[Federal Register Volume 72, Number 188 (Friday, September 28, 2007)]
[Rules and Regulations]
[Pages 55022-55042]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-19191]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-2653; File No. S7-23-07]
RIN 3235-AJ96


Temporary Rule Regarding Principal Trades With Certain Advisory 
Clients

AGENCY: Securities and Exchange Commission.

ACTION: Interim final temporary rule; request for comments.

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SUMMARY: The Commission is adopting a temporary rule under the 
Investment Advisers Act of 1940 that establishes an alternative means 
for investment advisers who are registered with the Commission as 
broker-dealers to meet the requirements of section 206(3) of the 
Advisers Act when they act in a principal capacity in transactions with 
certain of their advisory clients. The Commission is adopting the 
temporary rule on an interim final basis as part of its response to a 
recent court decision invalidating a rule under the Advisers Act, which 
provided that fee-based brokerage accounts were not advisory accounts 
and were thus not subject to the Advisers Act. As a result of the 
Court's decision, which takes effect on October 1, fee-based brokerage 
customers must decide whether they will convert their accounts to fee-
based accounts that are subject to the Advisers Act or to commission-
based brokerage accounts. We are adopting the temporary rule to enable 
investors to make an informed choice between those accounts and to 
continue to have access to certain securities held in the principal 
accounts of certain advisory firms while remaining protected from 
certain conflicts of interest. The temporary rule will expire and no 
longer be effective on December 31, 2009.

DATES: Effective Date: September 30, 2007, except for 17 CFR 
275.206(3)-3T will be effective from September 30, 2007 until December 
31, 2009.
    Comment Date: Comments on the interim final rule should be received 
on or before November 30, 2007.

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

Electronic Comments

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

Paper Comments

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

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

FOR FURTHER INFORMATION CONTACT: David W. Blass, Assistant Director, 
Daniel S. Kahl, Branch Chief, or Matthew N. Goldin, Attorney-Adviser, 
at (202) 551-6787 or [email protected], Office of Investment Adviser 
Regulation, Division of Investment Management, U.S. Securities and 
Exchange Commission, 100 F Street, NE., Washington, DC 20549-5041.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adopting temporary rule 206(3)-3T [17 CFR 
275.206(3)-3T] under the Investment Advisers Act of 1940 [15 U.S.C. 
80b] as an interim final rule.
    We are soliciting comments on all aspects of the rule. We will 
carefully consider the comments that we receive and respond to them in 
a subsequent release.

I. Background

A. The FPA Decision

    On March 30, 2007, the Court of Appeals for the District of 
Columbia Circuit (the ``Court''), in Financial Planning Association v. 
SEC (``FPA decision''), vacated rule 202(a)(11)-1 under the Investment 
Advisers Act of 1940 (``Advisers Act'' or ``Act'').\1\ Rule 202(a)(11)-
1 provided, among other things, that fee-based brokerage accounts were 
not advisory accounts and were thus not subject to the Advisers Act.\2\ 
As a consequence of the FPA decision, broker-dealers offering fee-based 
brokerage accounts became subject to the Advisers Act with respect to 
those accounts, and the client relationship became fully subject to the 
Advisers Act. Broker-dealers would need to register as investment 
advisers, if they had not done so already, act as fiduciaries with 
respect to those clients, disclose all potential material conflicts of 
interest, and otherwise fully comply with the Advisers Act, including 
the Act's restrictions on principal trading.
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    \1\ 482 F.3d 481 (D.C. Cir. 2007).
    \2\ Fee-based brokerage accounts are similar to traditional 
full-service brokerage accounts, which provide a package of 
services, including execution, incidental investment advice, and 
custody. The primary difference between the two types of accounts is 
that a customer in a fee-based brokerage account pays a fee based 
upon the amount of assets on account (an asset-based fee) and a 
customer in a traditional full-service brokerage account pays a 
commission (or a mark-up or mark-down) for each transaction.
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    We filed a motion with the Court on May 17, 2007 requesting that 
the Court temporarily withhold the issuance of its mandate and thereby 
stay the effectiveness of the FPA decision.\3\ We estimated at the time 
that customers of broker-dealers held $300 billion in one million fee-
based brokerage accounts.\4\ We sought the stay to protect the 
interests of those customers and to provide sufficient time for them 
and their brokers to discuss, make, and implement informed decisions 
about the assets in the affected accounts. We also informed the Court 
that we would use

[[Page 55023]]

the period of the stay to consider whether further rulemaking or 
interpretations were necessary regarding the application of the Act to 
fee-based brokerage accounts and other issues arising from the Court's 
decision. On June 27, 2007, the Court granted our motion and stayed the 
issuance of its mandate until October 1, 2007.\5\
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    \3\ May 17, 2007, Motion for the Stay of Mandate, in FPA v. SEC.
    \4\ Id.
    \5\ See June 27, 2007, Order of the U.S. Court of Appeals for 
the District of Columbia Circuit, in FPA v. SEC.
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B. Section 206(3) of the Advisers Act and the Issue of Principal 
Trading

    We and our staff received several letters regarding the FPA 
decision and about particular consequences to customers who hold fee-
based brokerage accounts.\6\ Our staff followed up with, and has been 
engaged in an ongoing dialogue with, representatives of investors, 
financial planners, and broker-dealers regarding the implications of 
the FPA decision. During that process, firms that offered fee-based 
brokerage accounts informed us that, unless the Commission acts before 
October 1, 2007, one group of fee-based brokerage customers is 
particularly likely to be harmed by the consequences of the FPA 
decision: Customers who depend both on access to principal transactions 
with their brokerage firms and on the protections associated with a 
fee-based (rather than transaction-based) compensation structure. Firms 
explained that section 206(3) of the Advisers Act, the principal 
trading provision, poses a significant practical impediment to 
continuing to meet the needs of those customers.
    Section 206(3) of the Advisers Act makes it unlawful for any 
investment adviser, directly or indirectly ``acting as principal for 
his own account, knowingly to sell any security to or purchase any 
security from a client * * *, without disclosing to such client in 
writing before the completion of such transaction the capacity in which 
he is acting and obtaining the consent of the client to such 
transaction.'' \7\ Section 206(3) requires an adviser entering into a 
principal transaction with a client to satisfy these disclosure and 
consent requirements on a transaction-by-transaction basis.\8\ An 
adviser may provide the written disclosure to a client and obtain the 
client's consent at or prior to the completion of the transaction.\9\
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    \6\ See, e.g., Letter from Barbara Roper, Director of Investor 
Protection, Consumer Federation of America, et al., to Christopher 
Cox, Chairman, U.S. Securities and Exchange Commission, dated April 
24, 2007; E-mail from Timothy J. Sagehorn, Senior Vice President--
Investments, UBS Financial Services Inc., to Christopher Cox, 
Chairman, U.S. Securities and Exchange Commission, dated May 15, 
2007; Letter from Kurt Schacht, Managing Director, CFA Institute 
Centre for Financial Market Integrity, to Christopher Cox, Chairman, 
U.S. Securities and Exchange Commission, dated May 23, 2007; Letter 
from Joseph P. Borg, President, North American Securities 
Administrators Association, Inc., to Christopher Cox, Chairman, U.S. 
Securities and Exchange Commission, dated June 18, 2007; Letter from 
Daniel P. Tully, Chairman Emeritus, Merrill Lynch & Co., Inc., to 
Christopher Cox, Chairman, U.S. Securities and Exchange Commission, 
dated June 21, 2007; Letter, with Exhibit, from Ira D. Hammerman, 
Senior Managing Director and General Counsel, Securities Industry 
and Financial Markets Association, to Robert E. Plaze, Associate 
Director, Division of Investment Management, U.S. Securities and 
Exchange Commission, and Catherine McGuire, Chief Counsel, Division 
of Market Regulation, U.S. Securities and Exchange Commission, dated 
June 27, 2007 (``SIFMA Letter''); Letter from Raymond A. ``Chip'' 
Mason, Chairman and CEO, Legg Mason, Inc., to Christopher Cox, 
Chairman, U.S. Securities and Exchange Commission, dated July 10, 
2007; Letter from Robert J. McCann, Vice Chairman and President--
Global Private Client, Merrill Lynch, to Christopher Cox, Chairman, 
U.S. Securities and Exchange Commission, dated July 11, 2007; Letter 
from Samuel L. Hayes, III, Jacob Schiff Professor of Investment 
Banking Emeritus, Harvard Business School, to Christopher Cox, 
Chairman, U.S. Securities and Exchange Commission, dated July 12, 
2007; Letter from Duane Thompson, Managing Director, Washington 
Office, Financial Planning Association, to Robert E. Plaze, 
Associate Director, Division of Investment Management, U.S. 
Securities and Exchange Commission, dated July 27, 2007 (``FPA 
Letter''); Letter from Richard Bellmer, Chair, and Ellen Turf, CEO, 
National Association of Personal Financial Advisors, to Robert E. 
Plaze, Associate Director, Division of Investment Management, U.S. 
Securities and Exchange Commission, dated August 14, 2007 (``NAPFA 
Letter''); Letter from Congressman Dennis Moore, et al., to 
Christopher Cox, Chairman, U.S. Securities and Exchange Commission, 
dated July 13, 2007; and Letter from Congressman Spencer Bachus, 
Ranking Member, Committee on Financial Services, to Christopher Cox, 
Chairman, U.S. Securities and Exchange Commission, dated July 10, 
2007. Each of these letters is available at: www.sec.gov/comments/s7-23-07.
    \7\ 15 U.S.C. 80b-6(3). Section 206(3) also addresses ``agency 
cross transactions,'' imposing the same procedural requirements 
regarding prior disclosure and consent on those transactions as it 
imposes on principal transactions. Agency cross transactions are 
transactions for which an investment adviser provides advice and the 
adviser, or a person controlling, controlled by, or under common 
control with the adviser, acts as a broker for that advisory client 
and for the person on the other side of the transaction. See Method 
for Compliance with Section 206(3) of the Investment Advisers Act of 
1940 with Respect to Certain Transactions, Investment Advisers Act 
Release No. 557 (Dec. 2, 1976) [41 FR 53808] (``Rule 206(3)-2 
Proposing Release'').
    \8\ See Commission Interpretation of Section 206(3) of the 
Investment Advisers Act of 1940, Investment Advisers Act Release No. 
1732 (July 17, 1998) [63 FR 39505 (July 23, 1998)] (``Section 206(3) 
Release'') (``[A]n adviser may comply with Section 206(3) either by 
obtaining client consent prior to execution of a principal or agency 
transaction, or after execution but prior to settlement of the 
transaction.''). See also Investment Advisers Act Release No. 40 
(Jan. 5, 1945) [11 FR 10997] (``[T]he requirements of written 
disclosure and of consent contained in this clause must be satisfied 
before the completion of each separate transaction. A blanket 
disclosure and consent in a general agreement between investment 
adviser and client would not suffice.'').
    \9\ Section 206(3) Release (``Implicit in the phrase `before the 
completion of such transaction' is the recognition that a securities 
transaction involves various stages before it is `complete.' The 
phrase completion of such transaction' on its face would appear to 
be the point at which all aspects of a securities transaction have 
come to an end. That ending point of a transaction is when the 
actual exchange of securities and payment occurs, which is known as 
`settlement.''').
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    During our discussions, firms informed our staff that the written 
disclosure and the client consent requirements of section 206(3) act as 
an operational barrier to their ability to engage in principal trades 
with their clients. Firms that are registered both as broker-dealers 
and investment advisers generally do not offer principal trading to 
current advisory clients (or do so on a very limited basis), and the 
rule vacated in the FPA decision had allowed broker-dealers to offer 
fee-based accounts without complying with the Advisers Act, including 
the requirements of section 206(3). Most informed us that they plan to 
discontinue fee-based brokerage accounts as a result of the FPA 
decision because of the application of the Advisers Act. They also 
informed us of their view that, unless they are provided an exemption 
from, or an alternative means of complying with, section 206(3) of the 
Advisers Act, they would be unable to provide the same range of 
services to those fee-based brokerage customers who elect to become 
advisory clients and would expect few to elect to do so.\10\
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    \10\ The firms explained that they plan to consult with their 
customers and obtain customers' consent to convert the fee-based 
accounts to one or more other types of accounts already operating on 
pre-existing business platforms. We understand that in most cases 
customers will be able to choose among different types of brokerage 
accounts, paying commissions for securities, and advisory accounts, 
paying asset-based fees. Firms indicated to us that, if we provide 
an alternative means of complying with section 206(3), they believe 
a significant number of their fee-based brokerage customers will 
elect to convert their accounts to non-discretionary advisory 
accounts. Those accounts operate in many respects like fee-based 
brokerage accounts, but fiduciary duties apply to the adviser, and 
the other obligations of the Advisers Act also apply. Firms offering 
these accounts provide investment advice, but clients retain 
decision making authority over their investment selections.
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    Several broker-dealers and the Securities Industry and Financial 
Markets Association (``SIFMA'') contended that providing written 
disclosure before completion of each securities transaction, as 
required by section 206(3) of the Advisers Act, makes it not feasible 
for an adviser to offer customers principal transactions for several 
reasons. Firms explained that there are timing and mechanical

[[Page 55024]]

impediments to complying with section 206(3)'s written disclosure 
requirement. SIFMA explained that, for example, the combination of 
rapid electronic trading systems and the limited availability of many 
of the securities traded in principal markets means that an adviser may 
be unable to provide written disclosure and obtain consent in 
sufficient time to obtain such securities at the best price or, in some 
cases, at all.\11\ Similarly, SIFMA contended that trade-by-trade 
written disclosure prior to execution is not practicable because 
``discussions between investment advisers and non-discretionary clients 
about a trade or strategy may occur before a particular transaction is 
effected, but at the time that discussion occurs the representative may 
not know whether the transaction will be effected on an agency or a 
principal basis.''\12\
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    \11\ SIFMA Letter, at 21 (``Many fixed income securities, 
including municipal securities, that have limited availability are 
quoted, purchased and sold quickly through electronic communications 
networks utilized by bond dealers. * * * In today's principal 
markets, investment advisers do not necessarily have `sufficient 
opportunity to secure the client's specific prior consent' and 
provide trade-by-trade disclosure, and opportunities to achieve best 
execution may be lost if the adviser does not act immediately on 
current market prices.'') (quoting Rule 206(3)-2 Proposing Release).
    \12\ Id.
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    Firms also explained that they engage in thousands--in many cases, 
tens of thousands--of principal trades a day and that, due to the sheer 
volume of transactions, providing a written notice to all the clients 
with whom they conduct trades in a principal capacity may only be done 
using automated systems.\13\ One such automated system is the system 
broker-dealers use to provide customers with transaction-specific 
written notifications, or trade confirmations, that include the 
information required by rule 10b-10 under the Exchange Act.\14\ Under 
rule 10b-10, a broker-dealer must disclose on its confirmation if it 
acts as principal for its own account with respect to a 
transaction.\15\ However, confirmations are provided to customers too 
late to satisfy the requirements of section 206(3). This is because 
trade confirmations are sent, rather than delivered, at completion of a 
transaction and much of the information required to be disclosed by 
rule 10b-10 may only be available at completion of a transaction, not 
before. Thus, even if firms were to rely on the Commission's 1998 
interpretation of section 206(3), under which disclosure and consent 
may be obtained after execution but before settlement of a 
transaction,\16\ no automated system currently exists that could ensure 
compliance.\17\
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    \13\ Firms asserted that, while possible, providing written 
notifications by fax or email prior to a transaction is impractical. 
Clients may not have ready access to either at the time they wish to 
conduct a trade and delaying the trade in order to provide the 
written notification likely would not be in the client's best 
interest, in particular as market prices may change rapidly.
    \14\ 17 CFR 240.10b-10. Rule 10b-10 under the Exchange Act 
requires a broker-dealer, at or before completion of a transaction, 
to give or send to its customer a written confirmation containing 
specified information about the transaction.
    \15\ Rule 10b-10(a)(2) under the Exchange Act [17 CFR 240.10b-
10(a)(2)].
    \16\ See Section 206(3) Release.
    \17\ It may be possible for firms to upgrade their confirmation 
delivery systems to provide an additional written disclosure that 
satisfies the content and chronological requirements of section 
206(3) of the Act. Based on our experience with changes to 
confirmation delivery systems (largely in response to our changes to 
Exchange Act rule 10b-10), any such upgrade could take years to 
accomplish and would not be available by October 1, 2007, the date 
the FPA decision becomes effective. Furthermore, even if an 
automated system were developed to provide those written disclosures 
at or before completion of the transaction, no such automated system 
exists to obtain the required consent from advisory clients. We also 
are mindful of the burdens associated with such a system change. 
SIFMA has submitted to us that ``[t]rade confirmation production 
systems are among the most expensive and most difficult to alter 
anywhere in the brokerage industry, because of the mass nature of 
confirmations, the sensitive and private nature of the information, 
and the extremely short deadlines for their production and 
mailing.'' Letter from Ira D. Hammerman, Senior Vice President and 
General Counsel, Securities Industry and Financial Markets 
Association, to Jonathan G. Katz, Secretary, U.S. Securities and 
Exchange Commission, U.S. Securities and Exchange Commission, dated 
April 4, 2005, available at: www.sec.gov/rules/proposed/s70604/ihammerman040405.pdf.
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    Additionally, even if an automated system existed to enable the 
disclosure and consent after execution of a trade but before its 
completion in satisfaction of section 206(3), firms indicated that they 
would be unlikely to trade on such a basis. The firms explained that 
they do not seek post-execution consent because allowing a client until 
settlement to consent to a trade that has already been executed creates 
too great a risk that intervening market changes or other factors could 
lead a client to withhold consent to the disadvantage of the firm.
    Access to securities held in a firm's principal accounts is 
important to many investors. We believe, based on our discussions with 
industry representatives and others throughout the transition process, 
that many customers may wish to access the securities inventory of a 
diversified broker-dealer through their non-discretionary advisory 
accounts.\18\ For example, the Financial Planning Association (``FPA'') 
noted that principal trades in a fiduciary relationship could be 
beneficial to investors, stating:
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    \18\ We have previously expressed our view that some principal 
trades may serve clients' best interests. See Section 206(3) 
Release.

    Depending on the circumstances, clients may benefit from 
principal trades, but only in the context of a fiduciary 
relationship with the best interests of the client being paramount. 
In favorable circumstances, advisers may obtain access to a broader 
range of investment opportunities, better trade execution, and more 
favorable transaction prices for the securities being bought or sold 
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than would otherwise be available.\19\

    \19\ FPA Letter, at 3.
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    As a result of the FPA decision, customers must elect on or before 
October 1, 2007, to convert their fee-based brokerage accounts to 
advisory accounts or to traditional commission-based brokerage 
accounts. Several firms emphasized to our staff that the inability of a 
client to access certain securities held in the firm's principal 
accounts--particularly municipal securities and other fixed income 
securities that they contend have limited availability and are dealt 
through a firm's account using electronic communications networks--may 
be a determinative factor in whether the client selects (or the firm 
makes available) a non-discretionary advisory account to replace the 
client's fee-based brokerage account. As discussed in this Release, 
many firms informed us that, because of the practical difficulties with 
complying with the trade-by-trade written disclosure requirements of 
section 206(3) discussed above, they simply refrain from engaging in 
principal trading with their advisory clients. Accordingly, customers 
who wish to access firms' principal inventories may, as a practical 
matter, have no choice but to open a traditional brokerage account in 
which they will pay transaction-based compensation, rather than convert 
their fee-based brokerage account to an advisory account.
    While we do not agree with SIFMA that an exemption from section 
206(3) of the Act in its entirety is appropriate, we do believe that 
there may be substantial benefits to many of the investors holding an 
estimated $300 billion in approximately one million fee-based brokerage 
accounts if their accounts are converted to advisory accounts instead 
of traditional brokerage accounts.\20\ Those investors will continue to 
be able

[[Page 55025]]

to avoid transaction-based compensation and the incentives such a 
compensation arrangement creates for a broker-dealer, a reason they may 
have initially opened fee-based brokerage accounts.\21\ They also will 
enjoy, as the Court pointed out in the FPA decision, the protections of 
the ``federal fiduciary standard [that] govern[s] the conduct of 
investment advisers.'' \22\
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    \20\ SIFMA asserted that firms should be exempt entirely from 
section 206(3) of the Act in order to ``preserve the [fee-based 
brokerage] client's ability to access certain securities that are 
best--or only--available through trades with the adviser or an 
affiliate of the adviser.'' SIFMA Letter, at 3. SIFMA further 
requested that we provide broker-dealers an exemption from all of 
the provisions of the Advisers Act with respect to their fee-based 
brokerage accounts. We are not adopting such a broad exemption.
    \21\ A brokerage industry committee formed in 1994 at the 
suggestion of then-Commission Chairman Arthur Levitt concluded that 
fee-based compensation would better align the interests of broker-
dealers and their customers and allow registered representatives to 
focus on what the committee described as their most important role--
providing investment advice to individual customers, not generating 
transaction revenues. See Report of the Committee on Compensation 
Practices (Tully Report) (Apr. 10, 1995). We already have sought and 
received public comment on the potential benefits to investors of 
fee-based accounts, see Certain Broker-Dealers Deemed Not to be 
Investment Advisers, Investment Advisers Act Release No. 2376 (Apr. 
12, 2005) [70 FR 20424 (Apr. 19, 2005]; Certain Broker-Dealers 
Deemed Not to be Investment Advisers, Investment Advisers Act 
Release No. 2340 (Jan. 6, 2005) [70 FR 2716 (Jan. 14, 2005)]; and 
Certain Broker-Dealers Deemed Not to be Investment Advisers, 
Investment Advisers Act Release No. 1845 (Nov. 4, 1999) [64 FR 61226 
(Nov. 10, 1999)].
    \22\ FPA decision, at 16, citing Transamerica Mortgage Advisors 
Inc. v. Lewis, 444 U.S. 11, 17 (1979).
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    To address the concerns described above and to protect the 
interests of customers who previously held fee-based brokerage 
accounts, we are adopting a temporary rule, on an interim final basis, 
that provides an alternative method for advisers who also are 
registered as broker-dealers to comply with section 206(3) of the Act. 
We believe this rule both protects investors' choice--fee-based 
brokerage customers would be able to choose an account that offers a 
similar set of services (including access to the same securities) that 
were available to them in fee-based brokerage accounts--and avoids 
disruption to, and confusion among, investors who may wish to access 
and sell securities only available through a firm acting in a principal 
capacity and who, as a result, may no longer be offered any fee-based 
account. We believe the temporary rule will allow fee-based brokerage 
customers to maintain their existing relationships with, and receive 
roughly the same services from, their broker-dealers. We believe 
further that making the rule temporary allows us an opportunity to 
observe how those firms use the alternative means of compliance 
provided by the rule, and whether those firms serve their clients' best 
interests.

II. Discussion

A. Overview of Temporary Rule 206(3)-3T

    Congress intended section 206(3) of the Advisers Act to address 
concerns that an adviser might engage in principal transactions to 
benefit itself or its affiliates, rather than the client.\23\ In 
particular, Congress appears to have been concerned that advisers might 
use advisory accounts to ``dump'' unmarketable securities or those the 
advisers fear may decline in value.\24\ Congress chose not to prohibit 
advisers from engaging in principal and agency transactions, but rather 
to prescribe a means by which an adviser must disclose and obtain the 
consent of its client to the conflicts of interest involved. Congress's 
concerns were and continue to be significant. Self-dealing by 
investment advisers involves serious conflicts of interest and a 
substantial risk that the proprietary interests of the adviser will 
prevail over those of its clients.\25\
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    \23\ See Investment Trusts and Investment Companies: Hearings on 
S. 3580 Before the Subcomm. of the Comm. on Banking and Currency, 
76th Cong., 3d Sess. 320 (1940) (statement of David Schenker, Chief 
Counsel, Securities and Exchange Commission Investment Trust Study) 
(``Senate Hearings''). As noted above, section 206(3) also addresses 
agency cross transactions, which raise similar concerns regarding an 
adviser engaging in transactions to benefit itself or its 
affiliates, as well as the concern that an adviser may be subject to 
divided loyalties.
    \24\ See Senate Hearings at 322 (``[i]f a fellow feels he has a 
sour issue and finds a client to whom he can sell it, then that is 
not right. * * *'') (statement of David Schenker, Chief Counsel, 
Securities and Exchange Commission Investment Trust Study).
    \25\ As we have stated before ``where an investment adviser 
effects a transaction as principal with his advisory account client, 
the terms of the transaction are necessarily not established by 
arm's-length negotiation. Instead, the investment adviser is in a 
position to set, or to exert influence potentially affecting, the 
terms by which he participates in such trade. The pressures of self-
interest which may be present in such principal transactions may 
require the prophylaxis of the disclosures [required by section 
206(3)].'' Rule 206(3)-2 Proposing Release.
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    In light of these concerns and the important protections provided 
by section 206(3) of the Advisers Act, rule 206(3)-3T provides advisers 
an alternative means to comply with the requirements of that section 
that is consistent with the purposes, and our prior interpretations, of 
the section. The temporary rule continues to provide the protection of 
transaction-by-transaction disclosure and consent, subject to several 
conditions.\26\ Specifically, temporary rule 206(3)-3T permits an 
adviser, with respect to a non-discretionary advisory account, to 
comply with section 206(3) of the Advisers Act by, among other things: 
(i) Providing written prospective disclosure regarding the conflicts 
arising from principal trades; (ii) obtaining written, revocable 
consent from the client prospectively authorizing the adviser to enter 
into principal transactions; (iii) making certain disclosures, either 
orally or in writing, and obtaining the client's consent before each 
principal transaction; (iv) sending to the client confirmation 
statements disclosing the capacity in which the adviser has acted and 
disclosing that the adviser informed the client that it may act in a 
principal capacity and that the client authorized the transaction; and 
(v) delivering to the client an annual report itemizing the principal 
transactions. The rule also requires that the investment adviser be 
registered as a broker-dealer under section 15 of the Exchange Act and 
that each account for which the adviser relies on this rule be a 
brokerage account subject to the Exchange Act, and the rules 
thereunder, and the rules of the self-regulatory organization(s) of 
which it is a member.\27\
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    \26\ We similarly provided, in a rule of analogous scope and 
structure to rule 206(3)-3T, an alternative means of compliance with 
the disclosure and consent requirements of section 206(3) relating 
to ``agency cross transactions.'' See rule 206(3)-2 under the 
Advisers Act.
    \27\ See Section II.B.7 of this Release.
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    These conditions, discussed below, are designed to prevent 
overreaching by advisers by requiring an adviser to disclose to the 
client the conflicts of interest involved in these transactions, inform 
the client of the circumstances in which the adviser may effect a trade 
on a principal basis, and provide the client with meaningful 
opportunities to refuse to consent to a particular transaction or 
revoke the prospective general consent to these transactions. We note 
that we have previously stated that ``Section 206(3) should be read 
together with Sections 206(1) and (2) to require the adviser to 
disclose facts necessary to alert the client to the adviser's potential 
conflicts of interest in a principal or agency transaction.'' \28\ We 
request comment generally on the need for the rule and its potential 
impact on clients of the advisers. Will the advantages described above 
that we believe accompany rule 206(3)-3T be beneficial to investors? 
Have we struck an appropriate balance between investor choice and 
investor protection? Does the alternative means of compliance

[[Page 55026]]

contained in rule 206(3)-3T provide all the necessary investor 
protections? \29\
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    \28\ Section 206(3) Release. For a further discussion, see 
Section II.B.8 of this Release.
    \29\ In this regard, see NAPFA Letter (``express[ing] its strong 
reservations regarding the possible grant of principal trading 
relief'').
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B. Section-by-Section Description of Rule 206(3)-3T

    Rule 206(3)-3T deems an investment adviser to be in compliance with 
the provisions of section 206(3) of the Advisers Act when the adviser, 
or a person controlling, controlled by, or under common control with 
the investment adviser, acting as principal for its own account, sells 
to or purchases from an advisory client any security, provided that 
certain conditions discussed below are met. The scope and structure of 
the rule are similar to our rule 206(3)-2 under the Advisers Act, 
which, as noted above, provides an alternative means of complying with 
the limitations on ``agency cross transactions,'' also contained in 
section 206(3).
    We have applied section 206(3) not only to principal transactions 
engaged in or effected by an adviser, but also to certain situations in 
which an adviser causes a client to enter into a principal transaction 
that is effected by a broker-dealer that controls, is controlled by, or 
is under common control with the adviser.\30\ Accordingly, rule 206(3)-
3T would be available if the adviser acts as principal by causing the 
client to engage in a transaction with a broker-dealer that is an 
affiliate of the adviser--that is, a broker-dealer that controls, is 
controlled by, or is under common control with the investment adviser.
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    \30\ See Section 206(3) Release at n. 3.
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1. Non-Discretionary Accounts
    Rule 206(3)-3T applies to principal trades with respect to accounts 
over which the client has not granted ``investment discretion, except 
investment discretion granted by the advisory client on a temporary or 
limited basis.'' \31\ Availability of the rule to discretionary 
accounts would be inconsistent with the requirement of the rule, 
discussed below, that the adviser obtains consent (which may be oral 
consent) from the client for each principal transaction.\32\ In 
addition, we are of the view that the risk of relaxing the procedural 
requirements of section 206(3) of the Advisers Act when a client has 
ceded substantial, if not complete, control over the account raises 
significant risks that the client will not be, or is not in a position 
to be, sufficiently involved in the management of the account to 
protect himself or herself from overreaching by the adviser.
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    \31\ Rule 206(3)-3T(a)(1). For purposes of the rule, the term 
``investment discretion'' has the same meaning as in section 
3(a)(35) of the Exchange Act [15 U.S.C. 78c(a)(35)], except that it 
excludes investment discretion granted by a customer on a temporary 
or limited basis. Section 3(a)(35) of the Exchange Act provides that 
a person exercises ''investment discretion'' with respect to an 
account if, directly or indirectly, such person: (A) Is authorized 
to determine what securities or other property shall be purchased or 
sold by or for the account; (B) makes decisions as to what 
securities or other property shall be purchased or sold by or for 
the account even though some other person may have responsibility 
for such investment decisions; or (C) otherwise exercises such 
influence with respect to the purchase and sale of securities or 
other property by or for the account as the Commission, by rule, 
determines, in the public interest or for the protection of 
investors, should be subject to the operation of the provisions of 
this title and rules and regulations thereunder.
    We would view a broker-dealer's discretion to be temporary or 
limited within the meaning of rule 206(3)-3T(a)(1) when the broker-
dealer is given discretion: (i) As to the price at which or the time 
to execute an order given by a customer for the purchase or sale of 
a definite amount or quantity of a specified security; (ii) on an 
isolated or infrequent basis, to purchase or sell a security or type 
of security when a customer is unavailable for a limited period of 
time not to exceed a few months; (iii) as to cash management, such 
as to exchange a position in a money market fund for another money 
market fund or cash equivalent; (iv) to purchase or sell securities 
to satisfy margin requirements; (v) to sell specific bonds and 
purchase similar bonds in order to permit a customer to take a tax 
loss on the original position; (vi) to purchase a bond with a 
specified credit rating and maturity; and (vii) to purchase or sell 
a security or type of security limited by specific parameters 
established by the customer.
    \32\ Rule 206(3)-3T(a)(4). See Section II.B.4 of this Release.
---------------------------------------------------------------------------

    The rule would apply to all non-discretionary advisory accounts, 
not only those that were originally established as fee-based brokerage 
accounts.\33\ As noted above, some portion of the customers converting 
fee-based brokerage accounts into advisory accounts will be converting 
those accounts into non-discretionary accounts offered by the same 
firm. We understand from our discussions with broker-dealers that 
maintaining principal trading distinctions between advisory accounts 
that were once fee-based brokerage accounts and those that were not 
would be very difficult. Trade execution routing for investment 
advisory programs often is derived through unified programs or 
electronic codes allowing or prohibiting certain kinds of trades 
uniformly for all accounts that are of the same type. As such, limiting 
relief to accounts that were formerly in fee-based brokerage programs 
would make the requested relief impractical for firms and would neither 
serve the best interests of clients (because the effect would be to 
limit their ability to continue to access the inventory of securities 
held by their brokerage firm) nor be administratively feasible to firms 
affected by the Court's ruling with respect to the transition and 
ongoing servicing of these and other accounts subject to the Advisers 
Act. We accordingly determined not to limit the availability of the 
temporary rule only to those non-discretionary advisory accounts that 
were fee-based brokerage accounts.
---------------------------------------------------------------------------

    \33\ We have not extended the rule to advisory accounts that are 
held only at investment advisers, as opposed to firms that are both 
investment advisers and registered broker-dealers. See Section 
II.B.7 of this Release.
---------------------------------------------------------------------------

    We welcome comment on this aspect of our interim final rule. Are we 
correct that the potential for abuse through self-dealing is less in 
non-discretionary accounts, where clients may be better able to protect 
themselves and monitor trading activity, than in accounts where clients 
have granted discretion and may not be in a position to protect 
themselves sufficiently? Should we further limit the availability of 
the rule so that it is only available for transactions with wealthy or 
sophisticated clients who, for other purposes under the Act, we have 
presumed are capable of protecting themselves? For example, should it 
apply only with respect to transactions with a ``qualified client'' as 
defined in Advisers Act rule 205-3?
    Should we limit the relief provided by the rule to accounts that 
originally were fee-based brokerage accounts? Do the operational 
burdens and complexities identified by the broker-dealers support 
application of the rule to all non-discretionary advisory accounts?
2. Issuer and Underwriter Limitations
    Rule 206(3)-3T is not available for principal trades of securities 
if the investment adviser or a person who controls, is controlled by, 
or is under common control with the adviser (``control person'') is the 
issuer or is an underwriter of the security.\34\ The rule includes one 
exception--an adviser may rely on the rule for trades in which the 
adviser or a control person is an underwriter of non-convertible 
investment-grade debt securities.
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    \34\ Rule 206(3)-3T(a)(2). The term ``underwriter'' is defined 
in section 202(a)(20) of the Advisers Act to mean ``any person who 
has purchased from an issuer with a view to, or sells for an issuer 
in connection with, the distribution of any security, or 
participates or has a direct or indirect participation in any such 
undertaking, or participates or has a participation in the direct or 
indirect underwriting of any such undertaking; but such term shall 
not include a person whose interest is limited to a commission from 
an underwriter or dealer not in excess of the usual and customary 
distributor's or seller's commission.''
---------------------------------------------------------------------------

    One benefit an investor may gain by establishing a brokerage 
account with a

[[Page 55027]]

large broker-dealer is the ability to obtain access to potentially 
profitable public offerings of securities. These securities are 
typically purchased by the broker-dealer participating in the 
underwriting as part of its allotment of the offering and then sold to 
customers in principal transactions. As noted above, many broker-
dealers have not made such offerings available to advisory clients 
because of the requirements of section 206(3).
    A broker-dealer participating in an underwriting typically has a 
substantial economic interest in the success of the underwriting, which 
might be different from the interests of investors. When a broker-
dealer acts as an underwriter with respect to a security, it is 
compensated precisely for the service of distributing that 
security.\35\ A successful distribution not only offers the possibility 
of a concession on the securities (the spread between the underwriter's 
purchase price from the issuer and the public offering price), but also 
often an over-allotment option, and potentially future business 
(whether as an underwriter, lender, adviser or otherwise) with the 
issuer. The incentives may bias the advice being provided or lead the 
adviser to exert undue influence on its client's decision to invest in 
the offering or the terms of that investment. As such, the broker-
dealer's incentives to ``dump'' securities it is underwriting are 
greater for sales by a broker-dealer acting as an underwriter than for 
sales by a broker-dealer not acting as an underwriter of other 
securities from its inventory.
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    \35\ The act of underwriting is purchasing ``with a view to * * 
* the distribution of any security.'' Section 202(a)(20) of the 
Advisers Act [17 CFR 275.202(a)(20)].
---------------------------------------------------------------------------

    A broker-dealer acting as an issuer has similar, if not greater, 
proprietary interests that are likely to adversely affect the 
objectivity of its advice. We therefore are of the view that an 
investment adviser who (or whose affiliate) is the issuer or 
underwriter of a security has such a significant conflict of interest 
as to make such a transaction, with one exception, an inappropriate 
subject of the relief we are providing today.
    We have, however, provided an exception for principal transactions 
in non-convertible investment grade debt securities underwritten by the 
adviser or a person who controls, is controlled by, or is under common 
control with the adviser.\36\ Non-convertible investment grade debt 
securities may be less risky and therefore less likely to be ``dumped'' 
on clients. Also, it may be easier for clients to identify whether the 
price they are being quoted for a non-convertible investment grade debt 
security is fair given the relative comparability, and the significant 
size, of the non-convertible investment grade debt markets.
---------------------------------------------------------------------------

    \36\ ``Investment grade debt securities'' are defined in the 
rule to mean any non-convertible debt security that is rated in one 
of the four highest rating categories of at least two nationally 
recognized statistical rating organizations (as defined in section 
3(a)(62) of the Exchange Act [15 U.S.C. 78c(a)(62)]). Rule 206(3)-
3T(c).
---------------------------------------------------------------------------

    Moreover, as the staff has discussed the effects of the FPA 
decision with broker-dealers, those broker-dealers have asserted that 
it is in the interest of investors to permit them to conduct principal 
trades with their advisory clients involving these securities, even 
where they or their affiliates are underwriters. Those firms argue that 
clients may face difficulties and higher costs in obtaining these debt 
instruments, particularly municipal bonds, through an advisory account 
if the adviser is not permitted to rely on the interim final rule's 
alternative means of complying with section 206(3).
    The limitation on issuer transactions makes the rule unavailable 
for principal transactions in traditional equity or debt offerings of 
the investment adviser or a control person of the adviser. It also 
makes the rule unavailable in connection with--and thus requires 
compliance with section 206(3)'s trade-by-trade written disclosure 
requirements before--non-discretionary placement by an adviser of a 
proprietary structured product, such as a structured note, with an 
advisory client.\37\ We request comment on whether we should consider 
expanding the availability of the rule to apply to structured products, 
and if so, on what terms.
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    \37\ There is no uniform definition of what constitutes a 
structured product and the term is not defined in the temporary 
rule. Structured products include, among other things, 
securitizations of pools of assets, such as asset-backed securities 
which are supported by a discrete pool of financial assets (e.g., 
mortgages or other receivables). See generally Securities Act 
Release No. 8518 (Dec. 22, 2004) [70 FR 1506 (Jan. 7, 2005)]. The 
Financial Industry Regulatory Authority, Inc. (``FINRA''), the self-
regulatory organization that oversees broker-dealers, defines 
structured products as ``securities derived from or based on a 
single security, a basket of securities, an index, a commodity, a 
debt issuance and/or a foreign currency.'' FINRA Notice to Members 
05-59 (Sept. 2005). FINRA has notified its members that they should 
consider only recommending structured products to customers who have 
been approved for options trading. Id. at 4. See also FINRA Notice 
to Members 03-71 (Nov. 2003) (expressing concern that investors, 
particularly retail investors, may not fully understand the risks 
associated with non-conventional investments--such as structured 
securities--and cautioning members to ensure that their sales 
conduct procedures fully and accurately address any of the special 
circumstances presented by the sale of these products).
---------------------------------------------------------------------------

    We also request comment on our exclusion for securities issued or 
underwritten by the adviser or its control persons. Do commenters agree 
with our assessment of the risks to clients and our interpretation of 
the purposes of section 206(3)? Should we consider making the rule 
available for principal transactions in all securities (including those 
issued or subject to an underwriting by the adviser or a control 
person) in light of the clients' interest in obtaining access to public 
offerings? Alternatively, is there an approach we might take that could 
distinguish types of underwriting arrangements that do not present 
unacceptable risks of conflicts for the adviser? In this regard, we 
request comment on the one exception we have provided for non-
convertible investment grade debt securities. Is the exception 
appropriate under the circumstances? Are there other circumstances in 
which an adviser should be able to rely on the rule when it (or a 
control person) is an issuer or underwriter of securities in certain 
circumstances?
3. Written Prospective Consent Following Written Disclosure
    An adviser may rely on rule 206(3)-3T only after having secured its 
client's written, revocable consent prospectively authorizing the 
adviser directly or indirectly acting as principal for its own account, 
to sell any security to or purchase any security from such client.\38\ 
The consent must be obtained only after the adviser provides the client 
with written disclosure about: (i) The circumstances under which the 
investment adviser may engage in principal transactions with the 
client; (ii) the nature and significance of the conflicts the 
investment adviser has with its clients' interests as a result of those 
transactions; and (iii) how the investment adviser addresses those 
conflicts.\39\ We anticipate that this consent normally would be 
obtained by the adviser when the client establishes the advisory 
account.\40\
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    \38\ Rule 206(3)-3T(a)(3).
    \39\ The FPA recommended a similar condition. See FPA Letter, at 
3.
    \40\ No additional disclosure regarding the principal capacity 
in which the adviser may be acting need be made pursuant to rule 
206(3)-3T(a)(3) at the time of the transaction, provided the 
disclosure required by paragraph (a)(3) of the rule has been made 
and is correct in all material respects.
---------------------------------------------------------------------------

    Rule 206(3)-3T is not exclusive. An adviser would still be able to 
effect principal trades with a client who either never grants the 
prospective consent required under paragraph (a)(3) of the rule 206(3)-
3T, or subsequently revokes

[[Page 55028]]

that consent after having granted it, so long as the adviser complies 
with the terms of section 206(3) of the Act.
    Will the disclosure required by paragraph (a)(3) be meaningful for 
clients in understanding the conflicts and risks inherent in principal 
trading by a fiduciary counterparty? Are there alternative approaches 
that we could adopt to make the prospective disclosures more meaningful 
to clients? Should we require disclosure to be prominent or, 
alternatively, require disclosure in a separately executed document to 
assure that the client has separately given attention to the request 
for consent?
    With each written disclosure, confirmation, and request for written 
prospective consent, the investment adviser must include a conspicuous, 
plain English statement clarifying that the prospective general consent 
may be revoked at any time.\41\ Thus, the client must be able to revoke 
his or her prospective consent at any time, thereby preventing an 
adviser from relying on rule 206(3)-3T with respect to that account 
going forward.\42\ Do these provisions adequately ensure that client 
consent is voluntary? Will advisers make a client's consent a condition 
to participation in non-discretionary advisory accounts they offer? If 
so, should we add a provision to the rule to address this issue, such 
as prohibiting advisers from doing so?
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    \41\ Rule 206(3)-3T(a)(8). The FPA recommended a similar 
condition. See FPA Letter, at 4.
    \42\ The right to revoke prospective consent is not intended to 
allow a client to rescind, after execution but prior to settlement, 
a particular trade to which the client provided specific consent 
prior to execution.
---------------------------------------------------------------------------

    The written prospective consent need only be executed once. Should 
we require that the client's consent be renewed periodically? What 
benefit would be gained by such a provision in light of the client's 
right to revoke his or her consent at any time?
4. Trade-by-Trade Consent Following Disclosure
    The temporary rule requires an investment adviser, before the 
execution of each principal transaction, to: (i) Inform the client of 
the capacity in which the adviser may act with respect to the 
transaction; and (ii) obtain consent from the client for the investment 
adviser to act as principal for its own account with respect to each 
such transaction.\43\ The trade-by-trade disclosure and consent may be 
written or oral. Although representatives of the brokerage industry 
have requested that we eliminate the requirement for transaction-by-
transaction disclosure and consent,\44\ we have determined that such 
disclosure and consent continues to be important to alert clients to 
the potential for conflicted advice they may be receiving on individual 
transactions. In light of the conflicts inherent in these transactions, 
generally notifying the client that a transaction may be effected on a 
principal basis close in time to the carrying out of such a trade is 
appropriate.
---------------------------------------------------------------------------

    \43\ Rule 206(3)-3T(a)(4).
    \44\ SIFMA Letter, at 3.
---------------------------------------------------------------------------

    Given the frequency and speed of trading in some advisory accounts 
as well as the increasing complexity of securities products available 
in the marketplace, trade-by-trade disclosure and consent, even if 
oral, might be a more effective protection against misunderstanding by 
advisory clients of the nature of a transaction and the conflicts 
inherent in it as well as a meaningful safeguard for investment 
advisers seeking to comply with their fiduciary obligations. We 
understand, however, that in many instances the adviser may not know 
whether a particular transaction will be effected on a principal basis. 
Accordingly, the rule permits advisers to disclose to clients that they 
``may'' act in a principal capacity with respect to the transaction.
    We do not believe the obligation to make oral disclosure will 
impose a significant burden on investment advisers of non-discretionary 
accounts who must, in most cases, obtain consent for each transaction 
regardless of whether the transaction will be done on a principal 
basis.\45\ We are interested in learning from investors whether this 
consent requirement is informative and helpful. We also are interested 
in learning from advisers whether they intend to document receipt of 
the oral consent and, if so, whether they will be able to do so 
efficiently.
---------------------------------------------------------------------------

    \45\ See rule 206(3)-3T(a)(1) (limiting the availability of the 
rule to accounts over which the adviser does not exercise 
discretionary authority).
---------------------------------------------------------------------------

    We request comment regarding whether investment advisers find 
useful the flexibility to provide oral instead of written disclosure on 
a trade-by-trade basis. Or, will advisers instead view the relief as 
unworkable?
5. Written Confirmation
    The investment adviser must send to each client with which it 
effects a principal trade pursuant to rule 206(3)-3T a written 
confirmation, at or before the completion of the transaction.\46\ In 
addition to the other information required to be in a confirmation by 
Exchange Act rule 10b-10,\47\ the confirmation must include a 
conspicuous, plain English statement informing the advisory client that 
the adviser disclosed to the client prior to the execution of the 
transaction that the adviser may act in a principal capacity in 
connection with the transaction, that the client authorized the 
transaction, and that the adviser sold the security to or bought the 
security from the client for its own account.\48\ An investment adviser 
need not send a duplicate confirmation. An adviser may satisfy its 
obligations under paragraph (a)(5) by including, or causing an 
affiliated broker-dealer to include, the additional required disclosure 
on a confirmation otherwise sent to the client with respect to a 
particular principal transaction.
---------------------------------------------------------------------------

    \46\ For a discussion of the meaning of ``completion'' of the 
transaction, see Section 206(3) Release. The temporary rule does not 
permit advisers to deliver confirmations using the alternative 
periodic reporting provisions of rule 10b-10(b) under the Exchange 
Act.
    \47\ 17 CFR 240.10b-10.
    \48\ Rule 206(3)-3T(a)(5).
---------------------------------------------------------------------------

    The requirement to provide a trade-by-trade confirmation is 
designed to ensure that clients are given a written notice and reminder 
of each transaction that the investment adviser effects on a principal 
basis and that conflicts of interest are inherent in such 
transactions.\49\ We request comment on our written confirmation 
condition. Is there additional information that should be included in 
the confirmation? Are there circumstances in which commenters believe 
it is appropriate for us to permit investment advisers to rely on rule 
206(3)-3T and also deliver confirmations to clients pursuant to the 
alternative periodic reporting provisions of rule 10b-10(b)?
---------------------------------------------------------------------------

    \49\ Rule 206(3)-2 under the Advisers Act, our agency cross 
transaction rule, requires similar confirmation disclosure.
---------------------------------------------------------------------------

6. Annual Summary Statement
    The investment adviser must deliver to each client, no less 
frequently than once a year, written disclosure containing a list of 
all transactions that were executed in the account in reliance on rule 
206(3)-3T, including the date and price of such transactions.\50\ The 
annual summary statement is designed to ensure that clients receive a 
periodic record of the principal trading activity in their accounts and 
are afforded an opportunity to assess the frequency with which their 
adviser engages in such trades. As with each other disclosure required 
pursuant to rule 206(3)-3T, to be able to rely on the rule the 
investment adviser must include a

[[Page 55029]]

conspicuous, plain English statement that its client's written 
prospective consent may be revoked at any time.\51\
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    \50\ Rule 206(3)-3T(a)(6). Rule 206(3)-2(a)(3) contains a 
similar annual report requirement with respect to agency cross 
transactions. In addition, the FPA recommended a similar condition. 
See FPA Letter, at 4.
    \51\ Rule 206(3)-3T(a)(8).
---------------------------------------------------------------------------

    We request comment generally on this aspect of the interim final 
rule. Should a summary statement be provided more or less frequently 
than annually? Is there additional information that we should require 
to be included in each summary statement? For example, we are not 
requiring advisers to disclose in an annual statement the total amount 
of all commissions or other remuneration they receive in connection 
with transactions with respect to which they are relying on this rule. 
Although that disclosure is required with respect to agency cross 
transactions pursuant to rule 206(3)-2(a)(3), we are concerned that 
disclosure of such amounts for principal trades may not accurately 
reflect the actual economic benefit to the adviser with respect to 
those trades or the consequence to the client for consenting to those 
trades. Are our concerns justified? Commenters are invited to submit 
suggestions for possible enhancements to the disclosures in annual 
statements that could enhance the disclosure to clients of the 
significance of their consenting to principal trades.
7. Advisory Account Must Be a Brokerage Account
    Rule 206(3)-3T is only available to an investment adviser that also 
is registered with us as a broker-dealer. Each account for which the 
investment adviser relies on this section must be a brokerage account 
subject to the Exchange Act, the rules thereunder, and the rules of 
applicable self-regulatory organizations (e.g., FINRA).\52\ The rule 
therefore requires that the protections of both the Advisers Act and 
the Exchange Act apply when advisers enter into principal transactions 
with clients in reliance on the rule.
---------------------------------------------------------------------------

    \52\ Rule 206(3)-3T(a)(7).
---------------------------------------------------------------------------

    The temporary rule permits, subject to compliance with the rule's 
conditions, an adviser that also is registered as a broker-dealer to 
execute a principal trade directly (out of its own account) or 
indirectly (out of an account of another person who is a control person 
of the adviser). Because we have decided to apply the rule only to 
advisers who also are registered as broker-dealers, an adviser who is 
not also a registered broker-dealer would be unable to rely on rule 
206(3)-3T if it causes a client to enter into a principal trade with a 
control person, even if that control person is a registered broker-
dealer.
    Our decision not to extend the rule to advisory accounts that are 
held only at investment advisers, as opposed to entities that are both 
investment advisers and broker dealers, is based on several 
considerations. First, firms that are both broker-dealers and 
investment advisers and their employees must comply with the 
comprehensive set of Commission and self-regulatory organization sales 
practice and best execution rules that apply to the relationship 
between a broker-dealer and its customer in addition to the fiduciary 
duties an adviser owes a client. We believe that it is important to 
maintain the application of the laws and rules regarding broker-dealers 
to these accounts.\53\ Second, as a practical matter, advisory clients 
most frequently need and desire principal trading services from firms 
that are dually registered as an adviser and a broker-dealer because 
they generally carry large inventories of securities. Providing a 
variation in the method of complying with section 206(3) of the 
Advisers Act for advisers that also are registered as broker-dealers 
thus addresses a large category of the situations in which clients are 
likely to benefit from access to the inventory of the adviser/broker-
dealer without sacrificing pricing or other sales practice protections.
---------------------------------------------------------------------------

    \53\ We note that fee-based brokerage accounts have been subject 
to Commission and self-regulatory organization sales practice and 
best execution rules since their inception.
---------------------------------------------------------------------------

    We request comment on this aspect of the interim final rule. What 
will be the benefit to customers of maintaining the sales practice 
rules of self-regulatory organizations? What will be the impact of the 
rule on advisers that are not themselves registered as broker-dealers? 
Would they choose to register as a broker-dealer in order to take 
advantage of the new rule? Are there particular requirements of broker-
dealer regulation that are clearly duplicative or clearly inapplicable 
to the regulation of investment advisers and so are unnecessary in this 
context?
8. Other Obligations Unaffected
    Rule 206(3)-3T(b) clarifies that the temporary rule does not 
relieve in any way an investment adviser from its obligation to act in 
the best interests of each of its advisory clients, including 
fulfilling the duty with respect to the best price and execution for a 
particular transaction.\54\ Compliance with rule 206(3)-3T also does 
not relieve an investment adviser from its fiduciary obligation imposed 
by sections 206(1) or (2) of the Advisers Act or by other applicable 
provisions of federal law.\55\
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    \54\ Rule 206(3)-2(e) contains a similar provision.
    \55\ Section 206(3) Release. See also SIFMA Memo at Exhibit page 
23 (noting that, in connection with any relief provided under 
section 206(3), ``[t]he adviser will continue to act in the best 
interests of the client, including a duty to provide best execution, 
and will be required to meet all disclosure obligations imposed by 
Sections 206(1) and (2) of the Advisers Act and by other applicable 
provisions of the federal securities laws and rules of SROs''); 
section 406 of the Employee Retirement Income Security Act of 1974 
(``ERISA'') (describing ``prohibited transactions'' of fiduciaries 
subject to ERISA); section 4975(c)(1) of the Internal Revenue Code 
(the ``Code'') (describing ``prohibited transactions'' of 
fiduciaries governed by the Code).
---------------------------------------------------------------------------

    We note specifically that an adviser engaging in principal 
transactions is subject to rule 206(4)-7, which, among other things, 
requires an investment adviser registered with us to adopt and 
implement written policies and procedures reasonably designed to 
prevent violations of the Advisers Act (and the rules thereunder) by 
the adviser or any of its supervised persons.\56\ Thus, an adviser 
relying on rule 206(3)-3T as an alternative means of complying with 
section 206(3) must have adopted and implemented written policies and 
procedures reasonably designed to comply with the requirements of the 
rule. In addition, rule 204-2,\57\ as well as Exchange Act rules 17a-3 
\58\ and 17a-4,\59\ requires the adviser to make, keep, and retain 
records relating to the principal trades the adviser effects.
---------------------------------------------------------------------------

    \56\ Rule 206(4)-7(a) [17 CFR 275.206(4)-7(a)].
    \57\ 17 CFR 275.204-2.
    \58\ 17 CFR 240.17a-3.
    \59\ 17 CFR 240.17a-4.
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9. Limited Duration of Relief
    Rule 206(3)-3T(d) contains a sunset provision. Absent further 
action by the Commission, the temporary rule will expire on December 
31, 2009, which is about 27 months from its effective date.\60\ Setting 
a termination date for the rule will necessitate further Commission 
action no later than the end of that period if the Commission intends 
to continue the same or similar relief.
---------------------------------------------------------------------------

    \60\ The FPA recommended a similar condition See FPA Letter, at 
2.
---------------------------------------------------------------------------

    We believe limiting the duration of the rule will give us an 
opportunity to observe how firms comply with their disclosure 
obligations under the rule, and whether, when they conduct principal 
trades with their clients, they put their clients' interests first. A 
significantly shorter period than the one we have established, however, 
may have disadvantaged former fee-based brokerage customers because of 
the uncertainty about the continuation of access through their advisory 
accounts to the securities in the inventory of their

[[Page 55030]]

brokerage firm. Those customers also could have faced renewed 
disruption and confusion if the rule on principal trades were abolished 
or substantially modified in the short term. Similarly, broker-dealers 
would have faced the same uncertainty about the continuation of the 
rule, which could have caused some broker-dealers to decide not to make 
the necessary expenditures and investments to offer advisory accounts 
with access to principal trades.
    We request comment on whether the 27-month time frame is 
appropriate. We also welcome comment on any other aspects of the rule 
that commenters believe should be modified.
10. Other Matters
    This rulemaking action must be: (i) Necessary or appropriate in the 
public interest; (ii) consistent with the protection of investors; and 
(iii) consistent with the purposes fairly intended by the policy and 
provisions of the Advisers Act.\61\ We also need to consider the effect 
of the rule on competition, efficiency, and capital formation, which we 
address below in Section VII of this Release. For the reasons described 
in this Release, we believe that the rule is necessary or appropriate 
in the public interest and consistent with the protection of investors. 
We also believe that the temporary rule is consistent with the purposes 
fairly intended by the policy and provisions of the Advisers Act.
---------------------------------------------------------------------------

    \61\ See 15 U.S.C. 80b-6a.
---------------------------------------------------------------------------

    In the FPA decision, the Court described the purposes of the Act, 
emphasizing that the ``overall statutory scheme of the [Advisers Act] 
addresses the problems identified to Congress in two principal ways: 
First, by establishing a federal fiduciary standard to govern the 
conduct of investment advisers, broadly defined, * * * and second, by 
requiring full disclosure of all conflicts of interest.'' \62\ The 
Congressional intent was to eliminate or expose all conflicts of 
interest that might incline an investment adviser, consciously or 
unconsciously, to render advice that was not disinterested.\63\ The 
Court further noted that Congress's purpose in enacting the Advisers 
Act was to establish fiduciary standards and require full disclosure of 
all conflicts of interests of investment advisers.\64\
---------------------------------------------------------------------------

    \62\ FPA decision, at 490.
    \63\ Id.
    \64\ Id.
---------------------------------------------------------------------------

    The temporary rule adopted today meets those purposes and adheres 
closely to the text of section 206(3), which reflects the basic 
conflict disclosure purposes of the Act. That section provides that an 
adviser, before engaging in a principal trade with an advisory client, 
must disclose to the client in writing before completion of the 
transaction the capacity in which the adviser is acting and must obtain 
the consent of the client to the transaction. As we have stated before, 
``[i]n adopting Section 206(3), Congress recognized the potential for 
[abuses such as price manipulation or the placing of unwanted 
securities into client accounts], but did not prohibit advisers 
entirely from engaging in all principal and agency transactions with 
clients. Rather, Congress chose to address these particular conflicts 
of interest by imposing a disclosure and client consent requirement in 
Section 206(3) of the Advisers Act.'' \65\
---------------------------------------------------------------------------

    \65\ Section 206(3) Release at text accompanying note 5.
---------------------------------------------------------------------------

    The temporary rule complies with Congressional intent. It provides 
an alternative procedural means of complying with section 206(3) that 
retains transaction-by-transaction disclosure and consent (as required 
by section 206(3) of the Act), but adds additional investor protections 
measures by requiring an adviser:
     At the outset of the relationship with the client, to 
disclose in writing the circumstances under which the investment 
adviser directly or indirectly may engage in principal transactions, 
the nature and significance of conflicts with its client's interests as 
a result of the transactions, and how the investment adviser addresses 
those conflicts;
     To obtain prospective written consent of the client in 
response to that initial disclosure;
     Before each transaction, to inform the advisory client, 
orally or in writing, that the adviser may act in a principal capacity 
with respect to the transaction and to obtain the consent from the 
advisory client, orally or in writing, for the transaction;
     To send to the client, at or before completion of the 
transaction, a written trade confirmation that, in addition to the 
information required by rule 10b-10 under the Exchange Act, discloses 
that the adviser informed the client prior to the execution of the 
transaction that the adviser may be acting in a principal capacity in 
connection with the transaction, that the client authorized the 
transaction, and that the adviser sold the security to, or bought the 
security from, the client for its own account;
     To send to the advisory client an annual statement listing 
each principal transaction during the preceding year and the date and 
price of each such transaction; and
     To acknowledge explicitly in each required disclosure the 
right of the client to revoke his or her prospective consent at any 
time.

We believe that these transaction-specific steps, taken together, 
fulfill the Congressional purpose behind section 206(3) of the Act.
    Another significant protection is that, as we discuss in Section 
II.B.7 above, to benefit from the rule, the investment adviser must 
also be a broker-dealer registered with us. Therefore, the firm must 
comply with the comprehensive set of Commission and self-regulatory 
organization sales practice and best execution rules that apply to the 
relationship between a broker-dealer and customer in addition to the 
fiduciary duties an adviser owes a client.
    We further believe that the temporary nature of the rule will give 
us an opportunity to observe how firms comply with their obligations, 
and whether, when they conduct principal trades with their clients, 
they put their clients' interests first. The rule therefore employs a 
range of features to achieve the transaction-by-transaction conflict 
disclosure and consent purposes and policies of the Advisers Act. The 
rule additionally enables the adviser to discharge its fiduciary duties 
by bolstering them with broker-dealer responsibilities.
11. Effective Date
    This temporary rule takes effect on September 30, 2007. For several 
reasons, including those discussed above, we have acted on an interim 
final basis.
    In the time since the FPA decision, the Commission staff has had 
numerous communications with affected customers, broker-dealers, and 
investment advisers about areas in which Commission action or relief 
might be required to protect the interests of investors as a result of 
the Court's decision. One area of significance identified as our 
deliberative process continued was the area of principal trades. Under 
the rule vacated in the FPA decision, principal trades in fee-based 
brokerage accounts were not subject to section 206(3) of the Act. 
Through the process of discussions with interested parties, it was 
brought to our attention that a large number of fee-based brokerage 
customers favor having the choice of advisory accounts with access to 
the inventory of a diversified broker-dealer and that for certain 
customers the access to such securities--many of which would otherwise 
be unavailable--was a critical

[[Page 55031]]

component of their investment strategy. We also learned that, as 
discussed above, the traditional method for complying with the 
principal trading restrictions on an adviser in section 206(3)--written 
disclosure and consent before completion of each securities 
transaction--made it not feasible for an adviser to engage in principal 
trading with its clients. The Commission received requests for 
principal trading relief from firms and the staff engaged in 
discussions with representatives of investors, financial planners, and 
broker-dealers about the terms of relief, considered their specific 
comments, and took those comments into account in developing the 
temporary rule we are adopting today.
    Because of the FPA decision and the October 1, 2007 expiration of 
the stay of the issuance of the Court's mandate to vacate the former 
rule, investors with fee-based brokerage accounts must now consider 
whether they should convert their accounts to advisory accounts or to 
traditional commission-based brokerage accounts. It is not possible for 
those customers to make a meaningful, well-informed decision if they do 
not know what services will be offered in advisory accounts. For 
example, it would be critical to a customer who invests primarily in 
fixed income securities (which generally are traded by firms on a 
principal basis) to know whether he or she could continue to access a 
firm's inventory of those securities (or sell those securities to the 
firm) in an advisory account. But firms informed us that they would not 
permit that kind of trading without a rule that is effective and that 
provides an alternative means of complying with section 206(3) of the 
Act. Until we could publish a rule for comment, receive and analyze 
those comments, and adopt a final rule, that customer would be left 
with the choice between a traditional brokerage account without the 
ability to pay a fee based on assets--presumably the customer's 
preferred manner of payment--or a fee-based advisory account without 
the ability to invest in fixed income products.
    Changing accounts and methods of payments can be highly disruptive 
and confusing to many investors, requiring a series of communications 
between the investor and one or more firms about the options available 
to give the investor the information he or she needs to make informed 
decisions about the services available in each type of account. We 
believe that it serves such investors' interests best to adopt the rule 
on an interim final basis, which permits them to continue the same kind 
of account, with similar services, that they had when they were fee-
based brokerage customers.
    We are aware that, as a result of the FPA decision, the process for 
converting as many as one million fee-based brokerage accounts to non-
discretionary advisory or other accounts requires a great deal of time 
and imposes significant conversion costs on firms. For example, in 
order to comply with the October 1 deadline, those firms needed to 
draft or revise agreements, policies, and other documents, hire and 
train employees, and make changes to data and recordkeeping, order 
entry, billing, and other systems. The firms offering fee-based 
brokerage accounts urged us to reduce the burdens that apply to them by 
adopting a rule that is effective on or before October 1 and that 
permits an alternative method of complying with section 206(3) of the 
Act (or, alternatively, to exempt them from section 206(3) altogether). 
They informed us that this would simplify the process of communicating 
with their customers and reduce investor confusion. This is mostly 
because the services and manner of payments would be substantially 
similar in non-discretionary advisory accounts as they were in fee-
based brokerage accounts--the firms would not have to explain why the 
services a customer has become accustomed to are changing, or why the 
manner of payment is changing.
    The firms also were concerned that, without a rule that is 
effective by the date the FPA decision takes effect, fee-based 
brokerage customers may elect (or the firm may recommend) a commission-
based brokerage account in order to have access to their firm's 
inventory of securities, then elect an advisory account only after a 
rule subject to notice and comment is finalized. This type of serial 
account change is costly to firms for the same reasons it is costly for 
them to convert accounts pursuant to the FPA decision. Moreover, such 
switching of account types can be confusing to customers if it is the 
firm that is recommending the changes.
    Those factors led to this rule and similarly explain why the rule 
needs to be available at the same time the broker-dealers complete the 
transition from fee-based brokerage to advisory or other accounts. 
Otherwise, the risk of disrupting services to the investors, depriving 
them of the choice of an advisory account with a broker-dealer, and 
confusing them with a series of changes to the services available to 
them would have been substantial. Obtaining a further postponement of 
the stay of the mandate to allow advance notice and comment rulemaking 
did not appear feasible. For these reasons, issuance of an immediately 
effective rule is necessary to ameliorate the likely harm to investors.
    Furthermore, we emphasize that we are requesting comments on the 
rule and will carefully consider and respond to them in a subsequent 
release. Moreover, this is a temporary rule. Setting a 27-month 
termination date for the rule will necessitate further Commission 
action no later than the end of that period if the Commission intends 
to continue the same or similar relief. The sunset provision will 
result in the Commission assessing the operation of the rule and 
intervening developments, as well as public comment letters, and 
considering whether to continue the rule with or without modification 
or not at all.
    A significantly shorter period than the 27-month period we have 
established could have disadvantaged investors. They would have faced 
uncertainty about the continuation of having access through their 
advisory accounts to the securities in the inventory of their brokerage 
firm and could have faced renewed disruption and confusion if the rule 
on principal trades were abolished or substantially modified in the 
short term. Similarly, broker-dealers would have faced the same 
uncertainty about the continuation of the rule, which could have caused 
some broker-dealers to decide not to make the necessary expenditures 
and investments to offer advisory accounts with access to principal 
trades.
    As a result, the Commission finds that it has good cause to have 
the rule take effect on September 30, 2007, and that notice and public 
procedure in advance of the effectiveness of the rule are 
impracticable, unnecessary, and contrary to the public interest. In 
addition, the rule in part has interpretive aspects and is a rule that 
recognizes an exemption and relieves a restriction.

III. Request for Comments

    The Commission is requesting comments from all members of the 
public during the next 60 days. We will carefully consider the comments 
that we receive and respond to them in a subsequent release.
    In addition, we are awaiting a report being prepared by RAND 
Corporation comparing how the different regulatory systems that apply 
to broker-dealers and advisers affect investors (the ``RAND Study''). 
As we have previously announced, the Commission commissioned a study 
comparing the levels of protection afforded customers of broker-dealers 
and investment

[[Page 55032]]

advisers under the federal securities laws.\66\ The Commission will 
have another opportunity to assess the operation and terms of the rule 
when it receives the results of the RAND Study comparing how the 
different regulatory systems that apply to broker-dealers and advisers 
affect investors. The RAND Study is expected to be delivered to the 
Commission no later than December 2007, several months ahead of 
schedule. The results of the RAND Study are expected to provide an 
important empirical foundation for the Commission to consider what 
action to take to improve the way investment advisers and broker-
dealers provide financial services to customers. One option then 
available to the Commission will be making the RAND Study results 
available to the public and seeking comments on them and their bearing 
on the terms of this rule.
---------------------------------------------------------------------------

    \66\ Commission Seeks Time for Investors and Brokers to Respond 
to Court Decision on Fee-Based Accounts, SEC Press Release No. 2007-
95 (May 14, 2007).
---------------------------------------------------------------------------

IV. Transition Guidance
    We are today providing guidance to assist broker-dealers who have 
offered fee-based brokerage accounts and are seeking the consent of 
their clients to convert those accounts to advisory accounts and meet 
the requirements of this rule by October 1, 2007.

A. Client Consent

    Broker-dealers have asked whether they must, before October 1, 
2007, obtain written consent from each of their fee-based brokerage 
customers to enter into an advisory agreement that meets the 
requirements of the Advisers Act, in particular section 205 of the Act. 
Broker-dealers have informed us that, as a practical matter, it is not 
feasible for them to do so and, if written consent is required, many 
fee-based brokerage customers will experience interrupted service or 
will be placed in traditional commission-based brokerage accounts, 
which may not be best for them.
    Interim final rule 206(3)-3T(a)(3) requires an adviser wishing to 
rely on the rule's alternative means for complying with section 206(3) 
of the Act to obtain a written prospective consent from each client 
authorizing the investment adviser to engage in principal transactions 
with the client. We understand that it likely will be impossible for 
advisers to obtain these written consents from fee-based brokerage 
customers who convert their accounts to non-discretionary advisory 
accounts prior to October 1, 2007. To make the alternative means 
provided in the interim final rule useful immediately upon its 
effective date to those customers, we will not object if an adviser 
obtains the required written consent no later than January 1, 2008 from 
each fee-based customer who converts his or her account to a non-
discretionary advisory account. During this transitional period, 
investment advisers must comply with the other conditions of rule 
206(3)-3T, including the condition in paragraph (a)(4) of the rule, 
which requires that the adviser make certain disclosures and obtain 
client consent before effecting a principal trade with the client. They 
also must provide a client with the written disclosure required by 
paragraph (a)(3) of the temporary rule prior to effecting the first 
trade with that client in reliance on this rule.

B. Client Brochures

    Advisers Act rule 204-3 requires an investment adviser to furnish 
its advisory clients with a disclosure statement, or brochure, 
containing at least the information required to be in Part II of Form 
ADV at the time of, or prior to, entering into an advisory 
contract.\67\ In light of the time constraints firms face in complying 
with the October 1st deadline, we will not object if, with respect to 
the fee-based brokerage customers that convert to non-discretionary 
advisory accounts, advisers deliver this statement no later than 
January 1, 2008.
---------------------------------------------------------------------------

    \67\ The Advisers Act does not specify any means by which a 
client must execute a new advisory contract or agree to changes in 
an existing one. For purposes of transitioning clients from fee-
based brokerage accounts, advisers presumably must look to the terms 
of the contracts they have in place, as well as applicable contract 
law, to determine the manner in which they need to enter into new 
contract or amend existing contracts in order to come into 
compliance with the Act.
---------------------------------------------------------------------------

V. Paperwork Reduction Act

A. Background

    Rule 206(3)-3T contains ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995.\68\ The 
collection of information is new. We submitted these requirements to 
the Office of Management and Budget (``OMB'') for review in accordance 
with 44 U.S.C. 3507(j) and 5 CFR 1320.13. Separately, we have submitted 
the collection of information to OMB for review and approval in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The OMB has 
approved the collection of information on an emergency basis with an 
expiration date of March 31, 2008. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid OMB control number. 
The title for the collection of information is: ``Temporary rule for 
principal trades with certain advisory clients, rule 206(3)-3T'' and 
the OMB control number for the collection of information is 3235-0630.
---------------------------------------------------------------------------

    \68\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    Rule 206(3)-3T provides an alternative method for investment 
advisers that are registered with us as broker-dealers to meet the 
requirements of section 206(3) when they act in a principal capacity 
with respect to transactions with certain of their advisory clients. In 
the absence of this rule, an adviser must provide a written disclosure 
and obtain consent for each transaction in which the adviser acts in a 
principal capacity. Rule 206(3)-3T permits an adviser, with respect to 
a non-discretionary advisory account, to comply with section 206(3) by: 
(i) Making certain written disclosures; (ii) obtaining written, 
revocable consent from the client prospectively authorizing the adviser 
to enter into principal trades; (iii) making oral or written disclosure 
that the adviser may act in a principal capacity and obtaining the 
client's consent orally or in writing prior to the execution of each 
principal transaction; (iv) sending to the client confirmation 
statements disclosing the capacity in which the adviser has acted and 
indicating that the adviser disclosed to the client that it may act in 
a principal capacity and that the client authorized the transaction; 
and (v) delivering to the client an annual report itemizing the 
principal transactions.

B. Collections of Information and Associated Burdens

    Under rule 206(3)-3T, there are four distinct collection burdens. 
Our estimate of the burden of each of the collections reflects the fact 
that the alternative means of compliance provided by the rule is 
substantially similar to the approach advisers currently employ to 
comply with the disclosure and consent obligations of section 206(3) of 
the Advisers Act and the approach that broker-dealers employ to comply 
with the confirmation requirements of rule 10b-10 under the Exchange 
Act. Thus, as discussed below, we estimate that rule 206(3)-3T will 
impose only small additional burdens.
    Providing the information required by rule 206(3)-3T is necessary 
to obtain the benefit of the alternative means of complying with 
section 206(3) of the Advisers Act. The rule contains two types of 
collections of information: Information provided by an adviser to its 
advisory clients and information

[[Page 55033]]

collected from advisory clients by an adviser. With respect to each 
type of collection, the information would be maintained by the adviser. 
Under Advisers Act rule 204-2(e), an adviser must preserve for five 
years the records required by the collection of information pursuant to 
rule 206(3)-3T. Although the rule does not call for any of the 
information collected to be provided to us, to the extent advisers 
include any of the information required by the rule in a filing, such 
as Form ADV, the information will not be kept confidential. The 
collection of information delivered by investment advisers pursuant to 
rule 206(3)-3T would be provided to clients and also would be 
maintained by investment advisers. The collection of information 
delivered by clients to advisers would be subject to the 
confidentiality strictures that govern those relationships, and we 
would expect them to be confidential communications.
Collections of Information
    Prospective Disclosure and Consent: Pursuant to paragraph (a)(3) of 
the rule, an investment adviser must provide written, prospective 
disclosure to the client explaining: (i) The circumstances under which 
the investment adviser directly or indirectly may engage in principal 
transactions; (ii) the nature and significance of conflicts with its 
client's interests as a result of the transactions; and (iii) how the 
investment adviser addresses those conflicts. Pursuant to paragraph 
(a)(8) of the rule, the written, prospective disclosure must include a 
conspicuous, plain English statement that a client's written, 
prospective consent may be revoked without penalty at any time by 
written notice to the investment adviser from the client. And, for the 
adviser to be able to rely on rule 206(3)-3T with respect to an 
account, the client must have executed a written, revocable consent 
after receiving such written, prospective disclosure.
    The first part of this collection of information involves the 
preparation and distribution of a written disclosure statement, which 
we anticipate will be largely uniform for clients in non-discretionary 
advisory accounts with a particular firm. This collection of 
information is necessary to explain to investors how their interests 
might be different from the interests of their investment adviser when 
the adviser engages in principal trades with them. It is designed to 
provide investors with sufficient information to be able to decide 
whether to consent to such trades.
    We anticipate that the cost of this collection will mostly be borne 
upfront as advisers develop and deliver the required disclosure. This 
will require drafting and distributing the required disclosure to 
clients with respect to the accounts for which the investment adviser 
seeks to rely on the rule.\69\ Once the disclosure has been developed 
and is integrated into materials provided upon opening a non-
discretionary advisory account, the ongoing burden will be minimal.
---------------------------------------------------------------------------

    \69\ We note that disclosure about the conflicts of interest for 
an adviser that engages in principal trades already is required to 
be disclosed by investment advisers in Form ADV. See Item 8 of Part 
1A of Form ADV; Item 9 of Part II of Form ADV; Item 7(l) of Schedule 
H to Part II of Form ADV.
---------------------------------------------------------------------------

    We estimate that the average burden for drafting the required 
prospective disclosure for each eligible adviser, taking into account 
both those advisers that previously engaged in principal trades with 
their non-discretionary advisory clients, will be approximately 5 hours 
on average. We expect that some advisers, particularly the large 
financial services firms, may take significantly longer to draft the 
required disclosure because they may have more principal trading 
practices, and potentially more conflicts, to describe.\70\ Other 
advisers may take significantly less time and some eligible advisers 
may choose not to rely on rule 206(3)-3T. Further, we expect the 
drafting burden will be uniform with respect to each eligible adviser 
regardless of how many individual non-discretionary advisory accounts 
that adviser administers or seeks to engage with in principal trading. 
As of August 1, 2007, there were 634 advisers that were eligible to 
rely on the temporary rule (i.e., also registered as broker-dealers), 
395 of which indicate that they have non-discretionary advisory 
accounts.\71\ We estimate that 90 percent of those 395 advisers, or a 
total of 356 of those advisers, will rely on this rule.\72\ Of the 239 
eligible advisers that do not currently provide non-discretionary 
advisory services, we estimate that 10 percent of these advisers, or 24 
advisers, will create non-discretionary advisory programs and rely on 
the alternative means of compliance provided by this rule.\73\ Thus, 
the total number of advisers we anticipate will rely on the rule is 
380.\74\ Accordingly, we estimate that the total drafting burden for 
the prospective disclosure statement for the estimated 380 advisers 
that will rely on the rule will be 1,900 hours.\75\
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    \70\ The opportunities to engage in principal trades with 
advisory clients will vary greatly among eligible investment 
advisers. We believe many of these advisers are registered as 
broker-dealers for limited purposes and do not engage in market-
making activities or otherwise carry extensive inventories of 
securities. These firms likely would limit their principal trading 
operations significantly. For example, they may choose to engage 
only in riskless principal trades, which may pose limited conflicts 
of interest resulting in brief disclosures. Investment advisers with 
large inventories of securities and multi-faceted operations, 
however, likely will have much more extensive disclosure.
    \71\ IARD data as of August 1, 2007, for Items 6.A(1) and 
5.F(2)(e) of Part 1A of Form ADV.
    \72\ We anticipate that most dually-registered advisers will 
make use of the rule to engage in, at a minimum, riskless principal 
transactions to limit the need for these advisers to process trades 
for their advisory clients with other broker-dealers. We estimate 
that 10% of these firms will determine that the costs involved to 
comply with the rule are too significant in relation to the benefits 
that the adviser, and their clients, will enjoy.
    \73\ We estimate that 10% of the dually-registered advisers that 
do not currently have non-discretionary advisory programs will 
create them due to a combination of market forces and the ability to 
enter into principal trades more efficiently as a result of the 
rule. We base this estimate on discussions with industry 
representatives.
    \74\ 356 dually-registered advisers that currently have non-
discretionary advisory account programs + 24 dually-registered 
advisers that do not currently have non-discretionary advisory 
programs, but we expect will initiate them = 380 eligible advisers 
that will have non-discretionary advisory programs.
    \75\ 5 hours per adviser x 380 eligible advisers that will rely 
on the rule = 1,900 total hours.
---------------------------------------------------------------------------

    The prospective disclosure will need to be distributed to all 
clients who have non-discretionary advisory accounts for which an 
adviser seeks to rely on rule 206(3)-3T. Registration data indicates 
that there are approximately 3,270,000 existing non-discretionary 
advisory accounts held with eligible advisers.\76\ Discussions with 
eligible advisers indicate that approximately: (i) 90 percent of these 
non-discretionary advisory accounts administered by them, or 2,943,000 
accounts, are in programs to which the rule will not apply, such as 
mutual fund asset allocation programs; and (ii) 40 percent of the 
remaining 327,000 non-discretionary advisory accounts administered by 
them, or 130,800 accounts, are retirement accounts, and thus unlikely 
to participate in principal trading,\77\ leaving 196,200 existing non-
retirement non-discretionary advisory accounts administered by eligible 
advisers.\78\
---------------------------------------------------------------------------

    \76\ IARD data as of August 1, 2007, for Item 5.F(2)(e) of Part 
1A of Form ADV.
    \77\ We have based this estimate on discussions with industry 
representatives. The Code and ERISA impose restrictions on certain 
types of transactions involving certain retirement accounts. We do 
not take a position on whether the Code or ERISA limits the 
availability of rule 206(3)-3T.
    \78\ 3,270,000 existing non-discretionary advisory accounts 
among eligible advisers-2,943,000 accounts in wrap fee and other 
programs to which the rule will not apply-130,800 retirement 
accounts = 196,200 non-retirement, non-discretionary advisory 
accounts among eligible advisers.

---------------------------------------------------------------------------

[[Page 55034]]

    As noted in Section I.B of this Release and confirmed by 
discussions with several firms, we anticipate that most fee-based 
brokerage accounts will be converted to non-discretionary advisory 
accounts. For purposes of our analysis, we have assumed that all of the 
estimated 1 million fee-based brokerage accounts will be converted to 
non-discretionary advisory accounts.\79\ Of those accounts, we estimate 
that substantially all of them are held at investment advisers that 
also are registered as broker-dealers.\80\ Discussion with broker-
dealers that have fee-based brokerage programs have informed us that 
approximately 40 percent of the existing fee-based brokerage accounts 
are retirement accounts, and are unlikely to engage in principal 
trading. We anticipate that all eligible advisers that are converting 
fee-based brokerage accounts to non-discretionary advisory accounts 
will conduct principal trading in reliance on the rule. Thus, we 
estimate that eligible investment advisers will distribute the 
prospective disclosure to approximately 600,000 former fee-based 
brokerage customers. When aggregated with the 196,200 existing non-
retirement, non-discretionary advisory accounts we believe likely will 
receive the prospective disclosure, we estimate the total number of 
accounts for which clients will receive prospective disclosure to be 
796,200.\81\
---------------------------------------------------------------------------

    \79\ This assumption may result in the estimated paperwork 
burdens and costs of proposed rule 206(3)-3T being overstated.
    \80\ Industry representatives have informed us that 
substantially all fee-based brokerage accounts are held with twelve 
broker-dealers, all of which also are registered as investment 
advisers according to IARD data as of August 1, 2007.
    \81\ 196,200 existing non-retirement, non-discretionary advisory 
accounts we estimate are likely to receive prospective disclosures + 
600,000 fee-based brokerage accounts we estimate will be converted 
to non-discretionary advisory accounts = 796,200 total accounts we 
expect to receive the prospective disclosure addressed in paragraph 
(a)(3) of rule 206(3)-3T.
---------------------------------------------------------------------------

    We estimate that the burden for administering the distribution of 
the prospective disclosure will be approximately 0.1 hours (six 
minutes) for every account. Based on the discussion above, we estimate 
that the prospective disclosure will be distributed to a total of 
approximately 796,200 eligible existing non-discretionary advisory 
accounts and eligible former fee-based brokerage accounts. We estimate 
the total hour burden under paragraph (a)(3) of rule 206(3)-3T for 
distribution of the prospective written disclosure to be 79,620 
hours.\82\
---------------------------------------------------------------------------

    \82\ 0.1 hours (six minutes) per account x 796,200 accounts = 
79,620 hours.
---------------------------------------------------------------------------

    We estimate an average one-time cost of preparation of the 
prospective disclosure to include outside legal fees for approximately 
three hours of review to total $1,200 per eligible adviser on 
average,\83\ for a total of $456,000.\84\ As we discuss above, advisers 
that rely on the rule will face widely varying numbers and severity of 
conflicts of interest with their clients. We believe that those 
advisers that engage in riskless principal trading, are unlikely to 
seek outside legal services in drafting the prospective disclosure. On 
the other hand, advisers with more significant conflicts are likely to 
engage outside legal services to assist in preparation of the 
prospective written disclosure. We also estimate a one-time average 
cost for printing and physical distribution of the various disclosure 
documents, including a disclosure and consent form and, if necessary, a 
revised account agreement, to be approximately $1.50 per account,\85\ 
for a total of $1,194,300.\86\
---------------------------------------------------------------------------

    \83\ Outside legal fees are in addition to the projected 5 hour 
per adviser burden discussed in note 75 and accompanying text.
    \84\ $400 per hour for legal services x 3 hours per adviser x 
380 eligible advisers that we expect to rely on the rule = $456,000. 
The hourly cost estimate is based on our consultation with advisers 
and law firms who regularly assist them in compliance matters.
    \85\ This estimate is based on discussions with firms. It 
represents our estimate of the average cost for printing and 
distribution, which we expect will include distribution of hard 
copies for approximately 85% of accounts and distribution of 
electronic copies for approximately 15% of accounts.
    \86\ $1.50 per account x 796,200 accounts = $1,194,300.
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    The second part of this burden is that the adviser must receive 
from each client an executed written, revocable consent prospectively 
authorizing the investment adviser, or a broker-dealer affiliate of the 
adviser, to act as principal for its own account, to sell any security 
to or purchase any security from the advisory client. This collection 
of information is necessary to verify that a client has provided the 
required prospective consent. It is designed to ensure that advisers 
that wish to engage in principal trades with their clients in reliance 
on the rule inform their clients that they have a right not to consent 
to such transactions.
    Compliance with this part of the temporary rule will require 
advisers to collect executed written, prospective consent from advisory 
clients. We anticipate that the bulk of the burden of this collection 
will be borne upfront. We expect that the consent solicitation for 
existing non-discretionary advisory accounts and fee-based brokerage 
accounts being converted to non-discretionary advisory accounts will be 
integrated into the prospective written disclosure. For new clients, we 
anticipate that the consent solicitation provision will be included in 
the account agreement signed by a client upon opening a non-
discretionary advisory account. Once the consent solicitation has been 
integrated into the account-opening paperwork, the ongoing burden will 
be minimal.
    We believe that the burden and costs to advisers of soliciting 
consent is included in the burdens and costs of drafting and 
distributing the notices described above. This is because we expect the 
consent solicitation to be integrated into the firm's prospective 
written disclosure. We estimate an average burden per accountholder of 
0.05 hours (three minutes) in connection with reviewing the consent 
solicitation, asking questions, providing consent, and, for those that 
so wish, revoking that consent at a later date. Assuming that there are 
796,200 accountholders who receive prospective disclosure and a 
prospective consent solicitation we estimate a total burden of 39,810 
hours on accountholders for reviewing and/or returning consents.\87\ We 
further estimate that 90 percent of these accountholders, or 716,580 
accountholders, will execute and return the consent.\88\
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    \87\ 0.05 hours (three minutes) per accountholder x 796,200 
accountholders executing and returning the consent = 39,810 total 
burden hours on accountholders with respect to returning consents.
    \88\ 796,200 eligible accountholders x 90 percent = 716,580 
accountholders who will return their prospective consents. We refer 
herein to these 716,580 accountholders who return their consents, 
and whose advisers are therefore eligible to rely on the rule with 
respect to them, as ``eligible accountholders.''
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    Finally, we estimate that the burden of updating the disclosure, 
maintaining records on prospective consents provided, and processing 
consent revocations and prospective consents granted subsequent to the 
initial solicitation will be approximately 100 hours per eligible 
adviser per year. We estimate that the total burden for all advisers to 
keep prospective consent information up to date will be 38,000 
hours.\89\
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    \89\ 100 hours per eligible adviser x 380 eligible advisers that 
will rely on the rule = a total burden of 38,000 hours for updating 
disclosure, maintaining records, and processing new consents and 
revocations.
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    Trade-By-Trade Disclosure and Consent: Pursuant to paragraph (a)(4) 
of the rule, an investment adviser, prior to the execution of each 
principal

[[Page 55035]]

transaction, must inform the advisory client, orally or in writing, of 
the capacity in which it may act with respect to such transaction. Also 
pursuant to paragraph (a)(4) of the rule, an investment adviser, prior 
to the execution of each principal transaction, must obtain oral or 
written consent from the advisory client to act as principal for its 
own account with respect to such transaction. This collection of 
information is necessary to alert an advisory client that a specific 
trade may be executed as principal and provide the client with the 
opportunity to withhold its authorization for the trade to be executed 
on a principal basis.
    We note that section 206(3) of the Advisers Act requires written 
trade-by-trade disclosure in connection with principal trades. We 
believe that complying with this part of rule 206(3)-3T provides an 
alternative method of compliance that is likely to be less costly than 
compliance with section 206(3) in many situations. However, to the 
extent that advisers are not currently engaging in principal trades 
with non-discretionary advisory accountholders (and thus are not 
preparing and providing written disclosure regarding conflicts of 
interest associated with principal trading in particular securities), 
advisers electing to rely on the rule will need to begin to prepare 
such disclosure and communicate it to clients. Based on discussions 
with industry and their experience with fee-based brokerage accounts 
and existing non-discretionary advisory programs, we estimate 
conservatively that non-discretionary advisory accountholders at 
eligible advisers engage in an average of approximately 50 trades per 
year and that, for purposes of this analysis, all those trades are 
principal trades for which the investment adviser seeks to rely on rule 
206(3)-3T.\90\ We estimate, based on our discussions with broker-
dealers, a burden of 0.0083 hours (approximately 30 seconds) per trade 
on average for preparation and communication of the requisite 
disclosure to a client, and for the client to consent, for an estimated 
total burden of approximately 297,381 hours per year.\91\
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    \90\ These assumptions may result in the estimated paperwork 
burdens and costs of proposed rule 206(3)-3T being overstated.
    \91\ 50 trades per account per year x 716,580 accountholders 
that will provide prospective consent and therefore enable their 
advisers to rely on the rule with respect to them x 0.0083 hours 
(approximately 30 seconds) per trade for disclosure = a burden of 
297,381 hours per year.
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    Trade-By-Trade Confirmations: Pursuant to paragraph (a)(5) of the 
rule, an investment adviser must deliver to its client a written 
confirmation at or before completion of each principal transaction that 
includes, in addition to the information required by rule 10b-10 under 
the Exchange Act [17 CFR 240.10b-10], a conspicuous, plain English 
statement that the investment adviser: (i) Informed the advisory client 
that it may be acting in a principal capacity in connection with the 
transaction and the client authorized the transaction; and (ii) owned 
the security sold to the advisory client (or bought the security from 
the client for its own account). Pursuant to paragraph (a)(8) of the 
rule, each confirmation must include a conspicuous, plain English 
statement that the written, prospective consent described above may be 
revoked without penalty at any time by written notice to the investment 
adviser from the client. This collection of information is necessary to 
ensure that an advisory client is reminded that a particular trade was 
made on a principal basis and is given the opportunity to revoke 
prospective consent to such trades.
    The majority of the information required in this collection of 
information is already required to be assembled and communicated to 
clients pursuant to requirements under the Exchange Act. As such, we do 
not believe that there will be an ongoing hour burden associated with 
this requirement. We estimate a one-time cost burden for reprogramming 
computer systems that generate confirmations to ensure that all the 
information required for purposes of paragraphs (a)(5) and (a)(8) of 
rule 206(3)-3T is included in such confirmations of $20,000 per 
eligible adviser for a total of $7,600,000.\92\
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    \92\ $20,000 to program system generating confirmations per 
adviser x 380 eligible advisers that will rely on the rule = 
$7,600,000 total programming costs for confirmations. Our estimate 
for the cost to program the confirmation system was derived from 
discussions with broker-dealers.
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    Principal Transactions Report: Pursuant to paragraph (a)(6) of the 
rule, the investment adviser must deliver to each client, no less 
frequently than annually, written disclosure containing a list of all 
transactions that were executed in the account in reliance upon the 
rule, and the date and price of such transactions. This report will 
require a collection of information that should already be available to 
the adviser or its broker-dealer affiliate executing the client's 
transactions. Pursuant to paragraph (a)(8) of the rule, each principal 
transactions report must include a conspicuous, plain English statement 
that the written, prospective consent described above may be revoked 
without penalty at any time by written notice to the investment adviser 
from the client. This collection of information is necessary to ensure 
that clients receive a periodic record of the principal trading 
activity in their accounts and are afforded an opportunity to assess 
the frequency with which their adviser engages in such trades.
    We estimate that other than the actual aggregation and delivery of 
this statement, the burden of this collection will not be substantial 
because the information required to be contained in the statement is 
already maintained by investment advisers and/or broker-dealers 
executing trades for their clients. Advisers and broker-dealers already 
send periodic or annual statements to clients.\93\ Thus, to comply, 
advisers will need to add information they already maintain to 
documents they already prepare and send. We expect that there will be a 
one-time burden associated with this requirement relating to 
programming computer systems to generate the report, aggregating 
information that is already available and maintained by advisers or 
their broker-dealer affiliates. We estimate this burden to be on 
average approximately 5 hours per eligible firm for a total of 1,900 
hours.\94\ We also estimate that in addition to the hour burden, firms 
may have costs associated with retaining outside professionals to 
assist in programming. We estimate these costs to average $10,000 per 
adviser for a total upfront cost of $3,800,000.\95\ Once

[[Page 55036]]

computer systems enable these reports to be generated electronically, 
we estimate that the average ongoing burden of generating the reports 
and delivering them to clients will be 0.05 hours (three minutes) per 
eligible non-discretionary advisory account, or a total of 35,829 hours 
per year.\96\
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    \93\ For example, investment advisers that are qualified 
custodians for purposes of rule 206(4)-2 under the Advisers Act and 
that maintain custody of their advisory clients' assets must, at a 
minimum, send quarterly account statements to their clients pursuant 
to rule 206(4)-2(a)(3).
    \94\ 5 hours per eligible adviser for programming relating to 
the principal trade report x 380 advisers = a total programming 
burden relating to the principal trade report of 1,900 hours. 
Advisers that use proprietary systems will likely devote 
considerably more time to programming reports. However, these 
advisers are also likely to have already programmed systems to meet 
the requirements of rule 206(3)-2(a)(3), which contains a similar 
annual report requirement with respect to agency cross transactions. 
Other advisers may be using commercial software to track and report 
trades in accounts. These software packages should take little time 
for an adviser to implement, and consequently should impose 
significantly less than a 5 hour burden.
    \95\ $10,000 for retaining outside professionals to assist in 
programming in connection with the principal transactions report per 
adviser x 380 advisers = $3,800,000 in outside programming costs in 
connection with the principal transactions report. We based our 
outside programming cost estimate on a rate of $250 per hour for 40 
hours of programming consultant time. We anticipate that the 
advisers that rely on commercial software solutions, many of which 
will be components to trading software they already have acquired, 
will not have to retain outside programming consultants.
    \96\ 0.05 hours (three minutes) per eligible accountholder to 
generate and deliver reports x 716,580 eligible accountholder = 
35,829 hours total burden for generating and delivering reports to 
accountholders. Because, as we note above, the information required 
by the rule will be added to documents advisers already send to 
clients, we estimate that there is no added cost associated with 
delivering the reports to clients (e.g., postage costs).
---------------------------------------------------------------------------

C. Summary of Estimated Paperwork Burden

    For purposes of the Paperwork Reduction Act, we estimate an annual 
incremental increase in the burden for investment advisers and their 
affiliated broker-dealers to comply with the alternative means for 
compliance with section 206(3) of the Advisers Act contained in rule 
206(3)-3T. As discussed above, our estimates reflect the fact that the 
alternative means of compliance is similar to the approach advisers 
currently employ to comply with the disclosure and consent obligations 
of section 206(3) of the Advisers Act and also is similar to the 
approach broker-dealers employ to comply with certain of the 
requirements of rule 10b-10 under the Exchange Act.
    Some amount of training of personnel on compliance with the rule 
and developing, acquiring, installing, and using technology and systems 
for the purpose of collecting, validating and verifying information may 
be necessary. In addition, as discussed above, some amount of time, 
effort and expense may be required in connection with processing and 
maintaining information. We estimate that the total amount of costs, 
including capital and start-up costs, for compliance with the rule is 
approximately $13,050,300.\97\ We estimate that the hour burden will be 
494,440 hours.\98\
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    \97\ $456,000 for outside professional fees associated with 
preparation of the prospective disclosure + $1,194,300 for printing 
and physical distribution costs associated with the prospective 
disclosure + $7,600,000 for programming costs for outside 
professionals for rendering trade confirmations compliant with the 
rule + $3,800,000 for programming costs for outside professionals to 
create principal trading reports = a total of $13,050,300.
    \98\ 1,900 hours for drafting prospective disclosure + 79,620 
hours for administering distribution of prospective disclosure to 
accountholders + 39,810 hours for review by accountholders of the 
consent solicitation and returning consents + 38,000 hours for 
advisers maintaining and updating consent information + 297,381 
hours for preparation and communication of trade-by-trade disclosure 
and consent + 1,900 hours for programming to create principal 
trading reports + 35,829 hours for ongoing generation of principal 
trading reports = a total of 494,440 hours.
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D. Request for Comment

    We invite comment on each of these estimates and the underlying 
assumptions. Pursuant to 44 U.S.C. 3506(c)(2)(B), we request comment 
with respect to the collections described in this section of this 
Release in order to: (i) Evaluate whether the collections of 
information are necessary for the proper performance of our functions, 
including whether the information will have practical utility; (ii) 
evaluate the accuracy of our estimate of the burden of the collections 
of information; (iii) determine whether there are ways to enhance the 
quality, utility, and clarity of the information to be collected; and 
(iv) evaluate whether there are ways to minimize the burden of the 
collections of information on those who respond, including through the 
use of automated collection techniques or other forms of information 
technology.\99\
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    \99\ Comments are requested pursuant to 44 U.S.C. 3506(c)(2)(B).
---------------------------------------------------------------------------

    Persons submitting comments on the collection of information 
requirements should direct the comments to the Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Washington, 
DC 20503, and should send a copy to Nancy M. Morris, Secretary, 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549-1090, with reference to File No. S7-23-07. Requests for materials 
submitted to OMB by the Commission with regard to these collections of 
information should be in writing, refer to File No. S7-23-07, and be 
submitted to the Securities and Exchange Commission, Records 
Management, Office of Filings and Information Services, Washington, DC 
20549. The OMB is required to make a decision concerning the collection 
of information between 30 and 60 days after publication of this 
release. Consequently, a comment to OMB is assured of having its full 
effect if OMB receives it within 30 days of publication.

VI. Cost-Benefit Analysis

A. Background

    We are adopting, as an interim final temporary rule, rule 206(3)-3T 
under the Advisers Act, which provides an alternative means for 
investment advisers that are registered with us as broker-dealers to 
meet the requirements of section 206(3) when they act in a principal 
capacity with respect to transactions with certain of their advisory 
clients. We are adopting this rule as part of our response to a recent 
court decision invalidating rule 202(a)(11)-1, which provided that fee-
based brokerage accounts were not advisory accounts and were thus not 
subject to the Advisers Act. As a result of the court's decision, these 
fee-based accounts are advisory accounts subject to the fiduciary duty 
and other requirements of the Advisers Act, unless converted to 
commission-based brokerage accounts. To maintain investor choice and 
protect the interests of investors holding an estimated $300 billion in 
approximately one million fee-based brokerage accounts, we are adopting 
rule 206(3)-3T.

B. Summary of Temporary Rule

    Rule 206(3)-3T permits an adviser, with respect to a non-
discretionary advisory account, to comply with section 206(3) by: (i) 
Making certain written disclosures; (ii) obtaining written, revocable 
consent from the client prospectively authorizing the adviser to enter 
into principal trades; (iii) making oral or written disclosure of the 
capacity in which the adviser may act and obtaining the client's 
consent orally or in writing prior to the execution of each principal 
transaction; (iv) sending to the client confirmation statements 
disclosing the capacity in which the adviser has acted and indicating 
that the adviser disclosed to the client that it may act in a principal 
capacity and that the client authorized the transaction; and (v) 
delivering to the client an annual report itemizing the principal 
transactions. These conditions are designed to require an adviser to 
fully apprise the client of the conflicts of interest involved in these 
transactions, inform the client of the circumstances in which the 
adviser may effect a trade on a principal basis, and provide the client 
with meaningful opportunities to revoke prospective consent or refuse 
to authorize a particular transaction.
    To avoid disruption that would otherwise occur to customers who 
currently hold fee-based brokerage accounts, we are adopting rule 
206(3)-3T on an interim final basis so that it will be available when 
the Court's decision takes effect on October 1, 2007.\100\ For reasons 
explained below, we are adopting the rule on a temporary basis so that 
it will expire on December 31, 2009.
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    \100\ See supra note 5 and accompanying text.

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[[Page 55037]]

C. Benefits

    As discussed above, the principal benefit of rule 206(3)-3T is that 
it maintains investor choice and protects the interests of investors 
holding an estimated $300 billion in one million fee-based brokerage 
accounts. It is our understanding that investors favor having the 
choice of advisory accounts with access to the inventory of a 
diversified broker-dealer but that meeting the requirements set out in 
section 206(3) is not feasible for advisers affiliated with broker-
dealers or advisers that also are registered as broker-dealers. By 
complying with what we believe to be relatively straightforward 
procedural requirements, investment advisers can avoid what they have 
indicated to us is a critical impediment to their providing access to 
certain securities which they hold in their own accounts--namely, 
written trade-by-trade disclosure. These advisers have communicated to 
us that the trade-by-trade written disclosure requirement is so 
impracticable in today's markets that it effectively stands in the way 
of their being able to give clients access to certain securities that 
might most cheaply or quickly be traded with a client on a principal 
basis. In fact, with respect to some securities, for which the risks 
might be relatively low (such as investment-grade debt securities), 
absent principal trading, clients may not have access to them at all. 
For other securities, execution may be improved where the adviser or 
affiliated broker-dealer can provide the best execution of the 
transaction.
    A resulting second benefit of the rule is that non-discretionary 
advisory clients of dually registered firms will have easier access to 
a wider range of securities. This in turn will likely increase 
liquidity in the markets for these securities and promote capital 
formation in these areas.
    A third benefit of the rule is that it provides the protections of 
the sales practice rules of the Exchange Act and the relevant self-
regulatory organizations because an adviser relying on the rule must 
also be a registered broker-dealer. As a result, clients will have the 
benefit of the fiduciary duties imposed on the investment adviser by 
the Advisers Act and of the Commission's rules and regulations under 
the Exchange Act as well as those of the SROs.
    Another benefit of Rule 206(3)-3T is that it provides a lower cost 
alternative for an adviser to engage in principal transactions. As 
discussed above, in the absence of this rule our view has been that an 
adviser must provide written disclosure and obtain consent for each 
specific principal transaction. Rule 206(3)-3T permits an adviser to 
comply with section 206(3) by, among other things, providing oral 
disclosure prior to the execution of each principal transaction. As 
discussed above, we understand traditional compliance is difficult and 
costly. This alternative means of compliance should be, consistent with 
the protection of investors, less costly and less burdensome.

D. Costs

    Prospective Disclosure and Consent: Pursuant to paragraph (a)(3) of 
the rule, an investment adviser must provide written, prospective 
disclosure to the client explaining: (i) The circumstances under which 
the investment adviser directly or indirectly may engage in principal 
transactions; (ii) the nature and significance of conflicts with its 
client's interests as a result of the transactions; and (iii) how the 
investment adviser addresses those conflicts. Pursuant to paragraph 
(a)(8) of the rule, the written, prospective disclosure must include a 
conspicuous, plain English statement that a client's written, 
prospective consent may be revoked without penalty at any time by 
written notice to the investment adviser from the client. And, for the 
adviser to be able to rely on rule 206(3)-3T with respect to an 
account, the client must have executed a written, revocable consent 
after receiving such written, prospective disclosure. The principal 
costs associated with this requirement include: (i) Preparation of the 
prospective disclosure and consent solicitation; (ii) distribution of 
the disclosure and consent solicitation to clients; and (iii) ongoing 
management of information, including revocations of consent and grants 
of consent that occur subsequent to the account opening process.
    We estimate that the costs of preparing the prospective disclosure 
and consent solicitation will be borne upfront. Once these items have 
been generated by eligible advisers, such advisers will be able to 
include them in other materials already required to be delivered to 
clients. For purposes of the Paperwork Reduction Act, we have estimated 
the number of hours and costs the average adviser would spend in the 
initial preparation of their prospective disclosure and consent 
solicitation.\101\ Based on those estimates, we estimate that advisers 
would incur costs of approximately $1,480 on average per adviser, 
including a conflicts review process, drafting efforts and consultation 
with clients, and legal consultation.\102\ Assuming there are 380 
eligible advisers (i.e., advisers that also are registered broker-
dealers) that will prepare the prospective disclosure and consent 
solicitation, we estimate that the total costs will be $562,400.\103\
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    \101\ See section V.B of this Release. We estimate the following 
burdens and/or costs: (i) For drafting the required prospective 
disclosure, approximately 5 hours on average per eligible adviser, 
of which we estimate there are 380, for a total of 1,900 hours; and 
(ii) for utilizing outside legal professionals in the preparation of 
the prospective disclosure, approximately $1,200 on average per 
eligible adviser, for a total of $456,000.
    \102\ We expect that the internal preparation function will most 
likely be performed by compliance professionals. Data from the 
SIFMA's Report on Office Salaries in the Securities Industry 2006 
(``Industry's Salary Report''), modified to account for an 1,800-
hour work-year and multiplied by 2.93 to account for bonuses, firm 
size, employee benefits and overhead, suggest that the cost for a 
Compliance Clerk is approximately $56 per hour. $56 per hour x 5 
hours on average per adviser = $280 on average per adviser of 
internal costs for preparation of the prospective disclosure. $280 
on average per adviser of internal costs + $1,200 on average per 
adviser of costs for external consultants = $1,480 on average per 
adviser.
    \103\ $1,480 on average per adviser in costs for preparation of 
the prospective disclosure x 380 advisers = $562,400 in total costs 
for preparation of the prospective disclosure.
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    For purposes of the Paperwork Reduction Act, we have estimated the 
number of hours and costs the average adviser would spend on the 
distribution of their prospective disclosure and consent solicitation 
as 210 hours and $3,143.\104\ We expect that the costs of distribution 
of the prospective disclosure and solicitation consent to existing non-
discretionary advisory clients and fee-based brokerage accountholders 
converting their accounts to non-discretionary advisory accounts will 
include duplication charges, postage and other mailing related 
expenses. We estimate that these costs will be approximately $5.60 on 
average per client, for a total of $4,458,720.\105\
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    \104\ See section V.B of this Release. We estimate the following 
burdens and/or costs: (i) For printing the prospective disclosure 
(including a disclosure and consent form and, if necessary, a 
revised Form ADV brochure and account agreement), approximately 
$1.50 on average per eligible account, of which we estimate there 
are approximately 796,200, for a total of $1,194,300 (which, if 
divided by the estimated 380 eligible advisers, equals a total cost 
for printing of approximately $3,143 on average per adviser); (ii) 
for distributing the prospective disclosure, approximately 0.1 hours 
on average per eligible account, for a total of 79,620 hours (which, 
if divided by the estimated 380 eligible advisers, equals a total 
burden of 210 hours on average per adviser).
    \105\ We expect that the distribution function for the 
prospective written disclosure and consent solicitation will most 
likely be performed by a general clerk. Data from the Industry's 
Salary Report, modified to account for an 1,800-hour work-year and 
multiplied by 2.93 to account for bonuses, firm size, employee 
benefits and overhead, suggest that cost for a General Clerk is 
approximately $41 per hour. $41 per hour x 0.1 hours on average for 
distribution per account = approximately $4.10 on average per 
account for distribution. $1.50 on average printing cost per account 
+ $4.10 on average distribution cost per account = $5.60 on average 
per account. $5.60 on average per account x 796,200 accounts to 
which we expect the disclosure to be distributed = a total printing 
and distribution cost for the prospective disclosure and consent 
solicitation of $4,458,720 (which, if divided by the estimated 380 
eligible advisers, equals a total cost for distribution of 
approximately $11,733 on average per eligible adviser).

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[[Page 55038]]

    For purposes of the Paperwork Reduction Act, we have estimated the 
number of hours the average accountholder would spend on reviewing the 
written disclosure document and, if it wishes, returning an executed 
consent.\106\ We estimate that the costs corresponding to this hour 
burden will be approximately $0.50 on average per eligible 
accountholder. Assuming that there are 796,200 eligible accountholders 
who will receive the written disclosure document and 716,580 that will 
provide consent during the transitional solicitation, we estimate that 
the total cost to clients will be $398,100.\107\
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    \106\ See section V.B of this Release. We estimate that the 
burden per client account that will return an executed consent 
(eligible accountholder), of which we estimate that there will be 
approximately 716,580, will be 0.05 hours (3 minutes) on average, 
for a total burden of 35,829 hours. We do not believe there will be 
a significant difference in burden between those clients that 
consent and those that do not.
    \107\ $0.50 on average for each accountholder who receives a 
written prospective disclosure document x 796,200 eligible 
accountholders = $398,100. We do not believe there will be a 
significant difference in burden between those accountholders that 
consent and those that do not.
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    For purposes of the Paperwork Reduction Act, we have estimated the 
number of hours the average adviser would spend in ongoing maintenance 
of prospective disclosure and consent solicitation efforts.\108\ Based 
on those estimates, we estimate that the average cost of updating the 
written prospective disclosure, maintaining records on prospective 
consents provided, and processing consent revocations and consents 
granted subsequent to the initial solicitation will be approximately 
$5,600 on average per eligible adviser per year.\109\ We estimate that 
the annual cost for all eligible advisers to keep consent information 
up to date will be $2,128,000.\110\
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    \108\ See section V.B of this Release. We estimate that the 
burden per eligible adviser of ongoing maintenance of the 
prospective disclosure and consent solicitation efforts will be 
approximately 100 hours on average per year, for a total of 38,000 
hours.
    \109\ We expect that this function will most likely be performed 
by compliance professionals at $56 per hour. See Industry's Salary 
Report. 100 hours on average per adviser per year x $56 per hour = 
$5,600 on average per adviser per year.
    \110\ $5,600 on average per adviser per year x 380 eligible 
advisers = $2,128,000.
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    Based on the discussion above, we estimate the costs relating to 
paragraph (a)(3) of rule 206(3)-3T to be on average approximately: (i) 
$13,213 per adviser in one-time costs; \111\ (ii) $5,600 per adviser in 
ongoing costs; and (iii) $0.50 per client account in costs. As such, we 
estimate the total costs associated with the prospective written 
disclosure and consent requirement of the rule to be $7,547,040.\112\
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    \111\ $1,480 on average per adviser in costs for preparation of 
the prospective disclosure and consent solicitation + $11,733 on 
average per adviser in costs for printing and distributing the 
prospective disclosure and consent solicitation = total one-time 
costs for preparation, printing and distribution of the prospective 
disclosure and consent solicitation of $13,213 on average per 
adviser.
    \112\ ($13,213 average one time cost per adviser x 380 eligible 
advisers) + ($5,600 average ongoing costs per adviser x 380 eligible 
advisers) + ($0.50 average costs per accountholder x 796,200 
accountholders who will review the written disclosure) = $5,020,940 
+ $2,128,000 + $398,100 = $7,547,040 total cost of compliance with 
paragraph (a)(3) of rule 206(3)-3T.
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    Trade-by-Trade Disclosure and Consent: Pursuant to paragraph (a)(4) 
of the rule, an investment adviser, prior to the execution of each 
principal transaction, must inform the advisory client, orally or in 
writing, of the capacity in which it may act with respect to such 
transaction. Also pursuant to paragraph (a)(4) of the rule, an 
investment adviser, prior to the execution of each principal 
transaction, must obtain oral or written consent from the advisory 
client to act as principal for its own account with respect to such 
transaction. Further, investment advisers likely will want to document 
for their own evidentiary purposes the receipt of trade-by-trade 
consent by their representatives.
    As noted in our Paperwork Reduction Act analysis, section 206(3) of 
the Advisers Act already requires written trade-by-trade disclosure in 
connection with principal trades. We believe that complying with this 
requirement of rule 206(3)-3T provides an alternative method of 
compliance that is likely to be less costly than compliance with 
section 206(3). To the extent that advisers are not currently engaging 
in principal trades with non-discretionary advisory accountholders (and 
thus are not preparing and providing written disclosure regarding 
conflicts of interest associated with principal trading in particular 
securities), advisers electing to rely on the rule will need to begin 
to prepare such tailored disclosure and communicate it to clients.
    We estimate that the costs of preparing and communicating trade-by-
trade disclosures to clients and obtaining their consents could 
include: (i) Preparing disclosure relating to the conflicts associated 
with executing that transaction on a principal basis; and (ii) 
communicating that disclosure to clients. For purposes of the Paperwork 
Reduction Act, we have estimated the number of hours advisers would 
spend on providing trade-by-trade disclosure and consent 
solicitation.\113\ Based on those estimates, we estimate that the cost 
of preparing each trade-by-trade disclosure will be approximately $0.47 
on average.\114\ For purposes of the Paperwork Reduction Act analysis, 
we have estimated that eligible clients engage in an average of 
approximately 50 trades per year, all of which we have conservatively 
assumed are principal trades. We further estimate that communicating 
the disclosure to clients orally will be at most a minimal cost (note 
that system programming costs are discussed separately under the 
subsection entitled ``Related Costs'' below). As such, we estimate the 
total annual cost for compliance with paragraph (a)(4) of rule 206(3)-
3T to be approximately $16,662,240.\115\
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    \113\ See section V.B of this Release. We estimate that based on 
discussions with industry representatives that there will be 
approximately 50 trades (which we conservatively assume will be 
principal trades) on average made per year per eligible account. We 
estimate a burden of 0.0083 hours (30 seconds) on average per trade 
for communication of the requisite disclosure to an eligible 
accountholder, of which we estimate there will be 716,580, for an 
estimated total burden of approximately 297,381 hours per year. The 
burden for the average adviser would thus be 297,381 total hours per 
year / 380 eligible advisers = approximately 783 hours on average 
per adviser per year.
    \114\ We expect that this function will most likely be performed 
by compliance professionals at $56 per hour (see Industry's Salary 
Report) and that the preparation and communication of trade-by-trade 
disclosure will comprise an average burden of approximately 0.0083 
hours (30 seconds) per trade. 0.0083 hours on average per trade x 
$56 per hour = approximately $0.47 on average per trade.
    \115\ 783 hours on average per adviser per year x $56 per hour = 
$43,848 on average per adviser per year. $43,848 on average per 
eligible adviser per year x 380 eligible advisers = $16,662,240 
total costs per year.
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    Trade-by-Trade Confirmations: Pursuant to paragraph (a)(5) of the 
rule, an investment adviser must deliver to its client a written 
confirmation at or before completion of each principal transaction that 
includes, in addition to the information required by rule 10b-10 under 
the Exchange Act [17 CFR 240.10b-10], a conspicuous, plain English 
statement that the investment adviser: (i) Informed the advisory client 
that it may be acting in a principal capacity in connection with the

[[Page 55039]]

transaction and the client authorized the transaction; and (ii) owned 
the security sold to the advisory client (or bought the security from 
the client for its own account). As noted above in the Paperwork 
Reduction Act section of this Release, the majority of the information 
that this provision requires to be delivered to clients is already 
required to be assembled and communicated to clients pursuant to 
requirements under the Exchange Act. We expect that the costs 
associated with conforming trade confirmations to the requirements of 
paragraph (a)(5) of rule 206(3)-3T will stem principally from 
programming computer systems that generate confirmations to ensure that 
all the required information is contained in the confirmations. Costs 
associated with programming are described under the subsection entitled 
``Related Costs'' below.
    Principal Transactions Report: Pursuant to paragraph (a)(6) of the 
rule, the investment adviser must deliver to each client, no less 
frequently than annually, written disclosure containing a list of all 
transactions that were executed in the account in reliance upon the 
rule, and the date and price of such transactions. This report will 
require advisers to aggregate and distribute information that should 
already be available to the adviser or its broker-dealer affiliate 
executing the client's transactions.
    As noted in the Paperwork Reduction Act section of this Release, we 
estimate that other than the actual aggregation and delivery of this 
statement, the burden of this collection will not be substantial 
because the information required to be contained in the statement is 
already collected and maintained by investment advisers and/or broker-
dealers executing trades for their clients. Advisers and broker-dealers 
already send periodic or annual statements to clients. Thus, to comply, 
advisers will need to add information they already maintain to 
documents they already prepare and send. We expect that there will be a 
one-time cost associated with this requirement relating to programming 
computer systems to generate the report, aggregating information that 
is already available and maintained by advisers or their broker-dealer 
affiliates. Costs associated with programming are described under the 
subsection entitled ``Related Costs'' below.
    Related Costs: We expect that the bulk of the costs of compliance 
with rule 206(3)-3T relate to: (i) The initial distribution of 
prospective disclosure and collection of consents (described above); 
(ii) systems programming costs to ensure that trade confirmations 
contain all of the information required by paragraph (a)(4) of the 
rule; and (iii) systems programming costs to aggregate already-
collected information to generate compliant principal transactions 
reports. For purposes of the Paperwork Reduction Act, we have estimated 
the cost an average adviser would incur on programming their computer 
systems, regardless of the size of their non-discretionary advisory 
account programs, to prepare compliant confirmations and principal 
transaction reports and to be able to track both prospective and trade-
by-trade consents. For purposes of the Paperwork Reduction Act 
analysis, we have estimated the number of hours the average adviser 
would spend on programming computer systems to facilitate compliance 
with the rule.\116\ Based on those estimates, we estimate the costs of 
programming, generating and delivering compliant confirmations and 
principal trade reports to be approximately $34,201 on average per 
eligible adviser,\117\ for a total of $12,996,289.\118\
---------------------------------------------------------------------------

    \116\ See section V.B of this Release. We estimate the following 
burdens and costs: (i) For programming computer systems to generate 
trade confirmations compliant with rule 206(3)-3T, approximately 
$20,000 on average per eligible adviser, of which we estimate there 
are approximately 380, for a total of $7,600,000; (ii) for the 
internal burden associated with programming computer systems 
relating to principal trade reports compliant with rule 206(3)-3T, 
approximately five hours on average per eligible adviser, for a 
total of 1,900 hours; (iii) for assistance of outside professionals 
to assist in programming computer systems to generate principal 
trade reports, approximately $10,000 on average per eligible 
adviser, for a total of $3,800,000; and (iv) for generation and 
delivery of annual principal trade reports each year, approximately 
0.05 hours (three minutes) on average per eligible account, of which 
we estimate there are approximately 716,580, for a total of 35,829 
hours total per year.
    \117\ We expect that the internal programming function most 
likely will be performed by computer programmers. Data from the 
Industry's Salary Report, modified to account for an 1,800-hour 
work-year and multiplied by 2.93 to account for bonuses, firm size, 
employee benefits and overhead, suggest that cost for a Sr. Computer 
Operator is approximately $67 per hour. Five hours on average per 
adviser x $67 per hour = $335 on average per adviser (or, across all 
380 eligible advisers, $127,300). We expect that the generation and 
delivery of annual principal trade reports will most likely be 
performed by general clerks at $41 per hour. $41 per hour x 35,829 
total hours per year = $1,468,989 (or, if divided among all 380 
eligible advisers, approximately $3,866 on average per adviser per 
year). $20,000 on average per adviser for programming to generate 
compliant trade confirmations + $335 on average per adviser for 
internal programming costs in connection with developing an annual 
principal trades report + $10,000 on average per adviser for outside 
computing assistance in developing the annual principal trade report 
+ $3,866 on average per adviser for generation and delivery of 
annual principal trade reports per year = approximately $34,201 on 
average per adviser in connection with compliance with the 
confirmation and principal trade report requirements.
    \118\ $7,600,000 for programming to generate compliant trade 
confirmations + $127,300 for internal programming costs in 
connection with developing an annual principal trades report + 
$3,800,000 for outside computing assistance in developing the annual 
principal trade report + $1,468,989 for generation and delivery of 
annual principal trade reports per year = $12,996,289 total costs in 
connection with compliance with the confirmation and principal trade 
report requirements.
---------------------------------------------------------------------------

    For those advisers that are converting fee-based brokerage accounts 
to non-discretionary advisory accounts, we are providing transition 
relief, described in section IV of this Release, that is designed, 
among other things, to avoid disruptions to clients and minimize costs 
to advisers.
    Total Costs: The total overall costs, including estimated costs for 
all eligible advisers and eligible accounts, relating to compliance 
with rule 206(3)-3T are $37,205,569.\119\
---------------------------------------------------------------------------

    \119\ $7,547,040 total costs in connection with compliance with 
the prospective disclosure and consent requirements of the rule + 
$16,662,240 total costs in connection with compliance with the 
trade-by-trade disclosure and consent requirements of the rule + 
$12,996,289 total costs in connection with compliance with the 
confirmation and principal trade report requirements of the rule = 
$37,205,569 total costs in connection with compliance with the rule.
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E. Request for Comment

    [cir] We solicit quantitative data to assist with our assessment of 
the benefits and costs of rule 206(3)-3T.
    [cir] What, if any, additional costs are involved in complying with 
the rule? What are the types of costs, and what are the amounts? Should 
the rule be modified in any way to mitigate costs? If so, how?
    [cir] Does the rule's requirement that a report be provided to each 
client, at

[[Page 55040]]

least annually, of the transactions undertaken with the client in 
reliance on the rule result in a meaningful identification of an 
adviser's trading patterns with its clients that will enable the client 
to evaluate more effectively than it would simply with prospective 
disclosure and trade-by-trade disclosure prior to the execution of a 
principal transaction whether it should continue to consent, or revoke 
its consent, to principal trading in reliance on the rule?
    [cir] What will the effect of the rule be on the availability of 
account services and securities to clients who do not consent to 
principal transactions?
    [cir] Have we accurately estimated the costs of compliance with the 
rule?
    [cir] We assumed that firms already collect much of the information 
that the rule would require for the principal trading reports. Are we 
correct? We solicit comments on the extent to which firms already 
aggregate the information that the rule will require to be disclosed in 
the principal trading reports.

VII. Promotion of Efficiency, Competition and Capital Formation

    Section 202(c) of the Advisers Act mandates that the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest, 
consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital 
formation.\120\
---------------------------------------------------------------------------

    \120\ 15 U.S.C. 80b-2(c).
---------------------------------------------------------------------------

    Rule 206(3)-3T permits an investment adviser, with respect to a 
non-discretionary advisory account, to comply with section 206(3) by: 
(i) Making certain written disclosures; (ii) obtaining written, 
revocable consent from the client prospectively authorizing the adviser 
to enter into principal trades; (iii) making oral or written disclosure 
and obtaining the client's consent orally or in writing prior to the 
execution of each principal transaction; (iv) sending to the client 
confirmation statements for each principal trade that disclose the 
capacity in which the adviser has acted and indicating that the client 
consented to the transaction; and (v) delivering to the client an 
annual report itemizing the principal transactions.
    Rule 206(3)-3T may increase efficiency by providing an alternative 
means of compliance with section 206(3) of the Advisers Act that we 
believe will be less costly and less burdensome. As discussed above, by 
permitting oral trade-by-trade disclosure, advisers may be more willing 
to engage in principal trades with advisory clients. As a result, 
advisers may provide access to certain securities the adviser or its 
affiliate has in inventory. Clients might want access to securities an 
adviser, or an affiliated broker-dealer, has in inventory, despite the 
conflicts inherent in principal trading, if those securities are scarce 
or hard to acquire. Firms have argued that purchasing such securities 
from, or selling them to, an adviser could lead to faster or less 
expensive execution, advantages a client may deem to outweigh the risks 
presented by principal trading with an adviser.\121\
---------------------------------------------------------------------------

    \121\ See, e.g., SIFMA Letter.
---------------------------------------------------------------------------

    We expect that rule 206(3)-3T will promote competition because it 
preserves investor choice for different types of advisory accounts. As 
a practical matter, advisers did not frequently engage in principal 
trades. By relying on the rule, advisers that are also registered 
broker-dealers will be able to offer advisory clients access to their 
(and their affiliates') inventory. Advisers that are not also 
registered as broker-dealers may seek to market their services without 
principal trades and their associated costs and benefits. We are not 
able to predict with certainty the effect of the rule on them, but it 
is possible that some advisers may elect to register as broker-dealers 
in order to rely on rule 206(3)-3T.
    We believe that if rule 206(3)-3T has any effect on capital 
formation it is likely to be positive, although indirect. We understand 
that most investment advisers will not trade with non-discretionary 
advisory client accounts on a principal basis so long as they must 
provide trade-by-trade written disclosure. Providing an alternative to 
the traditional requirements of trade-by-trade written disclosure might 
serve to broaden the potential universe of purchasers of securities, in 
particular investment grade debt securities for the reasons described 
above, opening the door to greater investor participation in the 
securities markets with a potential positive effect on capital 
formation.
    The Commission requests comment on whether the proposed amendments 
are likely to promote efficiency, competition, and capital formation.

VIII. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis (``FRFA'') has been 
prepared in accordance with 5 U.S.C. 604. It relates to rule 206(3)-3T, 
which we are adopting in this Release.\122\
---------------------------------------------------------------------------

    \122 \ Although the requirements of the Regulatory Flexibility 
Act are not applicable to rules adopted under the Administrative 
Procedure Act's ``good cause'' exception, see 5 U.S.C. 601(2) 
(defining ``rule'' and notice requirements under the Administrative 
Procedures Act), we nevertheless prepared a FRFA.
---------------------------------------------------------------------------

A. Need for and Objectives of the Rule

    Sections I and II of this Release describe the reasons for and 
objectives of rule 206(3)-3T. As we discuss in detail above, our 
reasons include the need to facilitate the transition of customers in 
fee-based brokerage accounts in the wake of the FPA decision and to 
address the stated inability of the sponsors of those accounts to offer 
clients some of the services the clients desire in the non-
discretionary advisory accounts to which they will be transitioned.

B. Small Entities affected by the Rule

    Rule 206(3)-3T is an alternative method of complying with Advisers 
Act section 206(3) and is available to all investment advisers that: 
(i) Are registered as broker-dealers under the Exchange Act; and (ii) 
effect trades with clients directly or indirectly through a broker-
dealer controlling, controlled by or under common control with the 
investment adviser, including small entities. Under Advisers Act rule 
0-7, for purposes of the Regulatory Flexibility Act an investment 
adviser generally is a small entity if it: (i) Has assets under 
management having a total value of less than $25 million; (ii) did not 
have total assets of $5 million or more on the last day of its most 
recent fiscal year; and (iii) does not control, is not controlled by, 
and is not under common control with another investment adviser that 
has assets under management of $25 million or more, or any person 
(other than a natural person) that had $5 million or more on the last 
day of its most recent fiscal year.\123\
---------------------------------------------------------------------------

    \123\ See 17 CFR 275.0-7.
---------------------------------------------------------------------------

    We have opted not to make the relief available to all investment 
advisers, but have instead restricted it to investment advisers that 
are dually registered as broker-dealers under the Exchange Act. We have 
taken this approach because, as more fully discussed above, in the 
context of principal trades which implicate potentially significant 
conflicts of interest, and which are executed through broker-dealers, 
we believe it is important that the protections of both the Advisers 
Act and the Exchange Act, which includes well developed sales practice 
rules, apply to advisers entering into principal transactions with 
clients.
    The Commission estimates that as of August 1, 2007, 597 investment 
advisers were small entities.\124\ The Commission

[[Page 55041]]

assumes for purposes of this FRFA that 29 of these small entities 
(those that are both as investment advisers and broker-dealers) could 
rely on rule 206(3)-3T, and that all of these small entities would rely 
on the new rule.\125\ We welcome comment on the availability of the 
rule to small entities. Do small investment advisers believe an 
alternative means of compliance with section 206(3) of the Advisers Act 
should be available to more of them? Do they believe that the dual 
registration requirement of the rule is too onerous for small advisers 
despite the discussion in subsection F below? If so, how do they 
propose replicating the additional protections afforded to clients by 
the broker-dealer regulations?
---------------------------------------------------------------------------

    \124\ IARD Data as of August 1, 2007.
    \125\ Id.
---------------------------------------------------------------------------

C. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The provisions of rule 206(3)-3T would impose certain new reporting 
or recordkeeping requirements, but are not expected to materially alter 
the time required for investment advisers that also are registered as 
broker-dealers to engage in transactions with their clients on a 
principal basis. Rule 206(3)-3T is designed to provide an alternative 
means of compliance with the requirements of section 206(3) of the 
Advisers Act. Investment advisers taking advantage of the rule with 
respect to non-discretionary advisory accounts would be required to 
make certain disclosures to clients on a prospective, trade-by-trade 
and annual basis. Specifically, rule 206(3)-3T permits an adviser, with 
respect to a non-discretionary advisory account, to comply with section 
206(3) of the Advisers Act by, among other things: (i) Making certain 
written disclosures; (ii) obtaining written, revocable consent from the 
client prospectively authorizing the adviser to enter into principal 
trades; (iii) making oral or written disclosure and obtaining the 
client's consent orally or in writing prior to the execution of each 
principal transaction; (iv) sending to the client confirmation 
statements for each principal trade that disclose the capacity in which 
the adviser has acted and indicating that the client consented to the 
transaction; and (v) delivering to the client an annual report 
itemizing the principal transactions. Advisers are already required to 
communicate the content of many of the disclosures pursuant to their 
fiduciary obligations to clients. Other disclosures are already 
required by rules applicable to broker-dealers.

D. Agency Action To Minimize Effect on Small Entities

    Small entities registered with the Commission as investment 
advisers seeking to rely on the rule would be subject to the same 
disclosure requirements as larger entities. In each case, however, an 
investment adviser, whether large or small, would only be able to rely 
on the rule if it also is registered with us as a broker-dealer. As 
noted above, we estimate that 25 small entities are registered as both 
advisers and broker-dealers and therefore those small entities are 
eligible to rely on the rule. In developing the requirements of the 
rule, we considered the extent to which they would have a significant 
impact on a substantial number of small entities, and included 
flexibility where possible, calling for disclosures that are already 
generated by the relevant firms in one form or another wherever 
possible in light of the objectives of the rule, to reduce the 
corresponding burdens imposed.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate or 
conflict with rule 206(3)-3T, which presents an alternative means of 
compliance with the procedural requirements of section 206(3) of the 
Advisers Act that relate to principal transactions.
    The Commission notes, however, that rule 10b-10 under the Exchange 
Act is a separate confirmation rule that requires broker-dealers to 
provide certain information to their customers regarding the 
transactions they effect. Furthermore, FINRA Rule 2230 requires broker-
dealers that are members of FINRA to deliver a written notification 
containing certain information, including whether the member is acting 
as a broker for the customer or is working as a dealer for its own 
account. Brokers and dealers typically deliver this information in 
confirmations that fulfill the requirements of rule 10b-10 under the 
Exchange Act. Rule G-15 of the Municipal Securities Rulemaking Board 
also contains a separate confirmation rule that governs member 
transactions in municipal securities, including municipal fund 
securities. In addition, investment advisers that are qualified 
custodians for purposes of rule 206(4)-2 under the Advisers Act and 
that maintain custody of their advisory clients' assets must send 
quarterly account statements to their clients pursuant to rule 206(4)-
2(a)(3) under the Advisers Act.
    These rules overlap with certain elements of rule 206(3)-3T, but 
the Commission has designed the temporary rule to work efficiently 
together with existing rules by permitting firms to incorporate the 
required disclosure into one confirmation statement.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objective, while 
minimizing any significant adverse impact on small entities.\126\ 
Alternatives in this category would include: (i) Establishing different 
compliance or reporting standards or timetables that take into account 
the resources available to small entities; (ii) clarifying, 
consolidating, or simplifying compliance requirements under the rule 
for small entities; (iii) using performance rather than design 
standards; and (iv) exempting small entities from coverage of the rule, 
or any part of the rule.
---------------------------------------------------------------------------

    \126\ See 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    The Commission believes that special compliance or reporting 
requirements or timetables for small entities, or an exemption from 
coverage for small entities, may create the risk that the investors who 
are advised by and effect securities transactions through such small 
entities would not receive adequate disclosure. Moreover, different 
disclosure requirements could create investor confusion if it creates 
the impression that small investment advisers have different conflicts 
of interest with their advisory clients in connection with principal 
trading than larger investment advisers. We believe, therefore, that it 
is important for the disclosure protections required by the rule to be 
provided to advisory clients by all advisers, not just those that are 
not considered small entities. Further consolidation or simplification 
of the proposals for investment advisers that are small entities would 
be inconsistent with the Commission's goals of fostering investor 
protection.
    We have endeavored through rule 206(3)-3T to minimize the 
regulatory burden on all investment advisers eligible to rely on the 
rule, including small entities, while meeting our regulatory 
objectives. It was our goal to ensure that eligible small entities may 
benefit from the Commission's approach to the new rule to the same 
degree as other eligible advisers. The condition that advisers seeking 
to rely on the rule must also be registered as broker-dealers and that 
each account with respect to which a dually-registered adviser seeks to 
rely on the rule must be a brokerage account subject to the Exchange 
Act, and the rules thereunder, and the rules

[[Page 55042]]

of the self-regulatory organization(s) of which it is a member, reflect 
what we believe is an important element of our balancing between easing 
regulatory burdens (by affording advisers an alternative means of 
compliance with section 206(3) of the Act) and meeting our investor 
protection objectives.\127\ Finally, we do not consider using 
performance rather than design standards to be consistent with our 
statutory mandate of investor protection in the present context.
---------------------------------------------------------------------------

    \127\ See Section II.B.7 of this Release.
---------------------------------------------------------------------------

G. General Request for Comments

    We solicit written comments regarding our analysis. We request 
comment on whether the rule will have any effects that we have not 
discussed. We request that commenters describe the nature of any impact 
on small entities and provide empirical data to support the extent of 
the impact.

IX. Statutory Authority

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

Text of Rule

List of Subjects in 17 CFR Part 275

    Investment advisers, Reporting and recordkeeping requirements.

0
For the reasons set out in the preamble, Title 17, Chapter II of the 
Code of Federal Regulations is amended as follows:

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

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

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

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


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

    (a) An investment adviser shall be deemed in compliance with the 
provisions of section 206(3) of the Advisers Act (15 U.S.C. 80b-6(3)) 
when the adviser directly or indirectly, acting as principal for its 
own account, sells to or purchases from an advisory client any security 
if:
    (1) The investment adviser exercises no ``investment discretion'' 
(as such term is defined in section 3(a)(35) of the Securities Exchange 
Act of 1934 (``Exchange Act'') (15 U.S.C. 78c(a)(35))), except 
investment discretion granted by the advisory client on a temporary or 
limited basis, with respect to the client's account;
    (2) Neither the investment adviser nor any person controlling, 
controlled by, or under common control with the investment adviser is 
the issuer of, or, at the time of the sale, an underwriter (as defined 
in section 202(a)(20) of the Advisers Act (15 U.S.C. 80b-2(a)(20))) of, 
the security; except that the investment adviser or a person 
controlling, controlled by, or under common control with the investment 
adviser may be an underwriter of an investment grade debt security (as 
defined in paragraph (c) of this section);
    (3) The advisory client has executed a written, revocable consent 
prospectively authorizing the investment adviser directly or indirectly 
to act as principal for its own account in selling any security to or 
purchasing any security from the advisory client, so long as such 
written consent is obtained after written disclosure to the advisory 
client explaining:
    (i) The circumstances under which the investment adviser directly 
or indirectly may engage in principal transactions;
    (ii) The nature and significance of conflicts with its client's 
interests as a result of the transactions; and
    (iii) How the investment adviser addresses those conflicts;
    (4) The investment adviser, prior to the execution of each 
principal transaction:
    (i) Informs the advisory client, orally or in writing, of the 
capacity in which it may act with respect to such transaction; and
    (ii) Obtains consent from the advisory client, orally or in 
writing, to act as principal for its own account with respect to such 
transaction;
    (5) The investment adviser sends a written confirmation at or 
before completion of each such transaction that includes, in addition 
to the information required by 17 CFR 240.10b-10, a conspicuous, plain 
English statement informing the advisory client that the investment 
adviser:
    (i) Disclosed to the client prior to the execution of the 
transaction that the adviser may be acting in a principal capacity in 
connection with the transaction and the client authorized the 
transaction; and
    (ii) Sold the security to, or bought the security from, the client 
for its own account;
    (6) The investment adviser sends to the client, no less frequently 
than annually, written disclosure containing a list of all transactions 
that were executed in the client's account in reliance upon this 
section, and the date and price of such transactions;
    (7) The investment adviser is a broker-dealer registered under 
section 15 of the Exchange Act (15 U.S.C. 78o) and each account for 
which the investment adviser relies on this section is a brokerage 
account subject to the Exchange Act, and the rules thereunder, and the 
rules of the self-regulatory organization(s) of which it is a member; 
and
    (8) Each written disclosure required by this section includes a 
conspicuous, plain English statement that the client may revoke the 
written consent referred to in paragraph (a)(3) of this section without 
penalty at any time by written notice to the investment adviser.
    (b) This section shall not be construed as relieving in any way an 
investment adviser from acting in the best interests of an advisory 
client, including fulfilling the duty with respect to the best price 
and execution for the particular transaction for the advisory client; 
nor shall it relieve such person or persons from any obligation that 
may be imposed by sections 206(1) or (2) of the Advisers Act or by 
other applicable provisions of the federal securities laws.
    (c) For purposes of paragraph (a)(2) of this section, an investment 
grade debt security means a non-convertible debt security that, at the 
time of sale, is rated in one of the four highest rating categories of 
at least two nationally recognized statistical rating organizations (as 
defined in section 3(a)(62) of the Exchange Act (15 U.S.C. 
78c(a)(62))).
    (d) This section will expire and no longer be effective on December 
31, 2009.

    By the Commission.

    September 24, 2007.
Nancy M. Morris,
Secretary.
[FR Doc. E7-19191 Filed 9-27-07; 8:45 am]
BILLING CODE 8010-01-P