[Federal Register Volume 77, Number 250 (Monday, December 31, 2012)]
[Rules and Regulations]
[Pages 76854-76860]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-31221]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
[Release No. IA-3522; File No. S7-23-07]
RIN 3235-AL28
Temporary Rule Regarding Principal Trades With Certain Advisory
Clients
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission is amending rule
206(3)-3T under the Investment Advisers Act of 1940, a temporary rule
that establishes an alternative means for investment advisers who are
registered with the Commission as broker-dealers to meet the
requirements of section 206(3) of the Investment Advisers Act when they
act in a principal capacity in transactions with certain of their
advisory clients. The amendment extends the date on which rule 206(3)-
3T will sunset from December 31, 2012 to December 31, 2014.
DATES: The amendments in this document are effective December 28, 2012
and the expiration date for 17 CFR 275.206(3)-3T is extended to
December 31, 2014.
FOR FURTHER INFORMATION CONTACT: Melissa S. Gainor, Attorney-Adviser,
Vanessa M. Meeks, Attorney-Adviser, Sarah A. Buescher, Branch Chief, or
Daniel S. Kahl, Assistant Director, at (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 20549-8549.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission is
adopting an amendment to temporary rule 206(3)-3T [17 CFR 275.206(3)-
3T] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] that
extends the date on which the rule will sunset from December 31, 2012
to December 31, 2014. Note that previous related releases used RIN
3235-AJ96. (See Temporary Rule Regarding Principal Trades with Certain
Advisory Clients, Investment Advisers Act Release No. 2653 (Sep. 24,
2007) [72 FR 55022 (Sep. 28, 2007)]; Temporary Rule Regarding Principal
Trades with Certain Advisory Clients, Investment Advisers Act Release
No. 2965 (Dec. 23, 2009) [74 FR 69009 (Dec. 30, 2009)]; Temporary Rule
Regarding Principal Trades with Certain Advisory Clients, Investment
Advisers Act Release No. 2965A (Dec. 31, 2009) [75 FR 742 (Jan. 6,
2010)]; Temporary Rule Regarding Principal Trades with Certain Advisory
Clients, Investment Advisers Act Release No. 3118 (Dec. 1, 2010) [75 FR
75650 (Dec. 6, 2010)]; Temporary Rule Regarding Principal Trades with
Certain Advisory Clients, Investment Advisers Act Release No. 3128
(Dec. 28, 2010) [75 FR 82236 (Dec. 30, 2010)]; Temporary Rule Regarding
Principal Trades with Certain Advisory Clients, Investment Advisers Act
Release No. 3483 (October 9, 2012), [77 FR 62185 (October 12, 2012)].)
I. Background
On September 24, 2007, we adopted, on an interim final basis, rule
206(3)-3T, a temporary rule under the Investment Advisers Act of 1940
(the ``Advisers Act'') that provides an alternative means for
investment advisers that are registered with us as broker-dealers to
meet the requirements of section 206(3) of the Advisers Act when they
act in a principal capacity in transactions with certain of their
advisory clients.\1\ In December 2009, we extended the rule's sunset
date by one year to December 31, 2010.\2\ In December 2010, we further
extended the rule's sunset date by two years to December 31, 2012.\3\
We deferred final action on rule 206(3)-3T at that time in
[[Page 76855]]
order to complete a study required by section 913 of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank Act'')
\4\ and to consider more broadly the regulatory requirements applicable
to broker-dealers and investment advisers, including whether rule
206(3)-3T should be substantively modified, supplanted, or permitted to
sunset.\5\
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\1\ Rule 206(3)-3T [17 CFR 275.206(3)-3T]. All references to
rule 206(3)-3T and the various sections thereof in this release are
to 17 CFR 275.206(3)-3T and its corresponding sections. See also
Temporary Rule Regarding Principal Trades with Certain Advisory
Clients, Investment Advisers Act Release No. 2653 (Sep. 24, 2007)
[72 FR 55022 (Sep. 28, 2007)] (``2007 Principal Trade Rule
Release'').
\2\ See Temporary Rule Regarding Principal Trades with Certain
Advisory Clients, Investment Advisers Act Release No. 2965 (Dec. 23,
2009) [74 FR 69009 (Dec. 30, 2009)] (``2009 Extension Release'');
Temporary Rule Regarding Principal Trades with Certain Advisory
Clients, Investment Advisers Act Release No. 2965A (Dec. 31, 2009)
[75 FR 742 (Jan. 6, 2010)] (making a technical correction to the
2009 Extension Release).
\3\ See Temporary Rule Regarding Principal Trades with Certain
Advisory Clients, Investment Advisers Act Release No. 3118 (Dec. 1,
2010) [75 FR 75650 (Dec. 6, 2010)] (proposing a two-year extension
of rule 206(3)-3T's sunset date) (``2010 Extension Proposing
Release''); Temporary Rule Regarding Principal Trades with Certain
Advisory Clients, Investment Advisers Act Release No. 3128 (Dec. 28,
2010) [75 FR 82236 (Dec. 30, 2010)] (``2010 Extension Release'').
\4\ Public Law 111-203, 124 Stat. 1376 (2010). Under section 913
of the Dodd-Frank Act, we were required to conduct a study and
provide a report to Congress concerning the obligations of broker-
dealers and investment advisers, including standards of care
applicable to those intermediaries and their associated persons.
Section 913 also provides that we may commence a rulemaking
concerning the legal or regulatory standards of care for broker-
dealers, investment advisers, and persons associated with these
intermediaries for providing personalized investment advice about
securities to retail customers, taking into account the findings,
conclusions, and recommendations of the study.
\5\ See 2010 Extension Release, Section II.
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The study mandated by section 913 of the Dodd-Frank Act was
prepared by the staff and delivered to Congress on January 21, 2011.\6\
Since that time, we have considered the findings, conclusions, and
recommendations of the 913 Study in order to determine whether to
promulgate rules concerning the legal or regulatory standards of care
for broker-dealers and investment advisers. In addition, since issuing
the 913 Study, Commissioners and the staff have held numerous meetings
with interested parties on the study and related matters.\7\
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\6\ See Study on Investment Advisers and Broker-Dealers (``913
Study'') (Jan. 21, 2011), available at http://www.sec.gov/news/studies/2011/913studyfinal.pdf. For a discussion regarding principal
trading, see section IV.C.1.(b) of the 913 Study. See also
Commissioners Kathleen L. Casey and Troy A. Paredes, Statement by
SEC Commissioners: Statement Regarding Study on Investment Advisers
and Broker-Dealers (Jan. 21, 2011), available at http://www.sec.gov/news/speech/2011/spch012211klctap.htm.
\7\ See Comments on Study Regarding Obligations of Brokers,
Dealers, and Investment Advisers, File No. 4-606, available at
http://sec.gov/comments/4-606/4-606.shtml.
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On October 9, 2012, we proposed to extend the date on which rule
206(3)-3T will sunset for a limited amount of time, from December 31,
2012 to December 31, 2014.\8\ We received five comment letters
addressing our proposal.\9\ Four of these commenters generally
supported extending rule 206(3)-3T for at least two years,\10\ and one
opposed a two-year extension.\11\ The comments we received on our
proposal are discussed below. After considering each of the comments,
we are extending the rule's sunset date by two years to December 31,
2014, as proposed.
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\8\ See Temporary Rule Regarding Principal Trades with Certain
Advisory Clients, Investment Advisers Act Release No. 3483 (October
9, 2012), [77 FR 62185 (October 12, 2012)] (``Proposing Release'').
\9\ See Comment Letter of Chris Barnard (Oct. 26, 2012)
(``Barnard Letter''); Comment Letter of fi360, Inc. (Nov. 13, 2012)
(``fi360 Letter''); Comment Letter of the Financial Services
Institute (Nov. 5, 2012) (``FSI Letter''); Comment Letter of the
Securities Industry and Financial Markets Association (Nov. 13,
2012) (``SIFMA Letter''); Comment Letter of Wells Fargo Advisors
(Nov. 13, 2012) (``Wells Fargo Letter'').
\10\ See Barnard Letter; FSI Letter; SIFMA Letter; Wells Fargo
Letter.
\11\ See fi360 Letter.
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II. Discussion
We are amending rule 206(3)-3T only to extend the rule's sunset
date by two additional years.\12\ We are not adopting any substantive
amendments to the rule at this time. Absent further action by the
Commission, the rule would sunset on December 31, 2012. We are adopting
this extension because, as we discussed in the Proposing Release, we
continue to believe that the issues raised by principal trading,
including the restrictions in section 206(3) of the Advisers Act and
our experiences with, and observations regarding, the operation of rule
206(3)-3T, should be considered as part of our broader consideration of
the regulatory requirements applicable to broker-dealers and investment
advisers in connection with the Dodd-Frank Act.\13\
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\12\ The rule includes a reference to an ``investment grade debt
security,'' which is defined as ``a non-convertible debt security
that, at the time of sale, is rated in one of the four highest
rating categories of at least two nationally recognized statistical
rating organizations (as defined in section 3(a)(62) of the Exchange
Act).'' Rule 206(3)-3T(a)(2) and (c). Section 939A of the Dodd-Frank
Act requires that we ``review any regulation issued by [us] that
requires the use of an assessment of the credit-worthiness of a
security or money market instrument; and any references to or
requirements in such regulations regarding credit ratings.'' Once we
have completed that review, the statute provides that we modify any
regulations identified in our review to ``remove any reference to or
requirement of reliance on credit ratings and to substitute in such
regulations such standard of credit-worthiness'' as we determine
appropriate. We believe that the credit rating requirement in the
temporary rule would be better addressed after the Commission
completes its review of the regulatory standards of care that apply
to broker-dealers and investment advisers. One commenter addressed
credit ratings and agreed with us that the issue would be better
addressed after the Commission completes its review. See SIFMA
Letter. We are not adopting any substantive amendments to the rule
at this time. See generally Report on Review of Reliance on Credit
Ratings (July 21, 2011), available at http://www.sec.gov/news/studies/2011/939astudy.pdf (staff study reviewing the use of credit
ratings in Commission regulations).
\13\ See Proposing Release, Section II. The 913 Study is one of
several studies relevant to the regulation of broker-dealers and
investment advisers mandated by the Dodd-Frank Act. See, e.g., Study
on Enhancing Investment Adviser Examinations (Jan. 19, 2011),
available at http://sec.gov/news/studies/2011/914studyfinal.pdf
(staff study required by section 914 of the Dodd-Frank Act, which
directed the Commission to review and analyze the need for enhanced
examination and enforcement resources for investment advisers);
Commissioner Elisse B. Walter, Statement on Study Enhancing
Investment Adviser Examinations (Required by Section 914 of Title IV
of the Dodd-Frank Wall Street Reform and Consumer Protection Act)
(Jan. 19, 2011), available at http://sec.gov/news/speech/2011/spch011911ebw.pdf. See also Study and Recommendations on Improved
Investor Access to Registration Information About Investment
Advisers and Broker-Dealers (Jan. 26, 2011), available at http://sec.gov/news/studies/2011/919bstudy.pdf (staff study required by
section 919B of the Dodd-Frank Act that directed the Commission to
complete a study, including recommendations (some of which have been
implemented) of ways to improve investor access to registration
information about investment advisers and broker-dealers, and their
associated persons); United States Government Accountability Office
Report to Congressional Committees on Private Fund Advisers (July
11, 2011), available at http://www.gao.gov/new.items/d11623.pdf
(study required by section 416 of the Dodd-Frank Act, which directed
the Comptroller General of the United States to study the
feasibility of forming a self-regulatory organization to oversee
private funds).
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Section 913 of the Dodd-Frank Act provides that we may commence a
rulemaking concerning, among other things, the legal or regulatory
standards of care for broker-dealers, investment advisers, and persons
associated with these intermediaries when providing personalized
investment advice about securities to retail customers. Since the
completion of the 913 Study in 2011, we have been considering the
findings, conclusions, and recommendations of the study and the
comments we have received from interested parties.\14\ In addition, our
staff has been working to obtain data and economic analysis related to
standards of conduct and enhanced regulatory harmonization of broker-
dealers and investment advisers to inform the Commission as it
considers any future rulemaking. At this time, our consideration of the
regulatory requirements applicable to broker-dealers and investment
advisers and the recommendations from the 913 Study is ongoing. We will
not complete our consideration of these issues before December 31,
2012, the current sunset date for rule 206(3)-3T.
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\14\ Section 913(f) of the Dodd-Frank Act requires us to
consider the 913 Study in any rulemaking authorized by that section
of the Dodd-Frank Act. See also Comments on Study Regarding
Obligations of Brokers, Dealers, and Investment Advisers, File No.
4-606, available at http://sec.gov/comments/4-606/4-606.shtml.
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If we permit rule 206(3)-3T to sunset on December 31, 2012, after
that date investment advisers registered with us as broker-dealers that
currently rely on rule 206(3)-3T would be required to comply with
section 206(3)'s transaction-by-transaction written disclosure and
consent requirements without the benefit of the alternative means of
complying with these requirements currently provided by rule 206(3)-3T.
This could limit the access of non-discretionary advisory clients of
[[Page 76856]]
advisory firms that are registered with us as broker-dealers to certain
securities.\15\ In addition, firms would be required to make
substantial changes to their disclosure documents, client agreements,
procedures, and systems.
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\15\ For a discussion of the costs and benefits underlying rule
206(3)-3T, see 2007 Principal Trade Rule Release, Section VI.C.
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As noted above, four commenters generally supported our proposal to
amend rule 206(3)-3T to extend it,\16\ and one commenter opposed the
two-year extension.\17\ Commenters who supported the extension cited
the disruption to investors that would occur if the rule expired at
this time, asserting that investors would lose access to the securities
currently offered through principal trades, receive less favorable
pricing on such securities, or be forced to buy such securities through
brokerage accounts.\18\ These commenters further explained that, if the
rule were allowed to expire, firms relying on the rule would be
required to make considerable changes to their operations, client
relationships, systems, policies and procedures at substantial expense,
without substantial benefits to investors.\19\ One commenter described
a recent survey it conducted that indicated reliance on rule 206(3)-3T
by dual registrants in order to engage in principal trades.\20\ In
addition, two commenters specifically addressed Commission
consideration of requests for exemptive orders as an alternative means
of compliance with section 206(3). Both commenters strongly supported
the two-year extension instead of Commission consideration of requests
for exemptive orders.\21\ One commenter expressed concern about the
potential inefficiency and uncertainty created by the need to submit
individual requests for exemptive relief.\22\ Commenters supporting the
extension agreed that extending the rule while the Commission conducted
its review of the obligations of broker-dealers and investment
advisers, as mandated by the Dodd-Frank Act, would be the least
disruptive option.\23\
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\16\ See Barnard Letter; FSI Letter; SIFMA Letter; Wells Fargo
Letter.
\17\ See fi360 Letter.
\18\ See FSI Letter; SIFMA Letter (noting that of seven advisory
firms that responded to a recent SIFMA survey, two firms indicated
that they would not be able to elicit customer consent in accordance
with section 206(3) of the Advisers Act, and the other five firms
indicated that although they would be able to elicit customer
consent in accordance with section 206(3), they would nonetheless
significantly limit their volume of principal trading); Wells Fargo
Letter.
\19\ See FSI Letter; SIFMA Letter; Wells Fargo Letter.
\20\ See SIFMA Letter (SIFMA noted responses from seven dual-
registrant firms that, in the aggregate, manage over $325 billion of
assets in over 1.1 million non-discretionary advisory accounts. The
firms indicated that 459,507 of these accounts with aggregate assets
of over $125 billion are eligible to engage in principal trading in
reliance on rule 206(3)-3T. These firms also indicated that, during
the previous two years, they engaged in principal trades in reliance
on rule 206(3)-3T with 106,682 accounts and executed an average of
12,009 principal trades per month in reliance on the rule.)
\21\ See SIFMA Letter; Wells Fargo Letter.
\22\ See SIFMA Letter.
\23\ See Barnard Letter; SIFMA Letter; Wells Fargo Letter.
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One commenter opposed extending the rule for more than a limited
period of time (no more than six months) and questioned maintaining
investor choice as a rationale for extending rule 206(3)-3T.\24\ This
commenter also noted that although instances of ``dumping'' have not
been discovered, the staff has observed related compliance problems in
the past. The commenter asserted that a more detailed analysis of
principal trades executed in reliance on rule 206(3)-3T, including
spreads paid by investors and investment returns, be conducted and
suggested that the Commission extend rule 206(3)-3T for no more than
six months to conduct such an assessment.\25\ The commenter also
expressed concern about the open-ended nature of extending this
temporary rule.\26\
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\24\ See fi360 Letter. This commenter also raised concerns
regarding the effectiveness of disclosure generally, including the
disclosures required by the temporary rule. Such concerns are beyond
the scope of this rulemaking.
\25\ See fi360 Letter.
\26\ Id.
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On balance, and after careful consideration of these comments, we
conclude that extending the rule for two years is the most appropriate
course of action at this time. First, with respect to investors, we
agree with commenters that permitting the rule to sunset before we
complete our consideration of the regulatory requirements applicable to
broker-dealers and investment advisers could produce substantial
disruption for investors with advisory accounts serviced by firms
relying on the rule.\27\ These investors might lose access to
securities available through principal transactions and be forced to
convert their accounts in the interim, only to face the possibility of
future change--and the costs and uncertainty such additional change may
entail.\28\ We believe that the rule benefits investors because it
provides them with greater access to a wider range of securities and
includes provisions designed to protect them.
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\27\ See Barnard Letter; SIFMA Letter; Wells Fargo Letter.
\28\ As discussed in each of the 2007 Principal Trade Rule
Release, 2009 Extension Release and 2010 Extension Release, firms
have explained that they may refrain from engaging in principal
trading with their advisory clients in the absence of the rule given
the practical difficulties of complying with section 206(3), and
thus may not offer principal trades through advisory accounts. See
2007 Principal Trade Rule Release, Section I.B; 2009 Extension
Release, Section I; 2010 Extension Release, Section II. See also
SIFMA Letter.
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Second, with respect to firms, the letters submitted by three
commenters demonstrate that firms in fact do rely on the rule, and that
those firms will be faced with uncertainty and disruption of operations
should the rule expire just as the Commission is engaging in a
comprehensive review process that may ultimately produce different
regulatory requirements.\29\ One commenter that represents securities
firms provided data showing that a substantial number of accounts and
volume of trades would be affected by a change in the rule.\30\ This
disruption will be avoided if the rule remains available while we
engage in our broader consideration of the regulatory requirements
applicable to broker-dealers and investment advisers.
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\29\ See FSI Letter; SIFMA Letter; Wells Fargo Letter.
\30\ See SIFMA Letter.
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We believe that the requirements of rule 206(3)-3T, coupled with
regulatory oversight, will adequately protect advisory clients for an
additional limited period of time while we consider more broadly the
regulatory requirements applicable to broker-dealers and investment
advisers.\31\ In the 2010 Extension Proposing Release, we discussed
certain compliance issues identified by the Office of Compliance,
Inspections and Examinations.\32\ One matter identified in the staff's
review resulted in a settlement of an enforcement proceeding and other
matters continue to be reviewed by the staff.\33\ We are sensitive to
the concerns regarding compliance issues with respect to rule 206(3)-3T
raised by one commenter.\34\ Since 2010 and throughout the period of
the extension,
[[Page 76857]]
the staff has and will continue to examine firms that engage in
principal transactions and will take appropriate action to help ensure
that firms are complying with section 206(3) or rule 206(3)-3T (as
applicable), including possible enforcement action.
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\31\ In addition, rule 206(3)-3T(b) provides that the rule does
not relieve an investment adviser from acting in the best interests
of its clients, or from any obligation that may be imposed by
sections 206(1) or (2) of the Advisers Act or any other applicable
provisions of the federal securities laws.
\32\ See 2010 Extension Proposing Release, Section II
(discussing certain compliance issues identified by the Office of
Compliance Inspections and Examinations with respect to the
requirements of section 206(3) or rule 206(3)-3T and noting that the
staff did not identify any instances of ``dumping'' as part of its
review).
\33\ See In the Matter of Feltl & Company, Inc., Investment
Advisers Act Release No. 3325 (Nov. 28, 2011) (settled order
finding, among other things, violations of section 206(3) of the
Advisers Act for certain principal transactions and section 206(4)
of the Advisers Act and rule 206(4)-7 thereunder for failure to
adopt written policies and procedures reasonably designed to prevent
violations of the Advisers Act and its rules).
\34\ See fi360 Letter.
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We received four comment letters specifically addressing the
duration of our proposed extension of rule 206(3)-3T.\35\ Three of
these commenters expressed support for extending the rule for an
additional two years, although two of these commenters suggested that
an extension of five years would be more appropriate.\36\ One commenter
opposed extending the rule for more than a six-month period, during
which the rule's effectiveness could be further assessed.\37\
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\35\ See fi360 Letter; FSI Letter; SIFMA Letter; Wells Fargo
Letter.
\36\ See FSI Letter; SIFMA Letter; Wells Fargo Letter. Two of
these commenters also recommended that the rule should ultimately be
made permanent. See FSI Letter; SIFMA Letter.
\37\ See fi360 Letter.
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As we noted in the Proposing Release, we believe that the rule's
sunset date should be extended only for a limited amount of time.\38\
That period of time, however, must be long enough to permit us to
engage in any rulemaking prompted by our broader review of regulatory
requirements applicable to investment advisers and broker-dealers. We
do not believe that six months is long enough to engage in this
process, and we do not believe that it is appropriate at this time to
extend the temporary rule for an additional five years. We are
sensitive to comments regarding the duration of the extension and the
uncertainty caused by extending a temporary rule, but we believe that a
two-year extension is necessary to provide investors uninterrupted
access to securities available through principal trades and to provide
us adequate time to engage in any rulemaking or other process.
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\38\ See Proposing Release, Section II.
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Three commenters addressed the question of whether we should
consider changing the requirements for adviser disclosures to have
registered advisers provide more information to us and their clients
about whether they are relying on rule 206(3)-3T.\39\ Each of these
commenters asserted that additional requirements for adviser
disclosures are unnecessary, noting that certain additional disclosures
may be redundant, and that current disclosures appear to be
adequate.\40\ We are not adopting amendments requiring additional
adviser disclosures at this time, but will consider the need for such
disclosures in future rulemakings or other processes as necessary.\41\
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\39\ See FSI Letter; SIFMA Letter; Wells Fargo Letter. See also
Proposing Release, Section III (requesting comment on whether we
should consider changing the requirements in Form ADV for adviser
disclosures to have registered advisers provide more information to
us and their clients about whether they are relying on the rule).
\40\ See FSI Letter; SIFMA Letter; Wells Fargo Letter.
\41\ See supra note 25.
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As noted above, one commenter suggested that there be a more
detailed analysis of data, including spreads paid and investor
returns.\42\ These factors are relevant to principal trades in general,
and are not specific to rule 206(3)-3T. This commenter also raised the
concern that the Commission may ultimately apply a ``uniform''
fiduciary standard to broker-dealers and investment advisers in two
different ways.\43\ These comments pertain to our broader consideration
of the regulatory requirements applicable to broker-dealers and
investment advisers, and we will consider these comments in conducting
this broader review.
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\42\ See fi360 Letter.
\43\ See fi360 Letter. We note that the standard of care to
which advisers are subject and the duties they owe clients are in no
way diminished by their reliance on rule 206(3)-3T. See supra note
30.
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III. Certain Administrative Law Matters
The amendment to rule 206(3)-3T is effective on December 28, 2012.
The Administrative Procedure Act generally requires that an agency
publish a final rule in the Federal Register not less than 30 days
before its effective date.\44\ However, this requirement does not apply
if the rule is a substantive rule which grants or recognizes an
exemption or relieves a restriction, or if the rule is
interpretive.\45\ Rule 206(3)-3T is a rule that recognizes an exemption
and relieves a restriction and in part has interpretive aspects.
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\44\ 5 U.S.C. 553(d).
\45\ Id.
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IV. Paperwork Reduction Act
Rule 206(3)-3T contains ``collection of information'' requirements
within the meaning of the Paperwork Reduction Act of 1995.\46\ The
Office of Management and Budget (``OMB'') last approved the collection
of information with an expiration date of May 31, 2014. An agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid OMB
control number. The title for the collection of information is:
``Temporary rule for principal trades with certain advisory clients,
rule 206(3)-3T'' and the OMB control number for the collection of
information is 3235-0630. The Proposing Release solicited comments on
our PRA estimates, but we did not receive comment on them.\47\
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\46\ 44 U.S.C. 3501 et seq.
\47\ See Proposing Release, Section IV.
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The amendment to the rule we are adopting today--to extend rule
206(3)-3T's sunset date for two years--does not affect the current
annual aggregate estimated hour burden of 378,992 hours.\48\ Therefore,
we are not revising the Paperwork Reduction Act burden and cost
estimates submitted to OMB as a result of this amendment.
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\48\ See Proposed Collection; Comment Request, 75 FR 82416 (Dec.
30, 2010); Submission for OMB Review; Comment Request, 76 FR 13002
(Mar. 9, 2011).
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V. Economic Analysis
A. Introduction
We are sensitive to the costs and benefits of our rules. The
discussion below addresses the costs and benefits of extending rule
206(3)-3T's sunset date for two years, as well as the effect of the
extension on the promotion of efficiency, competition, and capital
formation as required by section 202(c) of the Advisers Act.\49\
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\49\ 15 U.S.C. 80b-2(c). Section 202(c) of the Advisers Act
mandates that the Commission, when engaging in rulemaking that
requires it to consider or determine whether an action is necessary
or appropriate in the public interest, consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition, and capital formation.
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Rule 206(3)-3T provides an alternative means for investment
advisers that are registered with the Commission as broker-dealers to
meet the requirements of section 206(3) of the Advisers Act when they
act in a principal capacity in transactions with their non-
discretionary advisory clients. Other than extending the rule's sunset
date for two additional years, we are not modifying the rule from its
current form. We previously considered and discussed the economic
analysis of rule 206(3)-3T in its current form in the 2007 Principal
Trade Rule Release, the 2009 Extension Release, and the 2010 Extension
Release.\50\
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\50\ See 2007 Principal Trade Rule Release, Sections VI-VII;
2009 Extension Release, Sections V-VI; 2010 Extension Release,
Sections V-VI.
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The baseline for the following analysis of the benefits and costs
of the amendment is the situation in existence today, in which
investment advisers that are registered with us as broker-dealers can
choose to use rule 206(3)-3T as an alternative means to comply with
section 206(3) of the Advisers Act when engaging in principal
transactions with their non-discretionary advisory clients. The
amendment, which will extend rule 206(3)-3T's sunset date by
[[Page 76858]]
two additional years, will affect investment advisers that are
registered with us as broker-dealers and engage in, or may consider
engaging in, principal transactions with non-discretionary advisory
clients, as well as the non-discretionary advisory clients of these
firms that engage in, or may consider engaging in, principal
transactions. The extent to which firms currently rely on the rule is
unknown.\51\ Past comment letters have indicated that since its
implementation in 2007, both large and small advisers have relied upon
the rule.\52\ A recent letter submitted by one commenter describes
survey results of several of its members that rely on the rule.\53\
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\51\ As of November 1, 2012, we estimate that there are
491registered investment advisers that also are registered broker-
dealers. Based on IARD data as of November 1, 2012, we estimate that
there are approximately 100 registered advisers that also are
registered as broker-dealers that have non-discretionary advisory
accounts and that engage in principal transactions.
\52\ See Comment Letter of Securities Industry and Financial
Markets Association (Dec. 20, 2010); Comment Letter of Winslow,
Evans & Crocker (Dec. 8, 2009) (``Winslow, Evans & Crocker
Letter''); Comment Letter of Bank of America Corporation (Dec. 20,
2010) (``Bank of America Letter'').
\53\ See supra notes 18, 20.
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B. Benefits and Costs of Rule 206(3)-3T
As stated in previous releases, we believe the principal benefit of
rule 206(3)-3T is that it maintains investor choice among different
types of accounts and protects the interests of investors. Rule 206(3)-
3T also provides a lower cost and more efficient alternative for an
adviser that is registered with us as a broker-dealer to comply with
the requirements of section 206(3) of the Advisers Act. This, in turn,
may provide non-discretionary advisory clients greater access to a
wider range of securities. Non-discretionary advisory clients also
benefit from the protections of the sales practice rules of the
Securities Exchange Act of 1934 (the ``Exchange Act'') and the relevant
self-regulatory organization(s) and the fiduciary duties and other
obligations imposed by the Advisers Act. Greater access to a wider
range of securities may also allow non-discretionary advisory clients
to better allocate capital. In the long term, the more efficient
allocation of capital may lead to an increase in capital formation.
We received one comment on our economic analysis.\54\ The commenter
questioned the importance of investor choice as the principal benefit
of rule 206(3)-3T.\55\ We continue to believe that providing non-
discretionary advisory clients with greater access to a wider range of
securities is beneficial. As we have previously stated, many clients
wish to access the securities inventory of a diversified broker-dealer
through their non-discretionary advisory accounts.\56\ We believe that
it is appropriate to preserve investors' access to the securities
available through principal transactions made in reliance on rule
206(3)-3T while consideration of the regulatory requirements applicable
to broker-dealers and investment advisers is ongoing.
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\54\ See fi360 Letter.
\55\ Id.
\56\ See 2007 Principal Trade Rule Release, Section I.B.
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Also, in connection with the 2010 extension of the rule, one
commenter had disagreed with a number of the benefits of rule 206(3)-3T
described above, but did not provide any specific data, analysis, or
other information in support of its comment.\57\ That commenter argued
that rule 206(3)-3T would impede, rather than promote, capital
formation because it would lead to ``more numerous and more severe
violations * * * of the trust placed by individual investors in their
trusted investment adviser.'' \58\ While we understand the view that
numerous and severe violations of trust could impede capital formation,
we have not seen any evidence that rule 206(3)-3T has caused this
result. The staff has not identified instances where an adviser has
used the temporary rule to ``dump'' unmarketable securities or
securities that the adviser believes may decline in value into an
advisory account, a harm that section 206(3) and the conditions and
limitations of rule 206(3)-3T are designed to redress.\59\ No commenter
provided any substantive or specific evidence to contradict our
previous conclusion that the rule benefits investors, and we continue
to believe that the rule provides those benefits.\60\
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\57\ See Comment Letter of the National Association of Personal
Financial Advisors (Dec. 20, 2010) (``NAPFA Letter'') (questioning
the benefits of the rule in: (1) Providing protections of the sales
practice rules of the Exchange Act and the relevant self-regulatory
organizations; (2) allowing non-discretionary advisory clients of
advisory firms that are also registered as broker-dealers to have
easier access to a wider range of securities which, in turn, should
continue to lead to increased liquidity in the markets for these
securities; (3) maintaining investor choice; and (4) promoting
capital formation).
\58\ See id.
\59\ See supra note 32.
\60\ See 2007 Principal Trade Rule Release, Section VI.C; 2009
Extension Release, Section V; 2010 Extension Release, Section V.
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We also received comments on the 2007 Principal Trade Rule Release
from commenters who opposed the limitation of the temporary rule to
investment advisers that are registered with us as broker-dealers, as
well as to accounts that are subject to both the Advisers Act and
Exchange Act as providing a competitive advantage to investment
advisers that are registered with us as broker-dealers.\61\ Based on
our experience with the rule to date, and as we noted in previous
releases, we have no reason to believe that broker-dealers (or
affiliated but separate investment advisers and broker-dealers) are put
at a competitive disadvantage to advisers that are themselves also
registered as broker-dealers.\62\ Commenters on the Proposing Release
did not address this specific issue, but we intend to continue to
evaluate the effects of the rule on efficiency, competition, and
capital formation in connection with our broader consideration of the
regulatory requirements applicable to broker-dealers and investment
advisers.
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\61\ See Comment Letter of the Financial Planning Association
(Nov. 30, 2007); Comment Letter of the American Bar Association,
section of Business Law's Committee on Federal Regulation of
Securities (Apr. 18, 2008). See also 2009 Extension Release, Section
VI.
\62\ See 2009 Extension Release, Section VI; 2010 Extension
Release, Section VI.
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As we discussed in previous releases, there are also several costs
associated with rule 206(3)-3T, including the operational costs
associated with complying with the rule.\63\ In the 2007 Principal
Trade Rule Release, we presented estimates of the costs of each of the
rule's disclosure elements, including: prospective disclosure and
consent; transaction-by-transaction disclosure and consent;
transaction-by-transaction confirmations; and the annual report of
principal transactions. We also provided estimates for the following
related costs of compliance with rule 206(3)-3T: (i) The initial
distribution of prospective disclosure and collection of consents; (ii)
systems programming costs to ensure that trade confirmations contain
all of the information required by the rule; and (iii) systems
programming costs to aggregate already-collected information to
generate compliant principal transactions reports. Although one
commenter noted that the Commission's cost analysis had remained
unchanged, we do not believe the extension we are adopting today
materially affects the cost estimates associated with the rule.\64\ The
commenter did not provide supporting data discrediting the cost
[[Page 76859]]
analysis we presented in the 2007 Principal Trade Rule Release.\65\
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\63\ See supra note 50.
\64\ See 2007 Principal Trade Rule Release, Section VI.D. In the
2007 Principal Trade Rule Release, we estimated the total overall
costs, including estimated costs for all eligible advisers and
eligible accounts, relating to compliance with rule 206(3)-3T to be
$37,205,569.
\65\ See fi360 Letter.
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C. Benefits and Costs of the Extension
In addition to the benefits of rule 206(3)-3T described above and
in previous releases, we believe there are benefits to extending the
rule's sunset date for an additional two years. The temporary extension
of rule 206(3)-3T will have the benefit of providing the Commission
with additional time to consider principal trading as part of the
broader consideration of the regulatory requirements applicable to
broker-dealers and investment advisers without causing disruption to
the firms and clients relying on the rule.
One alternative to the extension of the rule's sunset date would be
to let the temporary rule sunset on its current sunset date, and so
preclude investment advisers from engaging in principal transactions
with their advisory clients unless in compliance with the requirements
of section 206(3) of the Advisers Act. As explained in the 2010
Extension Release, if we did not extend rule 206(3)-3T's sunset date,
firms currently relying on the rule would be required to restructure
their operations and client relationships on or before the rule's
current expiration date--potentially only to have to do so again later
(first when the rule sunsets or is modified, and again if we adopt a
new approach in connection with our broader consideration of the
regulatory requirements applicable to broker-dealers and investment
advisers).\66\ As a result of the two-year extension of the rule's
sunset date, firms relying on the rule will continue to be able to
offer clients and prospective clients the same level of access to
certain securities on a principal basis and will not need to incur the
cost of adjusting to a new set of rules or abandoning the systems
established to comply with the current rule during this two-year
period. The extension of the rule will also permit non-discretionary
advisory clients who have had greater access to certain securities
because of their advisers' reliance on the rule to trade on a principal
basis to continue to have the same level of access to those securities
without disruption.
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\66\ See 2010 Extension Release, Section V.
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Although we did not receive any comments on the rule's compliance
costs, we recognize that, as a result of our amendment, firms relying
on the rule will incur the costs associated with complying with the
rule for two additional years. We also recognize that a temporary rule,
by nature, creates long-term uncertainty, which in turn, may result in
a reduced ability of firms to coordinate and plan future business
activities.\67\ However, we believe that it would be premature to allow
the rule to sunset or to adopt the rule on a permanent basis while
consideration of the regulatory requirements applicable to broker-
dealers and investment advisers is ongoing. We also considered
extending the rule's sunset date for a period other than two years. Two
commenters suggested an extension of five years, noting that this
period of time would provide greater certainty for firms and more ample
time for the Commission to consider its broader regulation of broker-
dealers and investment advisers.\68\ Another commenter stated that the
rule should be extended for no more than six months.\69\ We do not
believe that six months is long enough to engage in a review of the
regulatory obligations of broker-dealers and investment advisers, and
we do not believe that it is appropriate at this time to extend the
temporary rule for an additional five years. Should our consideration
of the fiduciary obligations and other regulatory requirements
applicable to broker-dealers and investment advisers extend beyond the
sunset date of the temporary rule, a longer period may be appropriate.
On balance, however, we continue to believe that the two-year extension
of rule 206(3)-3T appropriately addresses the needs of firms and
clients relying on the rule while preserving the Commission's ability
to address principal trading as part of its broader consideration of
the standards applicable to investment advisers and broker-dealers. We
will continue to assess the rule's operation and impact along with
intervening developments during the period of the extension.
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\67\ One of the two commenters who argued that the rule should
eventually be made permanent specifically noted the uncertainty
caused by the need for additional extensions in the future. See
SIFMA Letter. We also received several comments in connection with
prior extensions of the rule urging us to make the rule permanent to
avoid such uncertainty. See e.g., Winslow, Evans & Crocker Letter;
Bank of America Letter.
\68\ See SIFMA Letter; Wells Fargo Letter.
\69\ See fi360 Letter.
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VI. Final Regulatory Flexibility Act Analysis
The Commission has prepared the following Final Regulatory
Flexibility Analysis (``FRFA'') regarding the amendment to rule 206(3)-
3T in accordance with 5 U.S.C. 604. We prepared and included an Initial
Regulatory Flexibility Analysis (``IRFA'') in the Proposing
Release.\70\
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\70\ See Proposing Release, Section VII.
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A. Need for the Rule Amendment
We are adopting an amendment to extend rule 206(3)-3T's sunset date
for two years because we believe that it would be premature to require
firms relying on the rule to restructure their operations and client
relationships before we complete our broader consideration of the
regulatory requirements applicable to broker-dealers and investment
advisers. The objective of the amendment to rule 206(3)-3T, as
discussed above, is to permit firms currently relying on rule 206(3)-3T
to limit the need to modify their operations and relationships on
multiple occasions before we complete our broader consideration of the
regulatory requirements applicable to broker-dealers and investment
advisers. Absent further action by the Commission, the rule will sunset
on December 31, 2012.
We are amending rule 206(3)-3T pursuant to sections 206A and 211(a)
of the Advisers Act [15 U.S.C. 80b-6a and 15 U.S.C. 80b-11(a)].
B. Significant Issues Raised by Public Comments
We did not receive any comment letters related to our IRFA.
C. Small Entities Subject to the Rule
Rule 206(3)-3T is an alternative method of complying with Advisers
Act section 206(3) and is available to all investment advisers that:
(i) Are registered as broker-dealers under the Exchange Act; and (ii)
effect trades with clients directly or indirectly through a broker-
dealer controlling, controlled by or under common control with the
investment adviser, including small entities. Under Advisers Act rule
0-7, for purposes of the Regulatory Flexibility Act an investment
adviser generally is a small entity if it: (i) Has assets under
management of less than $25 million; (ii) did not have total assets of
$5 million or more on the last day of its most recent fiscal year; and
(iii) does not control, is not controlled by, and is not under common
control with another investment adviser that has assets under
management of $25 million or more, or any person (other than a natural
person) that had total assets of $5 million or more on the last day of
its most recent fiscal year.\71\
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\71\ See 17 CFR 275.0-7.
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As noted in the Proposing Release, we estimated that as of August
1, 2012, 547 SEC-registered investment advisers were
[[Page 76860]]
small entities.\72\ As discussed in the 2007 Principal Trade Rule
Release, we opted not to make the relief provided by rule 206(3)-3T
available to all investment advisers, and instead have restricted it to
investment advisers that also are registered as broker-dealers under
the Exchange Act.\73\ We therefore estimated for purposes of the IRFA
that 7 of these small entities (those that are both investment advisers
and registered broker-dealers) could rely on rule 206(3)-3T.\74\ We did
not receive any comments on these estimates.
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\72\ IARD data as of August 1, 2012. As of November 1, 2012,
based on IARD data, we estimate that 502 SEC-registered investment
advisers were small entities.
\73\ See 2007 Principal Trade Rule Release, Section VIII.B.
\74\ IARD data as of August 1, 2012. As of November 1, 2012,
based on IARD data, we estimate that 6 of these small entities could
rely on rule 206(3)-3T.
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D. Projected Reporting, Recordkeeping, and other Compliance
Requirements
The provisions of rule 206(3)-3T impose certain reporting or
recordkeeping requirements and our amendment will extend the imposition
of these requirements for an additional two years. The two-year
extension will not alter these requirements.
Rule 206(3)-3T is designed to provide an alternative means of
compliance with the requirements of section 206(3) of the Advisers Act.
Investment advisers taking advantage of the rule with respect to non-
discretionary advisory accounts are required to make certain
disclosures to clients on a prospective, transaction-by-transaction and
annual basis.
Specifically, rule 206(3)-3T permits an adviser, with respect to a
non-discretionary advisory account, to comply with section 206(3) of
the Advisers Act by, among other things: (i) Making certain written
disclosures; (ii) obtaining written, revocable consent from the client
prospectively authorizing the adviser to enter into principal trades;
(iii) making oral or written disclosure and obtaining the client's
consent orally or in writing prior to the execution of each principal
transaction; (iv) sending to the client a confirmation statement for
each principal trade that discloses the capacity in which the adviser
has acted and indicating that the client consented to the transaction;
and (v) delivering to the client an annual report itemizing the
principal transactions. Advisers are already required to communicate
the content of many of the disclosures pursuant to their fiduciary
obligations to clients. Other disclosures are already required by rules
applicable to broker-dealers.
Our amendment will only extend the rule's sunset date for two years
in its current form. Advisers currently relying on the rule already
should be making the disclosures described above.
E. Agency Action To Minimize Effect on Small Entities
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.\75\
Alternatives in this category would include: (i) Establishing different
compliance or reporting standards or timetables that take into account
the resources available to small entities; (ii) clarifying,
consolidating, or simplifying compliance requirements under the rule
for small entities; (iii) using performance rather than design
standards; and (iv) exempting small entities from coverage of the rule,
or any part of the rule.
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\75\ See 5 U.S.C. 603(c).
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We believe that special compliance or reporting requirements or
timetables for small entities, or an exemption from coverage for small
entities, may create the risk that the investors who are advised by and
effect securities transactions through such small entities would not
receive adequate disclosure. Moreover, different disclosure
requirements could create investor confusion if it creates the
impression that small investment advisers have different conflicts of
interest with their advisory clients in connection with principal
trading than larger investment advisers. We believe, therefore, that it
is important for the disclosure protections required by the rule to be
provided to advisory clients by all advisers, not just those that are
not considered small entities. Further consolidation or simplification
of the proposals for investment advisers that are small entities would
be inconsistent with our goal 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 our approach to the rule to the same degree as other
eligible advisers. The condition that advisers seeking to rely on the
rule must also be registered with us as broker-dealers and that each
account with respect to which an adviser seeks to rely on the rule must
be a brokerage account subject to the Exchange Act, and the rules
thereunder, and the rules of the self-regulatory organization(s) of
which the broker dealer is a member, reflect what we believe is an
important element of our balancing between easing regulatory burdens
(by affording advisers an alternative means of compliance with section
206(3) of the Act) and meeting our investor protection objectives.\76\
Finally, we do not consider using performance rather than design
standards to be consistent with our statutory mandate of investor
protection in the present context.
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\76\ See 2007 Principal Trade Rule Release, Section II.B.7
(noting commenters that objected to this condition as disadvantaging
small broker-dealers (or affiliated but separate investment advisers
and broker-dealers)).
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VII. Statutory Authority
The Commission is amending rule 206(3)-3T pursuant to sections 206A
and 211(a) of the Advisers Act [15 U.S.C. 80b-6a and 80b-11(a)].
List of Subjects in 17 CFR Part 275
Investment advisers, Reporting and recordkeeping requirements.
Text of Rule Amendment
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 authority citation for Part 275 continues to read in part as
follows:
Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless
otherwise noted.
* * * * *
Sec. 275.206(3)-3T [Amended]
0
2. In Sec. 275.206(3)-3T, amend paragraph (d) by removing the words
``December 31, 2012'' and adding in their place ``December 31, 2014.''
Dated: December 20, 2012.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-31221 Filed 12-28-12; 8:45 am]
BILLING CODE 8011-01-P