[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]]

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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 

[[Page 39577]]
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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
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    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