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Proposed Rule

Temporary Rule Regarding Principal Trades With Certain Advisory Clients

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Information about this document as published in the Federal Register.

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Start Preamble

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission is proposing to amend rule 206(3)-3T under the Investment Advisers Act of 1940, a temporary rule that establishes 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 Investment Advisers Act when they act in a principal capacity in transactions with certain of their advisory clients. The amendment would extend the date on which rule 206(3)-3T will sunset from December 31, 2014 to December 31, 2016.

DATES:

Comments must be received on or before September 17, 2014.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

Paper Comments

  • Send paper comments to 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 email 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/​proposed.shtml). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 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.

Start Further Info

FOR FURTHER INFORMATION CONTACT:

Melissa S. Gainor, Senior Counsel, Sarah A. Buescher, Branch Chief, or Daniel S. Kahl, Assistant Director, at (202) 551-6787 or IArules@sec.gov, Investment Adviser Regulation Office, Division of Investment Management, U.S. Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-8549.

End Further Info End Preamble Start Supplemental Information

SUPPLEMENTARY INFORMATION:

The Securities and Exchange Commission is proposing 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 would extend the date on which the rule will sunset from December 31, 2014 to December 31, 2016.

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] The purpose of the rule was to permit broker-dealers to sell to their advisory clients, in the wake of Financial Planning Association v. SEC (the “FPA Decision”),[2] certain securities held in the proprietary accounts of their firms that might not be available on an agency basis—or might be available on an agency basis only on less attractive terms [3] —while protecting clients from conflicts of interest as a result of such transactions.[4]

As initially adopted on an interim final basis, rule 206(3)-3T was set to sunset on December 31, 2009. In December 2009, however, we adopted rule 206(3)-3T as a final rule in the same form in which it was adopted on an interim final basis in 2007, except that we extended the rule's sunset date by one year to December 31, 2010.[5] We Start Printed Page 48710deferred final action on rule 206(3)-3T in December 2009 because we needed additional time to understand how, and in what situations, the rule was being used.[6]

In both December 2010 and December 2012, we further extended the rule's sunset date, in each case for an additional two-year period.[7] We deferred final action on rule 206(3)-3T in 2010 in order to complete a study required by section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).[8] In 2012, we deferred final action on rule 206(3)-3T to further consider the findings, conclusions, and recommendations of the 913 Study and the comments we had received from interested parties.[9] In connection with each extension, we noted that our consideration of the regulatory requirements applicable to broker-dealers and investment advisers was ongoing and that an extension would allow the Commission 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.[10]

We have continued to consider the regulatory requirements applicable to broker-dealers and investment advisers. In 2013, we issued a request for data and other information, including quantitative data and economic analysis, relating to the benefits and costs that could result from alternative approaches regarding the standards of conduct and other obligations of broker-dealers and investment advisers.[11] The staff has received over 200 comment letters in response to the Request, several of which discussed rule 206(3)-3T, and Commissioners and the staff have held numerous meetings with interested parties.[12] None of the comment letters provided quantitative or qualitative information regarding the effects of the temporary rule.

II. Discussion

We are proposing to amend rule 206(3)-3T to extend the rule's sunset date by two additional years.[13] Absent further action by the Commission, the rule will sunset on December 31, 2014. We are proposing this extension because 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.[14]

As noted above, section 913 of the Dodd-Frank Act authorizes us to promulgate rules concerning, among other things, the legal or regulatory standards of conduct for broker-dealers, investment advisers, and persons associated with these intermediaries when providing personalized investment advice about securities to Start Printed Page 48711retail 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.[15] The Commission and its staff have continued to focus on evaluating options regarding regulatory requirements applicable to broker-dealers and investment advisers, taking into account the 913 Study's recommendations, the views of investors and other interested market participants, potential economic and market impacts, and the information we received in response to the Request in 2013. Staff has also been engaged in examinations of dual registrants and is assessing the impact to investors of the different supervisory structures and legal standards of conduct that govern the provision of brokerage and investment advisory services, which may help inform our considerations.[16] At this time, our consideration of the regulatory requirements applicable to broker-dealers and investment advisers is ongoing. We do not expect to complete our consideration of these issues before December 31, 2014, the current sunset date for rule 206(3)-3T.

If we permit rule 206(3)-3T to sunset on December 31, 2014, 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 advisory firms that are registered with us as broker-dealers to certain securities.[17] In addition, firms may be required to make substantial changes to their disclosure documents, client agreements, procedures, and systems.

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.[18] Since its adoption and throughout the period of the proposed extension, the staff has examined and would 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.[19] Since the last extension, examination staff also requested and received materials from a sample of dual registrants in 2014 to observe the use of the rule by these firms.[20] This examination showed that a number of the firms that were contacted by staff relied on the rule and that those firms had adopted written policies and procedures under rule 206(4)-7 that are designed to comply with the requirements of the temporary rule.[21] Based on the review, it appeared to the staff that the firms relying on the rule had processes in place for the purpose of effecting principal transactions in compliance with the requirements of the temporary rule.

In light of these considerations, we believe that it is not appropriate to require firms currently relying on the rule to restructure their operations and client relationships before we complete our consideration of the standards of conduct and regulatory requirements applicable to broker-dealers and investment advisers. To the extent our consideration of these issues leads to new rules concerning principal trading, these firms would be required to restructure their operations and client relationships, potentially at substantial expense.

As part of our broader consideration of the regulatory requirements applicable to broker-dealers and investment advisers, we intend to carefully consider principal trading by advisers, including whether rule 206(3)-3T should be substantively modified, supplanted, or permitted to sunset. In making these determinations, we will consider, among other things: The 913 Study; relevant comments and information received in connection with the 913 Study, the Request, and any rulemaking that may follow; the results of our staff's evaluation of the operation of rule 206(3)-3T; the information received in connection with the review of dual registrants; and comments we receive on rule 206(3)-3T in connection with this proposed extension.

III. Request for Comment

We request comment on our proposal to extend rule 206(3)-3T's sunset date for two additional years.

  • Should we allow the rule to sunset?
  • If so, what costs would advisers that currently rely on the rule incur? What would be the impact on their clients?
  • If we allow the rule to sunset, should we consider exemptive requests from investment advisers that are registered with us as broker-dealers for exemptive orders providing an alternative means of compliance with section 206(3)?
  • Are there any developments since the last extension that would make an extension not appropriate?
  • If we extend the rule's sunset date, is two years an appropriate period of time to extend the sunset date? Or should we extend the rule's sunset date for a different period of time? If so, for how long?
  • Is it appropriate to extend rule 206(3)-3T's sunset date for a limited period of time in its current form while we complete our broader consideration of the regulatory requirements applicable to broker-dealers and investment advisers?

IV. Paperwork Reduction Act

Rule 206(3)-3T contains “collection of information” requirements within the meaning of the Paperwork Reduction Act of 1995.[22] The Office of Management and Budget (“OMB”) last approved the collection of information with an expiration date of July 31, 2017. An agency may not conduct or sponsor, Start Printed Page 48712and 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 amendment to the rule we are proposing today—to extend rule 206(3)-3T's sunset date for two years—does not affect the current annual aggregate estimated hour burden of 139,358 hours.[23] Therefore, we are not revising the Paperwork Reduction Act burden and cost estimates submitted to OMB as a result of this proposed amendment.

We request comment on whether the estimates continue to be reasonable. Have circumstances changed such that these estimates (or the underlying assumptions embedded in these estimates) should be modified or revised? Persons submitting comments 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 Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090, with reference to File No. S7-23-07.

V. Economic Analysis

A. Introduction

The Commission is sensitive to the economic effects, including the benefits and costs and the effects on efficiency, competition, and capital formation, that would result from extending rule 206(3)-3T's sunset date for two years.[24] The economic effects considered in proposing this extension are discussed below.

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 proposing to extend rule 206(3)-3T's sunset date for two years, we are not otherwise proposing to modify the rule from its current form. We are proposing to extend rule 206(3)-3T in its current form to avoid disruption to firms and clients that rely on the rule while the Commission continues its ongoing consideration of the regulatory requirements applicable to broker-dealers and investment advisers and the recommendations from the 913 Study. In particular, an extension of the current rule would permit firms to continue to offer, and clients to have access to, certain securities on a principal basis without being required to restructure their operations and client relationships, adjust to a new set of rules, or abandon the operational systems established to comply with the current rule—potentially only to have to do so again when the rule expires or is modified, and once more if the Commission adopts a new approach to principal trading in connection with the broader consideration of the regulatory requirements applicable to broker-dealers and investment advisers. We previously considered and discussed the economic effects of rule 206(3)-3T in its current form in the 2007 Principal Trade Rule Release, the 2009 Extension Release, the 2010 Extension Release, and the 2012 Extension Release.[25]

At the outset, the Commission notes that, where possible, it has sought to quantify the costs, benefits, and effects on efficiency, competition, and capital formation expected to result from extending rule 206(3)-3T and its reasonable alternatives. In many cases, however, the Commission is unable to quantify the economic effects because it lacks the information necessary to provide a reasonable estimate.[26] The staff has also not found other information, including through examinations and comment letters, which impacts the discussion of economic effects in previous releases. We will continue to assess the rule's operation and impacts along with intervening developments during the period of the proposed extension.

The temporary rule currently in effect serves as the economic baseline against which the costs and benefits, as well as the impact on efficiency, competition, and capital formation, of the amendment are discussed. The proposed amendment, which will extend rule 206(3)-3T's sunset date by an additional two years, will affect investment advisers that are registered with the Commission 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.

Although the extent to which firms currently rely on the rule is unknown, based on IARD data as of June 1, 2014, there are 97 dual registrants that may rely on the rule.[27] Past comment letters also have indicated that since its implementation in 2007, both large and small advisers have relied upon the rule.[28] Additionally, one comment letter to the Request in 2013 provided survey results regarding the dollar amount of principal transactions that a small number of firms engaged in with retail clients in 2012.[29] Because the economic effects of extending the rule and its reasonable alternatives will depend on the extent to which eligible firms rely on the rule to engage in principal transactions with non-discretionary Start Printed Page 48713advisory clients, the economic effects could vary significantly among firms and their clients.

B. Analysis of the Proposed Extension and Alternatives

As noted above, the temporary rule currently in effect serves as the economic baseline against which the costs and benefits, as well as the impact on efficiency, competition, and capital formation, of the amendment are discussed. Because the extension of the sunset date in the temporary rule maintains the status quo, we do not expect additional costs or benefits to result from the extension. For the same reason, we also do not expect the extension to have additional effects on efficiency, competition or capital formation. Extending the current rule would provide 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.

Two reasonable alternatives to extending the current rule include allowing the rule to expire and adopting the rule on a permanent basis. If the rule is allowed to expire, then an adviser that is registered as a broker-dealer would no longer have a lower cost and more efficient alternative to the requirements under section 206(3) of the Advisers Act like that provided by the temporary rule,[30] and consequently non-discretionary advisory account clients could lose access to the principal accounts of firms that rely on the rule. As noted in the 2012 Extension Release, greater access to a wider range of securities may allow non-discretionary advisory clients to more efficiently allocate capital and, in the long term, the more efficient allocation of capital may lead to an increase in capital formation.[31] If the rule expires, the loss of access by non-discretionary advisory clients to a wider range of securities would reduce the ability of these investors to efficiently allocate capital and therefore could reduce any resulting long-term gains to capital formation. Allowing the rule to expire also would reduce the ability of investors to choose between brokerage accounts and advisory accounts if the investor wishes to maintain access to securities held in firm principal accounts, and may force non-discretionary advisory account clients to bear the costs associated with transferring accounts (or lose access to a firm's principal accounts). Firms may also bear the potentially substantial costs associated with restructuring their operations and client relationships. On the other hand, if the rule is allowed to expire, and firms engage in principal transactions with advisory account clients pursuant to the requirements of section 206(3) of the Act, investors will be able to more fully evaluate the conflicts of the principal transactions prior to the trades.

We continue to believe that non-discretionary advisory client access to a wider range of securities is beneficial.[32] Many clients wish to access securities held in firm inventory of a diversified broker-dealer, and clients may wish to access these securities through their non-discretionary advisory accounts.[33] 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.

In connection with the 2010 extension of the rule, a 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”, but did not provide any specific data, analysis, or other information in support of its comment.[34] 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.[35] In addition, non-discretionary advisory account clients benefit from the protections of sales practice rules under the Exchange Act and of relevant self-regulatory organizations, and the fiduciary duty and other obligations imposed by the Advisers Act.

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.[36] 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.[37] 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.

If the Commission allowed the rule to expire, firms would no longer incur the costs associated with rule 206(3)-3T, including the operational costs associated with complying with the rule.[38] In the 2007 Principal Trade Rule Release, we presented estimates of the costs of each of the rule's disclosure Start Printed Page 48714elements, 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 on the 2012 extension noted that the Commission's cost analysis had remained unchanged since 2007, the commenter did not provide any supporting information discrediting the cost analysis we presented in the 2007 Principal Trade Rule Release.[39] We do not believe the extension we are proposing today would affect the cost estimates associated with the rule.[40] Furthermore, we believe that an eligible adviser that begins to rely on Rule 206(3)-T today would bear the same upfront and ongoing cost estimates set forth in the 2007 Principal Trade Rule Release.[41]

If the rule is adopted on a permanent basis, then there may be additional economic effects. We recognize that a temporary rule, by nature, creates uncertainty, which in turn, may result in a reduced ability of firms to coordinate and plan future business activities. The uncertainty with respect to rule 206(3)-3T would be reduced if either the rule was allowed to expire or the rule was adopted on a permanent basis.[42] Nonetheless, we believe that it would not be appropriate to adopt the rule on a permanent basis (with any necessary substantive amendments) while consideration of the regulatory requirements applicable to broker-dealers and investment advisers is ongoing.

Another reasonable alternative would be to extend the rule for a period other than two years. For example, extending the rule for greater than two years would provide the Commission with additional time to evaluate the impact of any potential rulemaking or other process that may emerge from the broader consideration of fiduciary obligations and other regulatory requirements applicable to broker-dealers and investment advisers. Should our consideration of the fiduciary obligations and other regulatory requirements applicable to broker-dealers and investment advisers extend beyond the proposed sunset date of the temporary rule, such a longer period may be appropriate for the Commission to consider. On balance, however, we believe that the proposed two-year extension of rule 206(3)-3T appropriately addresses the concerns of firms and clients relying on the rule while the Commission continues its ongoing consideration of the standards applicable to investment advisers and broker-dealers.

C. Request for Comment

We request comment on all aspects of the economic analysis, including the accuracy of the potential costs and benefits identified and assessed in this release and the prior releases and information on any other costs or benefits that may result from the proposal and from alternatives to the proposal, and whether the proposal, if adopted, would promote efficiency, competition, and capital formation. Commenters are requested to provide quantitative and qualitative data and other information and economic analysis about the costs or benefits to support their views.

VI. Initial Regulatory Flexibility Act Analysis

The Commission has prepared the following Initial Regulatory Flexibility Analysis (“IRFA”) regarding the proposed amendment to rule 206(3)-3T in accordance with section 3(a) of the Regulatory Flexibility Act.[43]

A. Reasons for Proposed Action

We are proposing to extend rule 206(3)-3T's sunset date for two years because we believe that it would not be appropriate 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.

B. Objectives and Legal Basis

The objective of the proposed 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, both before and potentially after we complete any regulatory actions regarding the standards of conduct and other obligations applicable to broker-dealers and investment advisers.

We are proposing to amend 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)].

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.[44]

We estimate that as of June 1, 2014, 464 SEC-registered investment advisers were small entities.[45] 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 are registered as broker-dealers under the Exchange Act.[46] We therefore estimate for purposes of this IRFA that 12 of these small entities (those that are both investment advisers and registered broker-dealers) could rely on rule 206(3)-3T.[47]

Start Printed Page 48715

D. Reporting, Recordkeeping, and Other Compliance Requirements

The provisions of rule 206(3)-3T impose certain reporting or recordkeeping requirements, and our proposal, if adopted, would extend the imposition of these requirements for an additional two years. We do not, however, expect that the proposed two-year extension of the rule's sunset date would 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 would be 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 proposed amendment, if adopted, only would extend the rule's sunset date for two years. Advisers currently relying on the rule already should be making the disclosures described above.

E. Duplicative, Overlapping, or Conflicting Federal Rules

We believe 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.

We note, 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, including whether the broker or dealer is acting as an agent or as a principal for its own account in a given transaction. Furthermore, FINRA rule 2232 requires broker-dealers that are members of FINRA to deliver a written notification in conformity with rule 10b-10 under the Exchange Act containing certain information. Rule G-15 of the Municipal Securities Rulemaking Board also contains a separate confirmation rule that governs transactions in municipal securities, and requires brokers, dealers and municipal securities dealers to disclose, among other things, the capacity in which the firm effected a transaction (i.e., as an agent or principal). 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 we 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.[48] 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.

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 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 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.[49] 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.

G. Solicitation of 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.

Do small investment advisers believe an alternative means of compliance with section 206(3) should be available to them?

VII. Consideration of Impact on the Economy

For purposes of the Small Business Regulatory Enforcement Fairness Act of Start Printed Page 487161996, or “SBREFA,” [50] we must advise OMB whether a proposed regulation constitutes a “major” rule. Under SBREFA, a rule is considered “major” where, if adopted, it results in or is likely to result in: (1) An annual effect on the economy of $100 million or more; (2) a major increase in costs or prices for consumers or individual industries; or (3) significant adverse effects on competition, investment or innovation.

We request comment on the potential impact of the proposed amendment on the economy on an annual basis. Commenters are requested to provide empirical data and other factual support for their views to the extent possible.

VIII. Statutory Authority

The Commission is proposing to amend 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)].

Start List of Subjects

List of Subjects in 17 CFR Part 275

  • Investment advisers
  • Reporting and recordkeeping requirements
End List of Subjects

Text of Proposed Rule Amendment

For the reasons set out in the preamble, Title 17, Chapter II of the Code of Federal Regulations is proposed to be amended as follows.

Start Part

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

End Part Start Amendment Part

1. The authority citation for part 275 continues to read in part as follows:

End Amendment Part Start Authority

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.

End Authority
* * * * *
Start Amendment Part

2. In § 275.206(3)-3T, amend paragraph (d) by removing the words “December 31, 2014” and adding in their place “December 31, 2016”.

End Amendment Part Start Signature

By the Commission.

Dated: August 12, 2014.

Kevin M. O'Neill,

Deputy Secretary.

End Signature End Supplemental Information

Footnotes

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”).

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2.  482 F.3d 481 (D.C. Cir. 2007). In the FPA Decision, handed down on March 30, 2007, the Court of Appeals for the DC Circuit vacated (subject to a subsequent stay until October 1, 2007) rule 202(a)(11)-1 under the Advisers Act. 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. For further discussion of fee-based brokerage accounts, see 2007 Principal Trade Rule Release, Section I.

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3.  See 2007 Principal Trade Rule Release at nn.19-20 and Section VI.C.

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4.  As a consequence of the FPA Decision, broker-dealers offering fee-based brokerage accounts with an advisory component became subject to the Advisers Act with respect to those accounts, and the client relationship became fully subject to the Advisers Act. These broker-dealers—to the extent they wanted to continue to offer fee-based accounts and met the requirements for registration—had to: Register as investment advisers, if they had not done so already; act as fiduciaries with respect to those clients; disclose all material conflicts of interest; and otherwise fully comply with the Advisers Act, including the restrictions on principal trading contained in section 206(3) of the Act. See 2007 Principal Trade Rule Release, Section I.

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5.  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).

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6.  See 2009 Extension Release, Section II.c.

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7.  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 provision) (“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)] (extending rule 206(3)-3T's sunset provision from December 31, 2010 to December 31, 2012) (“2010 Extension Release”); Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Investment Advisers Act Release No. 3483 (Oct. 9, 2012) [77 FR 62185 (Oct. 12, 2012)] (proposing a two-year extension of rule 206(3)-3T's sunset provision); Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Investment Advisers Act Release No. 3522 (Dec. 20, 2012) [77 FR 76854 (Dec. 31, 2012)] (extending rule 206(3)-3T's sunset provision from December 31, 2012 to December 31, 2014) (“2012 Extension Release”).

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8.  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 authorizes us to promulgate rules 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.

The study mandated by section 913 of the Dodd-Frank Act was prepared by the staff and delivered to Congress on January 21, 2011. 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 (opposing the release of the 913 Study to Congress and stating that more rigorous analysis is required before the Commission engages in any follow-on rulemaking).

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9.  See 2012 Extension Release, Section II.

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10.  See id.; 2010 Extension Release, Section II.

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11.  Duties of Brokers, Dealers, and Investment Advisers, Investment Advisers Act Release No. 3558 (Mar. 1, 2013) [78 FR 14848 (Mar. 7, 2013)] (the “Request”).

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12.  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. See e.g., Comment Letter of Consumer Federation of America (Jul. 5, 2013) (“[B]y considering revisions to the principal trading rules as part of the fiduciary rulemaking, the Commission could arrive at a workable approach that is consistent for brokers and investment advisers and provides improved protections for investors.”); Comment Letter of North American Securities Administrators Association, Inc. (Jul. 5, 2013) (“[T]he Commission should consider SEC Rule 206(3)-3T as part of future fiduciary standard rulemaking.”); Comment Letter of Securities Industry and Financial Markets Association (“SIFMA”) (Jul. 5, 2013) (“SIFMA 2013 Letter”) (including survey results regarding the dollar amount of principal transactions engaged in with retail clients during 2012).

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13.  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 to be 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 conduct that apply to broker-dealers and investment advisers. Therefore, we are not proposing 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).

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14.  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 an self-regulatory organization to oversee private funds).

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15.  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.

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16.  See National Exam Program, Office of Compliance Inspections and Examinations, Examination Priorities for 2014 (Jan. 9, 2014), available at http://www.sec.gov/​about/​offices/​ocie/​national-examination-program-priorities-2014.pdf.

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17.  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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18.  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.

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19.  In the 2010 Extension Proposing Release, we discussed certain compliance issues identified by the Office of Compliance, Inspections and Examinations. See 2010 Extension Proposing Release, Section II. 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. 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).

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20.  Staff identified a representative sample set of dual registrants based on Form ADV data, including firm disclosures on Form ADV Part 2A, and requested materials from the firms that included compliance policies and procedures, sample disclosures, and data regarding the firm's principal transactions with advisory accounts. See also infra note 27.

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21.  17 CFR 275.206(4)-7. See also 2007 Principal Trade Rule Release (noting that 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).

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23.  See Proposed Collection; Comment Request, 78 FR 72932 (Dec. 4, 2013); Submission for OMB Review; Comment Request, 79 FR 7481 (Feb. 7, 2014).

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24.  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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25.  See 2007 Principal Trade Rule Release, Sections VI-VII; 2009 Extension Release, Sections V-VI; 2010 Extension Release, Sections V-VI; 2012 Extension Release, Sections V-VI.

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26.  In previous releases, the Commission has requested comment on the economic effects of rule 206(3)-3T, the economic effects of extending the rule, and the economic effects of alternatives. The Commission has not received comments providing quantitative data regarding the economic effects of extensions of rule 206(3)-3T, or to alternatives of the rule.

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27.  Based on IARD data as of June 2, 2014, there are 290 SEC-registered advisers that are also registered as broker-dealers that have non-discretionary accounts who could potentially rely on the rule; however, only 97 of these dual registrants indicate they currently engage in principal transactions on Form ADV. The actual number of advisers that engage in principal transactions in reliance on the temporary rule is likely smaller. The staff's recent outreach to observe the use of the rule by firms found that some of the dual registrants in the sample, which was derived based on Form ADV data, did not rely on the rule.

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28.  For example, SIFMA's 2012 comment letter included survey results 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 non-discretionary advisory accounts (with aggregate assets of over $125 billion) were eligible to engage in principal trading in reliance on the rule. These firms also indicated that, during 2010-2012, the firms engaged in principal trades in reliance on Rule 206(3)-3T with respect to 106,682 accounts and executed an average of 12,009 principal trades per month in reliance on the rule. Comment letter of SIFMA (Nov. 13, 2012). See also Comment Letter of Wells Fargo Advisors (Nov. 13, 2012) (noting that the firm managed 232,437 non-discretionary advisory accounts in which hundreds of principal trades are made on a monthly basis for the benefit of investors).

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29.  See SIFMA 2013 Letter, supra note 12. Ten firms responded to SIFMA's survey and reported that they relied on the temporary rule for $8 billion in principal transactions across 163,000 retail non-discretionary advisory accounts. In comparison, the ten firms engaged in $36 billion in principal transaction with 498,000 retail advisory accounts under section 206(3) of the Advisers Act and $809 billion in principal transactions with 2,480,000 retail brokerage accounts.

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30.  Section 206(3) of the Advisers Act requires an investment adviser to provide written conflict-of-interest disclosure describing its role as principal when transacting securities from its own account and obtain client consent prior to transaction completion. Rule 206(3)-3T provides a dual registrant firm the option of providing transaction-by-transaction disclosures verbally instead of in writing when engaging in principal transactions with non-discretionary advisory clients as long as the firm satisfies additional requirements before and after the transactions. Additional requirements of the temporary rule include the provision of a written prospective disclosure to clients describing the conflicts arising from principal transactions, acquisition of written revocable client consent prospectively authorizing such transactions, the provision of transaction-by-transaction confirmations, and the provision of annual reports itemizing the clients' principal transactions thereafter.

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31.  2012 Extension Release, Section V.B.

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32.  But see Comment Letter of fi360, Inc. (Nov. 13, 2012) (“fi360 Letter”) (questioning the importance of investor choice as the principal benefit of Rule 206(3)-3T); Comment Letter of 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).

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33.  See 2007 Principal Trade Rule Release, Section I.B.

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34.  See NAPFA Letter.

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35.  See 2010 Extension Proposing Release, Section II (noting that the staff did not identify instances of “dumping” in connection with OCIE's examinations regarding compliance with the temporary rule).

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36.  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.

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37.  See 2009 Extension Release, Section VI; 2010 Extension Release, Section VI; 2012 Extension Release, Section V.

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38.  See supra n. 25.

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39.  See fi360 Letter. See also 2012 Extension Release, Section V.B.

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40.  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. See 2007 Principal Trade Rule Release, Section VI.D.

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41.  See id.

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42.  We 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., Comment Letter of Winslow, Evans & Crocker (Dec. 8, 2009); Comment of Bank of America Corporation (Dec. 20, 2010).

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45.  IARD data as of June 1, 2014.

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46.  See 2007 Principal Trade Rule Release, Section VIII.B.

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47.  IARD data as of June 1, 2014.

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49.  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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50.  Public Law 104-121, Title II, 110 Stat. 857 (1996) (codified in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C. 601).

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[FR Doc. 2014-19421 Filed 8-15-14; 8:45 am]

BILLING CODE 8011-01-P