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SEC Release No. IA-3483: Temporary Rule Regarding Principal Trades with Certain Advisory Clients

On October 9, 2012, the Securities and Exchange Commission (“SEC”) issued Release No. IA-3483, which proposed to amend temporary Rule 206(3)-3T of the Investment Advisors Act of 1940 by extending the date of sunset from December 31, 2012 to December 31, 2014.

Rule 206(3)-3T, adopted in September 2007 on an interim basis, provides an alternative to Rule 206(3) for investment advisors that are registered as broker-dealers and are acting in a principal capacity in transactions with certain advisory clients. In part, the purpose of Rule 206(3)-3T is to allow broker-dealers to sell securities to their advisory clients held in “proprietary accounts of their firms that might not be available on an agency basis . . . while protecting clients from conflicts of interest.”

Since the inception of Rule 206(3)-3T in 2007, the SEC has on two occasions proposed, and subsequently adopted, extensions to the rule’s sunset date. In December 2009, the rule was extended for one year. Later, in December 2010, the rule was extended for an additional two years in light of section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which required the SEC to complete a study on the effectiveness of existing broker-dealer laws and regulations.

In proposing to extend Rule 206(3)-3T’s sunset date to December 31, 2014, the SEC explained that although the study mandated by section 913 of Dodd-Frank was delivered to Congress in January 2011, the SEC’s consideration of “regulatory requirements applicable to broker-dealers and investment advisors from the [study] is ongoing.” The SEC further opined:

[W]e believe that it would be premature 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 advisors. 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.

In weighing the benefits and costs to the proposed extension, the SEC noted that additional time was necessary to consider principal trading applicable to broker-dealers and broader regulatory requirements without disrupting the existing rule. Moreover, there are non-discretionary advisory clients that have access to certain securities because of their advisors’ reliance on the rule, and any disruption before a permanent rule is adopted may adversely affect those clients in the interim.

Correspondingly, the SEC stressed the fact that temporal rules create long-term uncertainty, which may inhibit broker-dealers’, and by extension their clients’, ability to plan for future business activities. Moreover, broker-dealers will bear the burden of two additional years of compliance costs. Nonetheless, as the SEC explained, “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 advisors is ongoing.”

The SEC accepted comments on Release No. IA-3483 through November 12, 2012. It is slated to make a final decision before the current sunset date of December 31, 2012.

The primary materials for this case may be found on the DU Corporate Governance website.

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