On December 1, 2010, the United States Securities and Exchange Commission proposed an amendment to extend the effectiveness of Rule 206(3)-3T under the Investment Advisers Act of 1940 (“Advisers Act”) for an additional two years. Rule 206(3)-3T is a temporary rule adopted in 2007 by the SEC that provides allows dual-registrant investment advisers/broker-dealers to conduct principal trades in certain securities for clients with non-discretionary advisory accounts based on an annual blanket consent. Without Rule 206(3)-3T, Section 206(3) of the Advisers Act would require firms to obtain trade-by-trade consent for any transactions as a principal — a requirement that most firms have found impractical, with the result that firms would have to conduct all transactions in an agency capacity. The amendment would extend the date on which Rule 206(3)-3T will expire from December 31, 2010, to December 31, 2012. The amendment only serves to extend the rule’s sunset date and otherwise makes no substantive changes.
Background of Rule 206(3)-3T
Rule 206(3)-3T was originally adopted in 2007 in response to the decision in Financial Planning Association v. SEC, 482 F.3d 481 (D.C. Cir. 2007). As a result of that decision, fee-based brokerage accounts with an advisory component became subject to the Advisers Act, including the trade-by-trade written disclosure requirements of Section 206(3) and the resulting restrictions on principal trading. Rule 206(3)-3T was subsequently adopted so that broker-dealers could sell certain securities held in the proprietary accounts of their firms that might not be available on an agency basis (or on less favorable terms) while protecting clients from conflicts of interest that could result.1 Rule 206(3)-3T only applies to securities for which the firm was not an underwriter, but with an exception for investment-grade debt securities. Although the Dodd-Frank Act requires that federal agencies remove all references to credit ratings from their rules, the extension of Rule 206(3)-3T does not change the reference to investment-grade debt in the rule.
This proposed extension represents a reversal of the position that the SEC staff took on Rule 206(3)-3T this previous summer. In an August 9, 2010, letter to SIFMA, the SEC’s Division of Investment Management had stated that it would not be recommending further action on Rule 206(3)-3T and that it anticipated allowing the rule to expire at the end of 2010. The Division also recognized that because of the expiration of the rule, some firms might wish to submit individual applications for exemptive orders that would provide for similar alternative means for compliance with Section 206(3).
In its December 1, 2010, proposed amendment, the SEC decided to change course and propose a two year extension of the rule, rather than letting it expire at the end of this year. The Commission cited the July 21, 2010, passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) as the main reason for the extension. Under Section 913 of the Dodd-Frank Act, the SEC is required to conduct a study and provide Congress with a report regarding the obligations of broker-dealers and investment advisers, including the standards of care applicable for the firms and their associated persons. This report is due to be presented to Congress no later than January 21, 2011. The Commission decided that it would be too disruptive to withdraw Rule 206(3)-3T while it is considering these broader changes.
The SEC reported that a number of firms continue to rely on Rule 206(3)-3T’s alternative means of meeting the requirements of Section 206(3). The SEC stated that it had not found any evidence of “dumping” securities in advisory accounts — the concern that had led to the passage of Section 206(3) in the first place. However, the SEC did observe some compliance issues with Rule 206(3)-3T, including inadequate or inaccurate disclosures, weaknesses in monitoring and testing compliance with the rule, and failure to keep adequate books and records. The Commission further stated that these compliance issues are being analyzed and pursued on an ongoing basis, including in some cases referrals to the Division of Enforcement. The SEC stated that Rule 206(3)-3T currently provides sufficient protections to advisory clients to warrant the rule’s continued operation for an additional limited period of time while the Dodd-Frank Act’s mandated study is completed.
The SEC requests comments on its proposed two-year extension of Rule 206(3)-3T. Comments must be received on or before December 20, 2010.
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1The rule allows a broker-dealer to comply with the requirements of Section 206(3) by, among other things: