A Small Entity Compliance Guide¹

Introduction

Section 206(3) of the Investment Advisers Act of 1940 (the "Advisers Act") makes it unlawful for any investment adviser, directly or indirectly "acting as principal for his own account, knowingly to sell any security to or purchase any security from a client …, without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction." Section 206(3) requires an adviser entering into a principal transaction with a client to satisfy these disclosure and consent requirements on a transaction-by-transaction basis.

Because of the practical difficulties regarding compliance with the trade-by-trade written disclosure requirements of Section 206(3), many firms have indicated they simply refrain from engaging in principal trading with their advisory clients. Accordingly, absent an alternative means of compliance with Section 206(3), clients who wish to access firms' principal inventories may, as a practical matter, have no choice but to open a traditional brokerage account in which they will pay transaction-based compensation in lieu of an advisory account in which they would pay an asset-based fee.

The Securities and Exchange Commission (the "SEC") adopted Rule 206(3)-3T to provide advisers who are also registered as broker-dealers an alternative means to comply with the requirements of Section 206(3) of the Advisers Act that is consistent with the purposes, and the Commission's prior interpretations, of the section. Rule 206(3)-3T operates the same for all eligible investment advisers, regardless of their size.

Advisers Act Rule 206(3)-3T

Rule 206(3)-3T continues to provide the protection of transaction-by-transaction disclosure and consent, subject to several conditions. 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:

1. providing written prospective disclosure regarding the conflicts arising from principal trades;
    
2. obtaining written, revocable consent from the client prospectively authorizing the adviser to enter into principal transactions;
    
3. making certain disclosures, either orally or in writing, and obtaining the client's consent before each principal transaction;
    
4. sending to the client confirmation statements disclosing the capacity in which the adviser has acted and disclosing that the adviser informed the client that it may act in a principal capacity and that the client authorized the transaction; and
    
5. delivering to the client an annual report itemizing the principal transactions.

The rule also requires that the investment adviser be registered as a broker-dealer under Section 15 of the Securities Exchange Act of 1934 (the "Exchange Act") and that each account for which the adviser relies on this rule be a brokerage account subject to the Exchange Act, and the rules thereunder, and the rules of the self-regulatory organization(s) of which it is a member.

Rule 206(3)-3T is not available for principal trades of securities if the investment adviser seeking to rely on the rule, or a person who controls, is controlled by, or is under common control with the adviser, is the issuer or is an underwriter of the security. The rule includes one exception — an adviser may rely on the rule for trades in which the adviser or a control person is an underwriter of non-convertible investment-grade debt securities — defined, for purposes of the rule, 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 (15 U.S.C. 78c(a)(62))).

Rule 206(3)-3T includes a sunset provision. Absent further SEC action, it will expire and no longer be effective on December 31, 2016.

Other Resources

The adopting release extending Rule 206(3)-3T's sunset date until December 31, 2016 can be found on the SEC's website at http://www.sec.gov/rules/final/2014/ia-3984.pdf. The adopting releases that previously extended Rule 206(3)-3T's sunset date can be found on the SEC's website at http://www.sec.gov/rules/final/2012/ia-3522.pdf (extending Rule 206(3)-3T's sunset date until December 31, 2014), http://www.sec.gov/rules/final/2010/ia-3128.pdf (extending Rule 206(3)-3T's sunset date until December 31, 2012) and http://www.sec.gov/rules/final/2009/ia-2965.pdf (extending Rule 206(3)-3T's sunset date until December 31, 2010). The interim final (original) adopting release for Rule 206(3)-3T can be found on the SEC's website at http://www.sec.gov/rules/final/2007/ia-2653.pdf.

The text of Rule 206(3)-3T can be accessed through the "Laws and Rules" section of the Division of Investment Management page of the SEC's website at http://www.sec.gov/divisions/investment.shtml.

Contacting the SEC

The SEC's Division of Investment Management is happy to assist small investment advisers with questions regarding Rule 206(3)-3T. The Division's Investment Adviser Regulation Office answers questions submitted by e-mail and telephone. You can submit a question by e-mail to iarules@sec.gov and a staff member of the office will call you to discuss your question. In addition, you can contact the Investment Adviser Regulation Office at (202) 551-6787. Questions on other investment management matters concerning small companies may be directed to the Division's Office of Chief Counsel by e-mail at IMOCC@sec.gov, or by telephone at (202) 551-6825.

¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a "small entity compliance guide" under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.