At the end of December 2009, the SEC adopted on an interim final basis Rule 206(3)-3T. The rule now expires on December 31, 2010. Rule 206(3)-3T had been adopted as an interim rule by the SEC in 2007 in order to provide an alternative means for investment advisers registered as broker-dealers to meet the requirements of Section 206(3) of the Advisers Act of 1940 (“Advisers Act”) when they act in a principal capacity in transactions with certain of their advisory clients.
Under Section 206(3) of the Advisers Act, an investment adviser acting as principal for its own account cannot (1) sell any security to, or purchase any security from, a client, or (2) acting as a broker-dealer for a person other than the client, effect any sale or purchase of any security for the account of the client, without (a) disclosing to the client in writing, prior to the completion of the transaction, the capacity in which it is acting, and (b) obtaining the client’s consent for the transaction, unless the investment adviser is not acting as such in connection with the transaction.
The SEC adopted Rule 206(3)-3T in order to provide investment advisers that are dually registered as brokerdealers (“Dual Registrants”) limited relief from the principal trading restriction under Section 206(3). The rule enables fee-based brokerage customers to convert their accounts to fee-based accounts subject to the Advisers Act or to commission-based brokerage accounts.
Under Section 206(3) of the Advisers Act, Dual Registrants must provide written notice and obtain client consent on a transaction-by-transaction basis when trading as a principal with a client. Rule 206(3)-3T provides Dual Registrants with an alternative means to comply with Section 206(3), while still requiring transaction-bytransaction disclosure. Specifically, the Rule permits a Dual Registrant to engage in principal transactions with a non-discretionary advisory client, subject to the following conditions:
- Blanket Written Notice and Revocable Consent. The Rule requires the Dual Registrant to provide the client with a blanket written prospective notice and obtain the client’s blanket written revocable prospective consent with respect to principal transactions.
- Eligible Securities. The Rule applies to any principal trade that does not involve (1) a security issued by the Dual Registrant (or by an affiliate of the Dual Registrant), or (2) a transaction in which the Dual Registrant (or an affiliate of the Dual Registrant) acts as underwriter, other than offerings of non-convertible investment grade debt securities.14
- Trade-by-Trade Disclosure/Client Consent. The Rule requires that the Dual Registrant, prior to the completion of each principal transaction, (1) inform the client that the Dual Registrant is acting as principal for its own account with respect to the transaction, and (2) obtain the consent from the client for the transaction. The trade-by-trade disclosure and consent may be written or oral.
- Confirmation Disclosure. The Rule requires that the confirmation provided to the client under Rule 10b- 10 of the Exchange Act, at or before completion of the transaction, indicate in Plain English that (1) the Dual Registrant disclosed to the client prior to the execution of the transaction that it may act in a principal capacity in connection with the transaction, (2) the client authorized the transaction, and (3) the Dual Registrant sold the security to or purchased the security from the client for its own account.
- Annual Report. The Rule requires that the Dual Registrant provide the client with list of all principal trades that were executed in the client’s account during the prior year, including the date and price of the transactions.
Investment advisers that trade in securities issued by, or underwritten by, affiliates, should be mindful that these securities are not eligible securities (as discussed above) and therefore, the investment adviser must obtain consent for each transaction on a trade-by-trade basis. The Rule does not relieve any investment adviser of its fiduciary obligations under the Advisers Act or other applicable provisions of federal law. The SEC will continue to study how the rule is being used and will also consider the rule in light of proposed legislative changes, such as those that would take effect in connection with the Investor Protection Act.