and 274
Investment companies, Reporting and recordkeeping requirements,
Securities.
For the reasons set out in the preamble, title 17, chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
1. The authority citation for Part 270 continues to read, in part,
as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-37, 80a-39 unless
otherwise noted;
* * * * *
2. By adding Sec. 270.3a-4 to read as follows:
[[Page 39583]]
Sec. 270.3a-4 Status of Investment Advisory Programs.
Note: This section is a nonexclusive safe harbor from the
definition of investment company for certain programs that provide
investment advisory services to clients. Interests in programs that
are organized and operated in compliance with the conditions of
Sec. 270.3a-4 also are not required to be registered under section 5
of the Securities Act of 1933 [15 U.S.C. 77e]. The section is not
intended, however, to create any presumption about a program that is
not organized and operated in compliance with the conditions.
(a) Notwithstanding section 3(a) of the Act [15 U.S.C. 80a-3], any
program under which investment advisory services are provided to
clients will not be deemed to be an investment company within the
meaning of the Act, provided that:
(1) Each client's account in the program is managed on the basis of
the client's financial situation, investment objectives, and
instructions.
(2) (i) At the opening of the account, the sponsor or another
person designated by the sponsor obtains information from the client
regarding the client's financial situation and investment objectives,
and gives the client the opportunity to provide specific instructions
concerning the management of the account;
(ii) At least annually, the sponsor or another person designated by
the sponsor contacts the client to determine whether there have been
any changes in the client's financial situation, investment objectives,
or instructions in the preceding year;
(iii) At least quarterly, the sponsor or another person designated
by the sponsor notifies the client in writing to contact the sponsor or
such other person if there have been any changes in the client's
financial situation, investment objectives, or instructions, and
provides the client with a means through which such contact is to be
made; and
(iv) The sponsor and persons authorized to make investment
decisions for the client's account are reasonably available to the
client for consultation.
(3) Each client has the ability to impose reasonable restrictions
on the management of its account, including the designation of
particular securities or types of securities that should not be
purchased for the account, or that should be sold if held in the
account.
(4) The sponsor or person designated by the sponsor provides each
client with a quarterly statement containing a description of all
activity in the client's account during the preceding quarter,
including all transactions made on behalf of the account, all
contributions and withdrawals made by the client, all fees and expenses
charged to the account, and the value of the account at the beginning
and end of the quarter.
(5) Each client retains indicia of ownership of all securities and
funds in the account, including the right to:
(i) Withdraw securities or cash;
(ii) Pledge securities;
(iii) Vote securities, or delegate the authority to vote securities
to another person;
(iv) Be provided in a timely manner with confirmations of
securities transactions of the type required by Sec. 240.10b-10 of this
chapter, and all other documents that would have been provided to the
client (or the client's agent) had the client purchased or sold the
same securities outside the program; and
(v) Proceed directly as a securityholder against the issuer of any
security in the client's account and not be obligated to join any
person involved in the operation of the program, or any other client of
the program, as a condition precedent to initiating such proceeding.
(6) (i) The sponsor of a program relying on this section must
establish and effect written policies and procedures that are
reasonably designed to ensure that each of the conditions of this
section is met. To the extent that the sponsor designates another
person to carry out its obligations under this section, the sponsor
must obtain from that person an agreement in writing to carry out those
obligations.
(ii) Notwithstanding the requirements of paragraph (e) of
Sec. 275.204-2 of this chapter as such requirements would apply to the
records set forth in paragraph (a)(6)(ii) of this section:
(A) The sponsor shall maintain and preserve in an appropriate
office of the sponsor during the period that it serves as the sponsor
of the program, and in an easily accessible place for a period not less
than three years after the sponsor ceases to serve in that capacity,
all written policies, procedures and agreements required to be
established under paragraphs (a)(6)(i) and (a)(6)(iii) of this section;
and
(B) The sponsor or another person designated by the sponsor shall
maintain and preserve in an easily accessible place for a period of not
less than five years from the end of the fiscal year during which the
document was created, all documents created pursuant to the policies
and procedures (including any client contracts, client questionnaires,
and copies of client statements).
(iii) The sponsor shall enter into a written agreement with any
person designated by the sponsor to maintain and preserve the books and
records pertaining to the program (other than those specified in
paragraph (a)(6)(ii)(A) of this section). Such agreement shall include
a list of the books and records to be maintained and preserved by that
person and a provision that the person will provide the sponsor copies
of such books and records within a reasonable time of the sponsor's
request.
(iv) The sponsor shall furnish to the Commission upon demand copies
of all documents maintained under paragraph (a)(6)(ii) of this section.
(7) The sponsor has filed with the Commission Form N-3a4 [17 CFR
274.222] and any amendments thereto.
(b) As used in this section, the term sponsor refers to any person
who receives compensation for sponsoring, organizing or administering
the program, or for selecting, or providing advice to clients regarding
the selection of, persons responsible for managing the client's account
in the program. If a program has more than one sponsor, one person
shall be designated the principal sponsor, and such person shall comply
with the provisions of this section relating to the duties and
responsibilities of the sponsor.
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
3. The authority citation for Part 274 continues to read as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, and 80a-29 unless otherwise noted.
4. By adding Sec. 274.222 to subpart C to read as follows:
Sec. 274.222 Form N-3a4, Notification of reliance on rule 3a-4 under
the Investment Company Act.
This form shall be filed with the Commission as required by rule
3a-4 (Sec. 270.3a-4 of this chapter) by sponsors of investment advisory
programs that intend to rely on the safe harbor provided by that rule.
Editorial Note: The text of Form N-3a4 appears in the Appendix
to this document and will not appear in the Code of Federal
Regulations.
Dated: July 27, 1995.
By the Commission.
Margaret L. McFarland,
Deputy Secretary.
Appendix
Note: The following Appendix will not appear in the Code of
Federal Regulations.
[[Page 39584]]
OMB APPROVAL
OMB Number:
Expires:
Estimated average burden hours per response:
Form N-3a4
U.S. Securities and Exchange Commission
Washington, D.C. 20549
Notification of Intention to Rely on Safe Harbor Pursuant to Rule 3a-4
[17 CFR 270.3a-4]
[ ] Initial Filing [ ] Amendment [ ] Withdrawal
1. Full name of investment advisory program:
----------------------------------------------------------------------
2. Full name of principal sponsor (as defined in rule 3a-4) of
investment advisory program:
----------------------------------------------------------------------
3. Principal sponsor's status under the Investment Advisers Act
[ ] Principal sponsor is registered under that Act; its SEC
Investment Advisers Act file number is: 801
[ ] Principal sponsor is not registered under that Act
4. Address of principal sponsor's principal place of business
(number, street, city, state, zip code):
----------------------------------------------------------------------
5. Telephone number at this location (include area code):
----------------------------------------------------------------------
6. If another person had previously served as principal sponsor of,
and filed Form N-3a4 with respect to, the investment advisory
program identified in Item 1:
a. Full name of previous principal sponsor:
----------------------------------------------------------------------
b. Previous principal sponsor's status under the Investment
Advisers Act
[ ] Previous principal sponsor is/was registered under that
Act; its SEC Investment Advisers Act file number is/was: 801-
[ ] Previous principal sponsor is/was not registered under that
Act
7. The undersigned hereby notifies the Securities and Exchange
Commission, in its capacity as principal sponsor, that
[ ] it intends to operate the program in reliance on the safe
harbor provided in rule 3a-4 under the Investment Company Act of
1940.
[ ] it no longer intends to operate the program in reliance on
the safe harbor provided in rule 3a-4 under the Investment Company
Act of 1940.
[ ] the program will cease operating as an investment advisory
program as of ____________ (insert date in blank).
Signed by:-------------------------------------------------------------
(Name of person signing on behalf of principal sponsor)
----------------------------------------------------------------------
(title of person)
Date:------------------------------------------------------------------
Instructions
1. This form is to be used to notify the Commission of the
intention of the principal sponsor of an investment advisory program
to operate the program in reliance on the safe harbor in rule 3a-4
under the Investment Company Act. This form also is to be used to
amend a prior filing, to notify the Commission that the sponsor no
longer intends to operate the program in reliance on the safe
harbor, or to notify the Commission that a program operating in
reliance on the safe harbor will cease operations.
2. This form shall be filed in triplicate with the Commission.
One copy shall be manually signed; the other copies may have
facsimile or typed signatures.
3. Under Item 1, insert name under which the investment advisory
program is marketed to clients. If no such name is used, insert a
name used to identify the program in internal documents (e.g.
contracts) or any other name that would clearly identify the
program.
4. The principal sponsor of an investment advisory program shall
file this form promptly after becoming principal sponsor of the
program. In the event that the previously submitted form becomes
inaccurate, the principal sponsor shall amend the form by submitting
an amended form, completed in its entirety, with the appropriate box
checked at the top of the form. If a previous principal sponsor of
the program had filed a Form N-3a4, the new principal sponsor shall
submit an amended form, completed in its entirety including the
information requested in Item 6.
5. If the principal sponsor no longer intends to operate the
program in reliance on rule 3a-4, or the program is ceasing
operations, the principal sponsor shall withdraw its notification on
Form N-3a4 by submitting another form, completed in its entirety
including the information required in Item 7, and checking the
appropriate box at the top of the form.
[FR Doc. 95-18891 Filed 8-1-95; 8:45 am]
BILLING CODE 8010-01-P