May 15, 2000
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. 4-433, Agenda for SEC Roundtable on Investment Adviser Issues
Dear Mr. Katz:
The Bond Market Association (the "Association")1 appreciates the opportunity to comment on the topics to be discussed at the SEC Roundtable on Investment Adviser Issues, which will be held on May 23, 2000. In particular, this letter will address item IV.C of the referenced agenda, entitled "Possible rule modifying Section 206(3)'s restrictions on principal trading."
We applaud the Commission's willingness to consider modifications to the restrictions contained in Section 206(3) of the Investment Advisers Act of 1940 (the "Act"). We believe that by crafting exemptions that incorporate appropriate safeguards, trading opportunities that are available to investment advisers' clients will be increased, thereby enhancing liquidity and price competition. We believe that these enhancements can be gained without creating a significant risk of self-dealing.2
I. Executive Summary
The Association recommends that rule making or other relief permit an adviser or its affiliates to enter into principal transactions with clients of the adviser that would otherwise be prohibited under Section 206(3), under the following conditions:
II. Overview of Section 206(3)
Section 206(3) of the Act, as interpreted by the SEC staff, generally prohibits an investment adviser and its affiliates, including any broker-dealer affiliate, from engaging in principal transactions with an advisory client. This section of the Act was intended to prevent self-dealing by advisers and their affiliates and to give clients of advisers an assurance of execution of transactions at a fair price.
The exemption set forth in Section 206(3) from this prohibition is premised on providing a written disclosure of the capacity in which the adviser is acting and obtaining the client's consent at or before the completion of each proposed transaction. This existing exemption from the requirement for trade-by-trade prior consent is generally not practical in today's debt markets, where the number of accounts under discretionary management has increased significantly and the need for timely execution has become even more severe. The prohibition on principal transactions between advisers or their broker-dealer affiliates, and the adviser's clients, has combined with the impracticality of the exemption to cause advisory clients to forego valuable trading opportunities and to incur unnecessary trading costs.
As a result of its activity as the only or principal underwriter of an issue of debt securities, the broker-dealer affiliate of an adviser will often have available blocks of debt securities that are suitable for clients of the adviser. In addition, competitive execution is often available from the adviser's affiliate acting in a principal capacity. Due to the difficulties in obtaining prior consent to the particular transaction, the debt security in question either may not be available at all or at a price that is not as competitive as the one offered by the adviser's affiliate.
Technology has made information about the prices of debt securities considerably more available to all market participants than was the case when the Act was instituted. Enhancements in surveillance have also decreased the possibility of self-dealing abuses. We believe that the prohibition of Section 206(3) is thus ripe for reexamination.3
III. Proposed Exemptions under Section 206(3)
The Association recommends that the Commission implement the following exemptions through rule making or other relief. We suggest that two conditions be considered for incorporation in both of the exemptions proposed below. The first condition is that the adviser must obtain a blanket consent on a prospective basis from the client covering principal transactions between the client and the adviser or its affiliates. The second
condition is that procedural safeguards, such as "Chinese walls," must be in place to prevent the flow of information from the adviser to a broker-dealer affiliate.
A. Exemption When a Client Is a Sophisticated Investor
We believe that certain categories of investors are sufficiently sophisticated to determine that they are willing to provide a blanket consent on a prospective basis. Therefore, we propose an exemption covering such investors, which could be crafted by reference to the Investment Company Act's definition of "qualified purchaser."4
An exemption covering investors who are "qualified purchasers" captures a class of investors that are not in need of the protections against self-dealing afforded by the Act, due to their ability to have ready access to the same informational sources as their advisers or the adviser's affiliates. In addition, such an exemption would be consistent with relief from the protection of other sections of the federal securities laws that the Commission has extended to this class of investors.5
B. Exemption When the Transaction Involves an Investment Grade Debt Security
We propose a second exemption for transactions that involve an investment grade debt security.6
Investment grade debt securities generally have readily ascertainable prices that can be effectively accessed by the parties to the transaction. In addition, such securities are largely fungible with other debt securities that share the same debt rating, maturity and call features. The fungible nature of this type of debt security means that the universe of available information is considerably increased. We believe that advisers and their broker-dealer affiliates would therefore have little incentive to engage in self-dealing with regard to such securities by "dumping" them onto unwilling advisory clients. The Commission has acknowledged that "it is very difficult, if not impossible, to manipulate the price" of investment grade debt."7
* * *
We appreciate the opportunity to offer our ideas on crafting exemptions from the restrictions of Section 206(3) of the Act. We also look forward to the opportunity to comment on any rule making or other relief that the Commission may propose in this area. If you have any questions or desire any clarification regarding any of the matters discussed in this letter, please contact the undersigned at 212.440.9476.
Very truly yours,
/s/ Michel de Konkoly Thege
Michel de Konkoly Thege
Vice President and Associate General Counsel
|cc:|| Annette L. Nazareth, Director, Division of Market Regulation
Robert Plaze, Associate Director, Division of Investment Management
Legal and Compliance Steering Committee of the Association
|1||The Association is the bond market trade association, representing securities firms and banks that underwrite, trade and sell debt securities, both domestically and internationally. More information about the Association is available on its Internet home page at http://www.bondmarkets.com.|
|2||We believe that the effort to consider modifications to Section 206(3) of the Act is consistent with one of the guiding concepts expressed in the Association's document entitled "Bond Markets 2000, A Conceptual Framework for Efficient Regulation of the Fixed Income Markets," which is to minimize regulatory costs by eliminating or modifying regulations that yield uncertain or minimal benefits. This document is available on the Association's Internet home page.|
|3||We note that analogous issues arise with regard to managed pension plans under the party in interest and prohibited transaction rules of the Employee Retirement and Income Security Act ("ERISA"). We believe that relief under Section 206(3) of the Act should also be accompanied by similar action under ERISA. See testimony of Louis Colosimo given on behalf of the Association on March 10, 2000 before the Subcommittee on Employer-Employee Relations of the House Committee on Education and the Workforce. This testimony is available on the Association's Internet home page.|
|4||Section 2(a)(51)(A) of the Investment Company Act of 1940 defines "qualified purchaser" to mean any natural person who owns not less than $5 million in investments, any company that owns not less than $5 million in investments and is owned by two or more related natural persons or estates or trusts of such persons, any trust whose trustees and settlors are persons previously described, or any person who owns and invests not less than $25 million on a discretionary basis for its own or others' account.|
|5||See, e.g., Rule 144A under the Securities Act of 1933.|
|6||Investment grade debt security should be defined as any non-equity security, including a security issued by the government of a foreign country or its political subdivisions, or a supranational entity, if at the time of the transaction the issue, the issuer or guarantor, or any other outstanding obligation of the issuer or guarantor ranked junior to or on a parity with the issue or guarantee, is assigned a rating (implicitly or explicitly) in one of the top four rating categories by at least one nationally recognized statistical rating organization or a foreign rating organization of equivalent stature.|
|7||Release No. 34-19565 (Mar. 4, 1983) (adopted), Release No. 34-18528 (Mar. 3, 1982 (proposed), with regard to adoption of exceptions to Rule 10b-6.|