-------------------- BEGINNING OF PAGE #1 -------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 270 and 274
Release No. IC-21260; IA-1510; S7-24-95]
RIN 3235-AG07
Status of Investment Advisory Programs under the Investment
Company Act of 1940
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule and form; request for comment.
SUMMARY: The Commission is publishing for public comment revised
proposed rule 3a-4 under the Investment Company Act of 1940,
which would provide a nonexclusive safe harbor from the
definition of investment company for certain programs under which
investment advisory services are provided to clients. Programs
that are organized and operated in a manner consistent with the
rule's conditions would not be required to register under the
Investment Company Act or to comply with the Act's substantive
requirements. The Commission also is proposing Form N-3a4 under
the Investment Company Act, which would be filed with the
Commission by sponsors of programs intending to rely on rule
3a-4. The rule and form are intended to provide guidance
regarding the status of investment advisory programs under the
Investment Company Act, and to facilitate Commission examination
of persons involved in the operation of these programs. Finally,
in connection with the preparation of an interpretive release,
the Commission is requesting comment regarding the application of
certain provisions of the Investment Advisers Act of 1940 to
investment advisers participating in investment advisory
programs.
DATES: Comments on the revised proposed rule and the proposed
form should be received on or before [60 days after publication
in the Federal Register].
ADDRESSES: Comments should be submitted in triplicate to
Jonathan G. Katz, Secretary, Securities and Exchange Commission,
450 Fifth Street, N.W., Washington, D.C. 20549. All comment
letters should refer to File No. S7-24-95. All comments received
will be available for public inspection and copying in the
Commission's Public Reference Room, 450 Fifth Street, N.W.,
Washington, D.C. 20549.
FOR FURTHER INFORMATION CONTACT: Rochelle Kauffman Plesset,
Senior Counsel, or Eric C. Freed, Special Counsel, (202) 942-
0660, Office of Chief Counsel, Division of Investment Management,
450 Fifth Street, N.W., Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION: The Securities and Exchange
Commission ("Commission") is publishing for comment revised
proposed rule 3a-4 [17 CFR
270.3a-4] under the Investment Company Act of 1940 [15 U.S.C.
80a-1 et seq.] (the "Investment Company Act"). Rule 3a-4 would
provide a nonexclusive safe harbor from the definition of
investment company for certain programs under which investment
advisory services are provided to clients ("investment advisory
programs"). The Commission also is proposing new Form N-3a4 [17
CFR 274.222] under the Investment Company Act, which would be
filed by sponsors of investment advisory programs that intend to
rely on rule
3a-4. Finally, the Commission is requesting comment with respect
to certain issues that investment advisory programs raise under
the Investment Advisers Act of 1940 (the "Advisers Act").
TABLE OF CONTENTS
EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . .
I. BACKGROUND . . . . . . . . . . . . . . . . . . . . . . .
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II. DISCUSSION . . . . . . . . . . . . . . . . . . . . . . .
A. Revised Proposed Rule 3a-4 . . . . . . . . . . . .
1. Role of the Sponsor . . . . . . . . . . . . .
2. Individualized Treatment . . . . . . . . . . .
i. Management of Client Accounts . . . . . .
ii. Client Contact -- Initial and Ongoing . .
iii. Reasonable Management Restrictions . . .
iv. Quarterly Account Statements . . . . . .
v. Minimum Account Size . . . . . . . . . .
3. Indicia of Ownership . . . . . . . . . . . . .
i. Ability to Withdraw and Pledge
Securities . . . . . . . . . . . . . . .
ii. Right to Vote Securities . . . . . . . .
iii. Right to Receive Confirmations and Other
Documents . . . . . . . . . . . . . . . .
iv. Rights as Securityholders . . . . . . . .
4. Written Procedures and Agreements . . . . . .
B. Form N-3a4 . . . . . . . . . . . . . . . . . . . .
C. Advisers Act Issues Raised by Investment Advisory
Programs . . . . . . . . . . . . . . . . . . . . .
III. COST/BENEFIT ANALYSIS . . . . . . . . . . . . . . . . .
IV. SUMMARY OF INITIAL REGULATORY FLEXIBILITY ANALYSIS . . .
V. STATUTORY AUTHORITY . . . . . . . . . . . . . . . . . .
TEXT OF REVISED PROPOSED RULE AND PROPOSED FORM . . . . . . .
EXECUTIVE SUMMARY
The Commission is publishing for public comment revised
proposed rule 3a-4 under the Investment Company Act to provide a
nonexclusive safe harbor from the definition of investment
company for certain investment advisory programs. Investment
advisory programs typically are designed to provide the same or
similar professional portfolio management services on a
discretionary basis to a large number of individual clients.
Revised proposed rule 3a-4 would exclude any investment
advisory program from the definition of investment company
provided that the program is organized and operated in compliance
with the rule's conditions.-[1]- The revised proposed rule would
require that: (i) each client's account be managed on the basis
of the client's financial situation, investment objectives, and
instructions; (ii) the sponsor of the program obtain information
from each client that is necessary to manage the client's account
individually; (iii) the sponsor and portfolio manager be
reasonably available to consult with clients; (iv) each client
have the ability to impose reasonable restrictions on the
management of the account; (v) each client be provided with a
quarterly statement containing a description of all activity in
the client's account; (vi) each client retain the indicia of
ownership of all securities and funds in the account; (vii) the
sponsor establish and effect written procedures that are
reasonably designed to ensure that each of the conditions of rule
3a-4 is met; (viii) if the sponsor designates another person to
perform certain obligations under the rule, the sponsor obtain
from that person a written agreement to perform those
---------- FOOTNOTES ----------
-[1]-If revised proposed rule 3a-4 is adopted, interests in
investment advisory programs that are organized and operated in
compliance with the conditions of the rule would not require
registration under section 5 of the Securities Act of 1933 (15
U.S.C. 77e).
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obligations; (ix) the sponsor maintain and preserve the policies,
procedures, agreements and other documents relating to the
program in the manner set forth in the rule; and (x) the sponsor
furnish to the Commission upon demand copies of specified
documents. The conditions of the revised proposed rule are based
on the conditions of a previously proposed rule, as modified and
interpreted in a series of no-action letters issued by the
Commission staff over the past thirteen years.
Programs that are organized and operated in a manner
consistent with the rule would not be required to register under
the Investment Company Act or be subject to that Act's
provisions. The rule is intended to be a nonexclusive safe
harbor; it is not intended to create any presumption about a
program that is not organized and operated in compliance with the
rule.
The Commission also is proposing Form N-3a4 under the
Investment Company Act. Revised proposed rule 3a-4 would require
Form N-3a4 to be filed by sponsors of programs intending to rely
on the rule.
Finally, the Commission is requesting comment with respect
to the application of certain provisions of the Advisers Act to
investment advisers participating in investment advisory
programs. These comments will be considered in the preparation
of an interpretive release dealing with certain issues raised
under the Advisers Act by investment advisory programs.
I. BACKGROUND
In recent years, there has been a proliferation of
investment advisory programs that typically are designed to
provide professional portfolio management services to a large
number of individual clients. These programs have historically
been marketed to clients who are investing an amount of money
less than the amount otherwise required by portfolio managers but
more than the minimum account size of most mutual funds.
Investment advisory programs typically are organized and
administered by a sponsor, which provides, or arranges for the
provision of, asset allocation advice and administrative
services.-[2]- In some programs, the sponsor or its employees
also provide portfolio management services, including the
selection of particular securities, to the program's clients. In
other programs, the sponsor selects, or provides advice to
clients regarding the selection of, a portfolio manager (which
may or may not be affiliated with the sponsor).-[3]- In these
programs, the sponsor generally is responsible for continuously
monitoring the portfolio manager selected and its management of
client accounts. The sponsor, rather than the portfolio manager,
often serves as the primary contact for the client in connection
---------- FOOTNOTES ----------
-[2]-The sponsor is often a broker-dealer or mutual fund adviser
or, in some instances, a bank or money management firm. See,
e.g., Wall Street Preferred Money Managers, Inc. (pub. avail.
Apr. 10, 1992) (broker-dealer); Strategic Advisers Inc. (pub.
avail. Dec. 13, 1988) (mutual fund adviser); Atlantic Bank of New
York (pub. avail. June 7, 1991) (bank). The sponsor also may
execute some or all of the transactions in client accounts.
-[3]-More than one portfolio manager may manage the client's
assets, depending on the program, the client's investment
objectives, and the size of the client's account. See, e.g.,
Westfield Consultants Group (pub. avail. Dec. 13, 1991); Rauscher
Pierce Refsnes, Inc. (pub. avail. Apr. 10, 1992); Wall Street
Preferred Money Managers, Inc., supra note 2.
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with the program.-[4]- The sponsor and the portfolio managers
usually meet the definition of "investment adviser" under the
Advisers Act-[5]- and are required to register under that
Act,-[6]- unless they are excepted from the definition of
investment adviser-[7]- or exempted from registration.-[8]-
Included among these investment advisory programs are those
commonly referred to as "wrap fee programs." In a wrap fee
program, the client is typically provided with portfolio
management, execution of transactions, asset allocation, and
administrative services for a single fee based on assets under
---------- FOOTNOTES ----------
-[4]-Some investment advisory programs, however, are marketed by
the sponsor through unaffiliated investment advisers, such as
small financial planners. In some of these programs, the
unaffiliated investment adviser rather than the sponsor may serve
as the primary contact for its clients that participate in the
program. See, e.g., Westfield Consultants Group, supra note 3.
-[5]-15 U.S.C. 80b-1 et seq.
-[6]-Section 203(a) of the Advisers Act (15 U.S.C. 80b-3(a))
requires any person who meets the definition of investment
adviser and is not otherwise exempt from registration to register
with the Commission. Section 202(a)(11) of the Advisers Act (15
U.S.C. 80b-2(a)(11)) defines "investment adviser" as "any person
who, for compensation, engages in the business of advising
others, either directly or through publications or writings, as
to the value of securities or as to the advisability of investing
in, purchasing, or selling securities, or who, for compensation
and as part of a regular business, issues or promulgates analyses
or reports concerning securities . . . ."
-[7]-See section 202(a)(11)(A)-(F) of the Advisers Act (15 U.S.C.
80b-2(a)(11)(A)-(F)) (persons excepted from the definition of
investment adviser). A sponsor of an investment advisory program
that is a broker-dealer or a registered representative of a
broker-dealer generally cannot rely on the exception from the
definition of investment adviser for broker-dealers in section
202(a)(11)(C) of the Advisers Act. See, e.g., National
Regulatory Services, Inc. (pub. avail. Dec. 2, 1992). That
exception is available only to a broker-dealer that provides
investment advice that is "solely incidental" to its brokerage
business and that does not receive special compensation for the
investment advice. Id. The staff is of the view that an
investment advisory program generally is not incidental to a
sponsor's broker-dealer business and, at least in a wrap fee
program, the sponsor's portion of the wrap fee is special
compensation. Id.
-[8]-See section 203(b) of the Advisers Act (15 U.S.C. 80b-3(b))
(persons exempted from registration). Unlike a person excepted
from the definition of investment adviser, a person that meets
the definition but is exempted from registration remains subject
to the Advisers Act's antifraud provision, section 206 (15 U.S.C.
80b-6). The exemption from registration provided in section
203(b)(3) of the Advisers Act would not be available as a general
matter to the sponsor or portfolio manager of an investment
advisory program because participation in the program would cause
the sponsor or portfolio manager to be holding itself out to the
public as an investment adviser. See, e.g., Resource Bank &
Trust (pub. avail. Mar. 29, 1991).
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management.-[9]- As of year-end 1994, assets in wrap fee
programs totaled approximately $116.8 billion, an increase of 42
percent over a two-year period.-[10]-
Under wrap fee and other investment advisory programs, a
client's account typically is managed on a discretionary basis in
accordance with pre-selected investment objectives. Clients with
similar investment objectives often receive the same investment
advice and may hold the same or substantially the same securities
in their accounts. In light of this similarity of management,
some of these investment advisory programs meet the definition of
investment company under the Investment Company Act, and can be
deemed to be issuing securities for purposes of the Securities
Act of 1933 ("Securities Act").-[11]-
Section 3(a)(1) of the Investment Company Act defines the
term investment company generally to include any "issuer" which
is engaged primarily in the business of investing, reinvesting,
or trading in securities.-[12]- The definition of issuer
includes any organized group of persons, whether or not
incorporated, that issues or proposes to issue any
security.-[13]- An investment advisory program could be
considered to be an issuer because the client accounts in the
program, taken together, could be considered to be an organized
group of persons.-[14]- Investors in the program could be viewed
---------- FOOTNOTES ----------
-[9]-See paragraph (g)(4) of rule 204-3 under the Advisers Act
(17 CFR 275.204-3(g)(4)) (defining wrap fee program for purposes
of wrap fee brochure requirement).
-[10]-THE CERULLI REPORT, THE STATE OF THE WRAP ACCOUNT INDUSTRY
3 (1995). According to this report, assets in mutual fund wrap
programs, also called mutual fund asset allocation programs,
represented 11% of total assets in wrap fee programs as of year-
end 1994. These programs differ from traditional wrap fee
programs, in part, in that a client's assets are allocated only
among specified mutual funds.
-[11]-15 U.S.C. 77a et seq. See In the Matter of Clarke Lanzen
Skalla Investment Firm, Inc., Investment Company Act Release No.
21140 (June 16, 1995); SEC v. First National City Bank,
Litigation Release No. 4534 [1969-1970 Transfer Binder] Fed. Sec.
L. Rep. (CCH) 92592 (Feb. 6, 1970).
-[12]-15 U.S.C. 80a-3(a)(1).
-[13]-Section 2(a)(22) of the Investment Company Act defines
issuer generally to include any person who issues any security
(15 U.S.C. 80a-2(a)(22)). Under section 2(a)(28), a person
includes a company, and under section 2(a)(8), a company includes
any organized group of persons, whether incorporated or not (15
U.S.C. 80a-2(a)(28), 2(a)(8)).
-[14]-The accounts managed by a particular portfolio manager also
can be considered an organized group of persons under certain
circumstances. The legislative history of the Investment Company
Act explained that one type of investment company involves "an
agency relationship between the individual contributors to the
fund and the management upon whom they confer substantially a
power of attorney to act as agent in the investment of the moneys
contributed. The group of individual investors is not a legal
entity but rather constitutes in essence a combination of
distinct individual interests." H.R. Doc. No. 707, 75th Cong.,
3rd Sess. 24 (1939). In Prudential Insurance Co. of America v.
(continued...)
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as purchasing securities in the form of investment
contracts.-[15]- If an investment advisory program is deemed to
be an "issuer," it also would be deemed to be an investment
company because it is engaged in the business of investing,
reinvesting, or trading in securities.
The status of investment advisory programs under the
Investment Company Act and the Securities Act has been a subject
of debate for twenty-five years. In 1972, the Commission
established the Advisory Committee on Investment Management
Services for Individual Investors ("Advisory Committee") to
assist the Commission in developing policies regarding these
programs.-[16]- The Advisory Committee published a report
generally concluding that an investment advisory program should
not be required to register under the Investment Company Act as
long as the program's clients maintain all indicia of ownership
of the securities in their accounts, thereby avoiding the
"pooling" of client assets.-[17]-
---------- FOOTNOTES ----------
-[14]-(...continued)
SEC, the court, citing this legislative history, found that an
organized group of persons does not refer only to identifiable
business entities. 326 F.2d 383 (3rd Cir.), cert. denied, 377
U.S. 953 (1964).
-[15]-The definition of security in both section 2(a)(36) of the
Investment Company Act (15 U.S.C. 80a-2(a)(36)) and section 2(1)
of the Securities Act (15 U.S.C. 77b(1)) includes an "investment
contract." The Supreme Court, in SEC v. W.J. Howey Co., defined
an investment contract for purposes of the Securities Act as a
scheme that "involves an investment of money in a common
enterprise with profits to come solely from the efforts of
others." 328 U.S. 293, 301 (1946). The Commission has taken the
view that an investment advisory program could satisfy the common
enterprise element of the Howey test if the accounts are
discretionary, the investors receive the same or substantially
overlapping investment advice, and the investment advice is not
"individualized." See Individualized Investment Management
Services, Investment Company Act Release No. 11391 (Oct. 10,
1980), 45 FR 69479 (Oct. 21, 1980) ("Release 11391"). See also
In the Matter of Clarke Lanzen Skalla Investment Firm Inc., supra
note 11; SEC v. First National City Bank, supra note 11.
-[16]-The Advisory Committee was established after the Commission
instituted an enforcement action against an investment adviser
and broker-dealer for operating an unregistered investment
company in the form of an investment advisory program. While the
program was advertised as offering individualized advice, the
adviser invested client funds in a virtually identical manner and
made investment decisions in a generally uniform manner to all
clients. SEC v. First National City Bank, supra note 11. The
Division subsequently denied no-action relief to similar
investment advisory programs. See, e.g., Wheat & Co., Inc. (pub.
avail. July 9, 1971); Finanswer America/Investments, Inc. (pub.
avail. Apr. 26, 1971); Jacobs Persinger & Parker (pub. avail.
Mar. 8, 1971).
-[17]-ADVISORY COMMITTEE ON INVESTMENT MANAGEMENT SERVICES
FOR
INDIVIDUAL INVESTORS, SMALL ACCOUNT INVESTMENT MANAGEMENT
SERVICES (Jan. 1973). The Advisory Committee also concluded that
the interests in the program (i.e., the client accounts) should
not be required to be registered as securities under the
Securities Act if the program provides each client with
individualized treatment.
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In 1980, the Commission proposed rule 3a-4 under the
Investment Company Act, which would have provided a safe harbor
from the definition of investment company for investment advisory
programs meeting the conditions of the rule.-[18]- The proposed
rule would have required that: (i) the client receive continuous
advice based on its individual needs; (ii) the persons authorized
to make investment decisions have significant contact with the
client, as described in the rule; (iii) each client maintain all
indicia of ownership of the securities in its account; and (iv)
each client have the opportunity and authority to instruct the
person managing its account to refrain from purchasing particular
securities that otherwise might be purchased. The Commission
expressed the view that when an investment manager provides each
client with individualized treatment, the likelihood of a common
enterprise existing among a group of advisory clients is
substantially reduced and no investment company is created.-[19]-
Commenters generally opposed the proposed rule, arguing,
among other things, that the rule's conditions were burdensome,
would cause unnecessary changes in industry practice, and were
too detailed for purposes of a safe harbor rule.-[20]- In
contrast, one commenter argued that the proposed rule would have
permitted programs that are de facto investment companies to be
excluded from regulation under the Investment Company Act merely
by meeting "mechanistic and ritualistic conditions," the
performance of which is not indicative of individualized
investment advice being provided.-[21]- The proposed rule was
never adopted.
Since the proposal of rule 3a-4, the Division of Investment
Management ("Division") has responded to numerous inquiries with
respect to the status of wrap fee and other types of investment
advisory programs under the Investment Company Act. The Division
has issued over 20 letters to persons requesting assurance that
the Division would not recommend that the Commission bring
---------- FOOTNOTES ----------
-[18]-See Release 11391, supra note 15. Release 11391 also
stated that the Commission's Division of Corporation Finance had
indicated that if rule 3a-4 was adopted, that Division would not
recommend that the Commission take enforcement action under the
Securities Act with respect to the interests in an investment
advisory program operated in accordance with the proposed rule's
requirements. Id. at n.15.
-[19]-Id. at note 15 and accompanying text. Although the
statements in the Release 11391 focused on the necessity for each
client to be provided with individualized treatment, the proposed
rule also would have included conditions designed to avoid the
"pooling" of client assets.
-[20]-E.g., Letter from the American Bar Association to George A.
Fitzsimmons, Secretary, SEC 1-2, 4 (Jan. 9, 1981), File No. S7-
854; Letter from the Investment Counsel Association of America,
Inc. to George A. Fitzsimmons, Secretary, SEC 3-4 (Jan. 9, 1981),
File No. S7-854; Letter from Neuberger and Berman to George A.
Fitzsimmons, Secretary, SEC 2 (Jan. 12, 1981), File No. S7-854.
-[21]-Letter from the Investment Company Institute to George A.
Fitzsimmons, Secretary, SEC 2, 4 (Jan. 9, 1981), File No. S7-
854. This commenter also pointed out that the proposed rule
would have permitted commercial banks, which are excepted from
regulation under the Advisers Act, to sponsor investment advisory
programs without being subject to the Advisers Act's prohibitions
against conflicts of interest, the Act's brochure requirements,
and inspection by Commission staff. Id. at 2.
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enforcement action with respect to investment advisory programs
that are not registered under the Investment Company Act (the
"no-action letters").-[22]- Each of these letters was
conditioned on representations that were based primarily on the
terms of proposed rule 3a-4.-[23]-
II. DISCUSSION
The investment advisory program industry has developed and
matured since the original proposal of rule 3a-4 in 1980. During
this time period, the Commission has acquired substantial
experience with the organization and operation of investment
advisory programs. This experience has come from the review of
numerous requests for no-action relief, as well as from
examinations of sponsors and other registered investment advisers
that are involved with operating these programs. For many of
these programs, registration and regulation under the Investment
Company Act would not appear to be necessary.-[24]-
Nevertheless, that the law in this area has been defined and
redefined principally through a series of no-action letters has
created some uncertainty regarding the status of these programs
under the federal securities laws. While counsel can (and
frequently does) offer advice and issue opinions based on the no-
action letters, those letters do not provide the same degree of
certainty that would be provided by a Commission rule and may not
be as readily accessible. The Commission is therefore publishing
for comment revised proposed rule 3a-4 to provide a regulatory
safe harbor from investment company regulation for programs that
satisfy certain conditions. The Commission also is proposing new
Form N-3a4, which would be filed with the Commission by sponsors
of investment advisory programs intending to rely on rule 3a-
4.-[25]-
A. Revised Proposed Rule 3a-4
Revised proposed rule 3a-4 would provide a nonexclusive safe
harbor from the definition of investment company for investment
advisory programs that are organized and operated in a manner
consistent with the rule's conditions.-[26]- The revised
proposed rule would include a number of conditions intended to
---------- FOOTNOTES ----------
-[22]-In each case, the Division of Corporation Finance also has
granted no-action relief with respect to registration of
interests in the programs under the Securities Act.
-[23]-See, e.g., Wall Street Preferred Money Managers, Inc.,
supra note 2; Rauscher Pierce Refsnes, Inc., supra note 3.
-[24]-The Commission, however, recently brought an enforcement
action against a sponsor of an investment advisory program that
was operating as an unregistered investment company. In the
Matter of Clarke Lanzen Skalla Investment Firm, Inc., supra note
11.
-[25]-The Commission previously has adopted amendments to rule
204-3 (17 CFR 275.204-3) and Form ADV under the Advisers Act to
require sponsors of wrap fee programs to provide prospective
clients of these programs with specified information. Disclosure
by Investment Advisers Act Regarding Wrap Fee Programs,
Investment Advisers Release No. 1411 (Apr. 19, 1994), 59 FR 21657
(Apr. 26, 1994).
-[26]-If revised proposed rule 3a-4 is adopted, interests in
investment advisory programs that are organized and operated in
compliance with the conditions of the rule would not require
registration under the Securities Act. See Preliminary Note to
revised proposed rule 3a-4.
-------------------- BEGINNING OF PAGE #9 -------------------
ensure that clients in programs that rely on the rule receive
individualized treatment. While the Commission believes that an
investment advisory program that meets the rule's conditions need
not be regulated as an investment company, the Commission
acknowledges that there may be investment advisory programs that
do not comply with all of the rule's conditions and yet also
should not be regulated as investment companies. Thus, revised
proposed rule 3a-4 is intended to be a nonexclusive safe harbor,
and is not intended to create any presumption about a program
that is not organized and operated in compliance with the rule's
requirements.-[27]-
1. Role of the Sponsor
Generally, the rule would require the "sponsor" of the
program or another person designated by the sponsor to perform
the duties and responsibilities set forth in the rule. Under
paragraph (b), "sponsor" would be defined as any person who
receives compensation for sponsoring, organizing, or
administering the program, or for selecting, or providing advice
to clients regarding the selection of, persons responsible for
managing the client's account in the program. This definition is
the same as the definition of sponsor used in paragraph (f) of
rule 204-3 under the Advisers Act, which sets forth a separate
brochure requirement for sponsors of wrap fee programs.-[28]-
The definition of sponsor is broad, and, in some investment
advisory programs, more than one person performing services for
the program may meet the definition. Accordingly, paragraph (b)
would provide that if a program has more than one sponsor, the
sponsors must designate one person as the principal sponsor, and
that person would be responsible for carrying out the sponsor's
duties and responsibilities under the rule.-[29]-
---------- FOOTNOTES ----------
-[27]-Id. In addition, adoption of revised proposed rule 3a-4
would not affect the status of no-action letters previously
issued by the Division with respect to investment advisory
programs. Therefore, investment advisory programs that operate
in a manner consistent with these letters would not be required
to register under the Investment Company Act. If rule 3a-4 is
adopted, the Division as a general matter will not consider
requests for no-action or exemptive relief with respect to
programs that do not comply with the rule.
-[28]-The sponsor of an investment advisory program usually is
required to register under the Advisers Act and comply with the
substantive provisions of that Act and the rules thereunder. See
supra notes 5-8 and accompanying text. Revised proposed rule 3a-
4 would be available to any sponsor of investment advisory
programs, even if the sponsor is excepted from the definition of
investment adviser under the Act (e.g., banks) or is exempt from
registration. Persons wishing to rely on the revised proposed
rule, however, would be required, among other things, regardless
of their status under the Advisers Act, to furnish certain
specified records to the Commission upon demand. See infra
section II.A.4. (Written Procedures and Agreements).
-[29]-Paragraph (b) would not specify which sponsor must be
designated as the principal sponsor. However, the principal
sponsor would be responsible for carrying out the duties of the
sponsor under the rule, which would include establishing and
effecting written procedures and entering into agreements with
other persons. See infra section II.A.4. (Written Procedures and
Agreements). Typically the principal sponsor would be the person
or entity that is responsible for the overall organization and
(continued...)
-------------------- BEGINNING OF PAGE #10 -------------------
2. Individualized Treatment
Revised proposed rule 3a-4 would contain four provisions
that are intended to ensure that clients of investment advisory
programs that are organized and operated in reliance on the rule
receive individualized treatment. These provisions are based on
provisions of rule 3a-4 as originally proposed, as those
conditions were applied in the no-action letters.
i. Management of Client Accounts
Paragraph (a)(1) would require that each client's account be
managed on the basis of the client's financial situation,
investment objectives, and instructions.-[30]- This paragraph is
derived from a provision in the originally proposed rule that
would have required each client to be furnished with continuous
advice as to the investment of funds on the basis of the client's
individual needs.-[31]-
Paragraph (a)(1) is intended to delineate one of the key
differences between clients of investment advisers and investors
in investment companies. Each client of an investment adviser
typically is provided with individualized advice regarding the
management of the client's account that is based on the client's
financial situation and investment objectives. The investment
adviser of an investment company, on the other hand, need not
consider the individual needs of the company's shareholders when
making investment decisions regarding the company's portfolio,
and has no obligation to ensure that each security purchased for
the company's portfolio is an appropriate investment for each
shareholder. Thus, the clients of an investment advisory program
complying with paragraph (a)(1) would receive individualized
advice of a type not typically provided to investment company
shareholders.
Unlike the originally proposed rule, paragraph (a)(1) of the
revised proposed rule would not require a portfolio manager to
make separate determinations regarding the appropriateness of
each transaction for each client prior to effecting the
transaction.-[32]- The revised proposed rule also would modify
the Commission's prior view that the use of model portfolios is
"presumptively inconsistent with individualized treatment."-[33]-
The Commission believes that an investment advisory program in
which clients with similar investment objectives hold
---------- FOOTNOTES ----------
-[29]-(...continued)
operation of the program. The person designated as the principal
sponsor would be the person whose name appears on the program's
Form N-3a4. See infra section II.B. (Form N-3a4).
-[30]-Under paragraph (a)(1), a sponsor or portfolio manager
would have to comply with any instructions given by a client
concerning the management of the client's account in an
investment advisory program, unless the instructions are so
extensive or burdensome to the management of the account as to be
unreasonable, or the sponsor or portfolio manager believes that
the instructions are inappropriate for the client. See infra
section II.A.2.iii. (Reasonable Management Restrictions). In
these cases, the sponsor or portfolio manager must notify the
client that, unless the instructions are modified, the client
will not be permitted to participate in the program.
-[31]-See proposed paragraph (a)(1).
-[32]-See Release 11391, supra note 15, at text accompanying
n.18.
-[33]-See id., at text following n.18.
-------------------- BEGINNING OF PAGE #11 -------------------
substantially the same securities in their accounts in accordance
with the portfolio manager's model does not necessarily indicate
that the clients in the program have not received individualized
treatment, particularly if the program is operated in a manner
consistent with revised proposed rule 3a-4.-[34]-
ii. Client Contact -- Initial and Ongoing
Paragraph (a)(2) would contain four requirements that
generally are intended to ensure that the sponsor has sufficient
contact with each client to be able to obtain the information
necessary to manage the client's account in accordance with
paragraph (a)(1). Paragraph (a)(2)(i) would require that, at the
opening of the account, the sponsor or a person designated by the
sponsor-[35]- obtain information from the client concerning the
client's financial situation and investment objectives. The
client must at that time also be asked to provide specific
instructions, if any, concerning the management of the account.
The provision permits the sponsor (or its designee) to obtain
this information through interviews (either in person or by
telephone) and/or through questionnaires that clients must
complete and return prior to the opening of the account.-[36]-
Paragraph (a)(2)(ii) would require that, at least annually,
the sponsor or a person designated by the sponsor contact the
client to determine whether there have been any changes in the
client's financial situation, investment objectives, or
instructions. This contact need not be made in any particular
way and could be made, for example, in person, by telephone, or
by letter requesting the client to provide the information.-[37]-
The provision would require sponsors to request current
information about clients of the program that is necessary for
the individualized management of a client's account.
Paragraph (a)(2)(iii) would require that, at least
---------- FOOTNOTES ----------
-[34]-The Division has issued no-action letters with respect to
programs that allocate client assets in accordance with
computerized investment allocation models. See, e.g., Qualivest
Capital Management Inc. (pub. avail. July 30, 1990) (sponsor will
use computerized investment allocation model to allocate and
reallocate client assets among money managers); Atlantic Bank of
New York, supra note 2 (sponsor's asset allocation recommendation
will be based on client's investment needs and sponsor's model
portfolios).
-[35]-See infra note 63.
-[36]-See, e.g., Rauscher Pierce Refsnes, Inc., supra note 3
(prospective client will be interviewed and client will complete
questionnaire during interview); Strategic Advisers, Inc., supra
note 2 (prospective client will be interviewed over the
telephone); Manning & Napier Advisors, Inc. (Apr. 24, 1990)
(prospective client initially will submit written questionnaire
followed by interview over telephone).
-[37]-The Commission recognizes that in some circumstances the
sponsor or designated person may be unable to reach the client.
The Commission would not take any enforcement action under this
provision if the sponsor or designated person is unsuccessful in
obtaining this information from the client, provided the sponsor
or designated person makes reasonable efforts to contact the
client and documents these efforts. Sponsors may wish to include
the procedures for contacting clients and documenting these
efforts in the procedures enacted pursuant to paragraph (a)(6)(i)
of the rule. See infra section II.A.4. (Written Procedures and
Agreements).
-------------------- BEGINNING OF PAGE #12 -------------------
quarterly, the sponsor or a person designated by the sponsor
notify the client in writing that the sponsor or designated
person should be contacted if there have been any changes in the
client's financial situation, investment objectives or
instructions.-[38]- The paragraph also requires the sponsor or
designated person to provide the client with a means in which
such contact is to be made (e.g., by giving a telephone number or
an address). Like paragraph (a)(2)(ii), this provision is
intended to provide a procedure by which sponsors can obtain
current information about clients of the program. However,
unlike paragraph (a)(2)(ii), paragraph (a)(2)(iii) would require
the sponsor or designated person only to remind the client to
contact the sponsor or designated person if any changes have
occurred in the client's financial situation, investment
objectives, or instructions. The client would be responsible for
contacting the sponsor or designated person if changes had
occurred.-[39]-
Paragraphs (a)(2)(i)-(iii) would place the obligations to
contact or notify the client on the sponsor or a person
designated by the sponsor. In contrast, the originally proposed
rule would have required the portfolio manager to contact the
client.-[40]- The revised proposed rule recognizes that, in many
investment advisory programs, the sponsor is the person primarily
responsible for client contact.-[41]- The revised proposed rule,
however, would permit a person other than the sponsor to fulfill
these obligations, so long as the sponsor specifically designated
the person to do so.-[42]-
---------- FOOTNOTES ----------
-[38]-The notice need not be included as a separate piece of
paper, but could be included on another mailing sent to the
client. For example, the notification could appear in the
quarterly statement that would be sent to clients in accordance
with proposed paragraph (a)(4). See infra section II.A.2.iv.
(Quarterly Account Statements). The notice also could be
delivered to the client by e-mail or other electronic means
consented to by the client.
-[39]-See, e.g., Scudder, Stevens & Clark Ltd. (pub. avail Aug.
17, 1988) (quarterly statement will include a reminder that
client should contract sponsor if client needs or objectives
change); Qualivest Capital Management, Inc. supra note 34 (client
will be sent reminders to notify sponsor of any change in
client's financial situation or investment objectives).
-[40]-Paragraph (b) of proposed rule 3a-4.
-[41]-See, e.g., Strategic Advisers, Inc., supra note 2 (sponsor
primarily responsible); Wall Street Preferred Money Mangers,
Inc., supra note 2 (same).
-[42]-The revised proposed rule would permit persons such as
portfolio managers or advisers that refer clients to the program
to be primarily responsible for client contact. Paragraph
(a)(6)(i) would require the sponsor to obtain from each
designated person an agreement in writing to perform these
duties. In addition, paragraph (a)(6)(i) would require the
sponsor to establish written procedures that are reasonably
designed to ensure that each of the conditions of the rule is
met. The procedures might, for example, describe in detail the
manner in which paragraphs (a)(2)(i)-(iii) are to be effectuated,
specify the persons primarily responsible for client contact, and
include provisions designed to monitor and record the actions
(continued...)
-------------------- BEGINNING OF PAGE #13 -------------------
Regardless of the person responsible for contacting the
client and obtaining the information necessary to manage the
client's account, the Commission expects that, in most cases, the
information obtained would be provided to the client's portfolio
manager. If such information is not provided to the portfolio
manager, the manager may not be able to manage the client's
account on the basis of the client's financial situation,
investment objectives, and instructions, as would be required
under paragraph (a)(1). The Commission, however, requests
comment whether the sponsor or designated person should be
explicitly required by rule 3a-4 to convey this information to
the portfolio manager.
Paragraph (a)(2)(iv) would require the sponsor and the
client's portfolio manager to be reasonably available to consult
with the client concerning the management of the client's
account. This provision is intended to provide for reasonable
client access to the sponsor and the portfolio manager to ask
questions or to seek additional information about an investment
advisory program. Even if a program's sponsor serves as the
primary contact for clients in the program, a procedure must be
provided by which the client has reasonable access to the
portfolio manager.-[43]- Individualized treatment would not be
provided if a program's procedures do not provide an opportunity
for reasonable availability of the portfolio manager.-[44]-
iii. Reasonable Management Restrictions
Paragraph (a)(3) would require each client to have the
ability to impose reasonable restrictions on the management of
its account. These restrictions could include, for example, the
---------- FOOTNOTES ----------
-[42]-(...continued)
taken by such persons. See infra section II.A.4. (Written
Procedures and Agreements).
-[43]-See, e.g., Rauscher Pierce Refsnes, Inc., supra note 3 (the
portfolio manager, when necessary, will be available to discuss
more complex questions regarding the client's account); Westfield
Consultants Group, supra note 3 (client will be furnished the
name and direct telephone number of manager, who will be
reasonably available during business hours). In one no-action
request, a representation was made that the client would be able
to contact an unaffiliated adviser, the sponsor or the portfolio
manager to obtain information or assistance during normal
business hours, but the client might be charged hourly fees
whenever the client requests the services of investment officers
to answer specific questions regarding investment strategies with
respect to its account. Manning & Napier Advisors, Inc., supra
note 36. Sponsors of programs complying with revised proposed
rule 3a-4 may impose similar procedures, provided the client is
informed prior to entering the program that such fees may be
charged.
-[44]-Whether a sponsor or portfolio manager is "reasonably
available" would depend on an analysis of the facts and
circumstances. The procedures required under paragraph (a)(6)(i)
may include provisions detailing the manner in which the sponsor
and the portfolio manager intend to meet this requirement. Such
procedures could, for example, describe the manner in which the
sponsor and portfolio manager will be reasonably available to
clients while still allowing for time to perform their duties.
However, a sponsor or portfolio manager would not be "reasonably
available," for example, if a client's contact with the sponsor
or portfolio manager were limited to viewing or listening to
recorded interviews.
-------------------- BEGINNING OF PAGE #14 -------------------
designation of particular securities or types of securities that
should not be purchased for the client's account.
The originally proposed rule would have required that each
client have the ability to instruct its portfolio manager to
refrain from purchasing particular securities that otherwise
might be purchased.-[45]- Under the revised proposal, the client
must be able to impose reasonable restrictions on the management
of its account. The revised proposal specifically states that
restrictions may include prohibitions with respect to the
purchase or sale of particular securities or types of securities.
Whether a particular restriction is reasonable would depend
on an analysis of relevant facts and circumstances, including the
nature of the restriction and the portfolio manager's investment
strategy.-[46]- For example, the exclusion of individual stocks,
stocks of an industry group, or stocks from a specific country
generally would be considered to be reasonable restrictions. A
restriction would not be unreasonable simply because it placed
administrative burdens on the manager or could affect the
performance of the accounts. Nonetheless, a restriction would be
unreasonable if it was clearly contradictory to the adviser's
investment philosophy or strategies. For example, it may be
unreasonable for a client to instruct a portfolio manager whose
investment strategy is to achieve long-term capital appreciation
through investments in equity securities to purchase only short-
term debt securities. Restrictions also may be deemed
unreasonable if the client changes the restrictions on the
account with such frequency that it interferes with the orderly
management of the account. This may be true even if each
individual restriction, taken alone, would be reasonable.-[47]-
The ability of clients of a program to place restrictions is
a critical factor in determining whether individualized treatment
is provided under that program. This ability is a crucial
difference between a client receiving investment advisory
services and an investor in an investment company.-[48]-
iv. Quarterly Account Statements
Paragraph (a)(4) would require that each client be provided,
---------- FOOTNOTES ----------
-[45]-Proposed paragraph (d). The no-action letters involving
investment advisory programs typically have included
representations that were based on the proposed provision. See,
e.g., Rauscher Pierce Refsnes, Inc, supra note 3; Westfield
Consultants Group, supra note 3.
-[46]-The procedures required by paragraph (a)(6)(i) may define
what restrictions are considered unreasonable. To the extent
that the "unreasonableness" of restrictions is a matter of
judgment, the procedures, for example, may identify the person or
persons responsible for this determination and specify the
factors to be considered by those persons. See infra section
II.A.4. (Written Procedures and Agreements).
-[47]-If particular restrictions sought to be imposed by a client
are found to be unreasonable, the client should be notified and
given a chance to restate the restriction more reasonably. If
unable or unwilling to do so, the client may be removed from the
program.
-[48]-Under paragraph (a)(2), a sponsor or person designated by
the sponsor would be required to ask the client for instructions
regarding the management of its account. The request for
instructions is intended, in part, to give the client the
opportunity to convey any investment restrictions it wishes to
impose on the management of its account.
-------------------- BEGINNING OF PAGE #15 -------------------
on a quarterly basis, with a statement describing all activity in
the client's account during the preceding quarter, including all
transactions made on behalf of the account, all contributions and
withdrawals made by the client, and all fees and expenses charged
to the account. The statement also would be required to include
the value of the account at both the beginning and end of the
quarter. The originally proposed rule also would have required
quarterly statements, but did not specify the information to be
included in such statements.-[49]-
v. Minimum Account Size
Like the proposed rule, the revised proposed rule would not
specify a minimum size for client accounts in the program,
leaving the account size for each program up to the sponsor of
the program.-[50]- The conditions of the revised proposed rule
should be sufficient to ensure individualized treatment. In
addition, innovations in computer technology may permit
individualized treatment to be provided to clients, including
those with relatively small accounts, with greater efficiency and
minimal costs. A requirement for a minimum account size also
could effectively deny certain investors the opportunity to
participate in investment advisory programs that may be
appropriate for them. Nonetheless, providing individualized
advice to a large number of small accounts may be so costly and
time-consuming as to render individualized treatment
impracticable.
The Commission requests comment whether a minimum account
size should be required. Commenters favoring this requirement
should specify the minimum size that they believe that would be
most appropriate (e.g., $50,000, $100,000, $200,000), and address
whether the minimum amount should be required to be met only at
the time the account is opened, or whether the minimum or some
lesser amount should be required to be maintained while the
client remains in the program. Commenters favoring a requirement
that a client maintain a minimum account size while in the
program also should comment whether the client should be removed
from the program if the account size fell below the initial
minimum due to investment loss rather than withdrawal. In
addition, commenters favoring a minimum size requirement should
address whether the minimum should apply to the client's
aggregate investment in the program, or to each account managed
by a portfolio manager. Commenters should also address whether
any or all of the conditions of the revised proposed rule would
be rendered unnecessary by a minimum account size requirement.
Finally, commenters should address whether programs with small
account minimums should be subject to additional conditions not
imposed on programs with larger minimums, and if so, what those
---------- FOOTNOTES ----------
-[49]-Proposed paragraph (b)(3). A number of the no-action
letters have specified the content of the quarterly reports. See
Westfield Consultants Group, supra note 3 (quarterly statements
will contain a review and analysis of client account); Strategic
Advisers, Inc., supra note 2 (quarterly statements will contain a
description of investments); Republic National Bank of New York
(pub. avail. Aug. 23, 1982) (quarterly statements will show
holdings, value and change in value since preceding quarter).
-[50]-The Division has granted no-action relief to investment
advisory programs with varying minimum account sizes. See, e.g.,
Qualivest Capital Management, Inc., supra note 34 ($5 million);
Atlantic Bank of New York, supra note 2 ($500,000); Wall Street
Preferred Money Managers, Inc., supra note 2 ($100,000);
Strategic Advisers, Inc., supra note 2 ($50,000).
-------------------- BEGINNING OF PAGE #16 -------------------
conditions should be.
3. Indicia of Ownership
Paragraph (a)(5) would require that a client in an
investment advisory program retain certain indicia of ownership
of all securities and funds in the client's account. The
paragraph lists specific attributes of ownership that the client
must retain.
The proposed rule would have required clients to maintain
all indicia of ownership of the funds in their accounts, and
specified certain requisite attributes of ownership.-[51]- The
revised proposed rule would not require the client to maintain
all indicia of ownership, but would require the client to
maintain, at a minimum, those indicia listed. The Commission
believes that these specific indicia of ownership, which are
based on those represented as being retained by clients of
programs described in the no-action letters, provide clients with
the ability to act as owners of their securities.-[52]-
i. Ability to Withdraw and Pledge Securities
Paragraph (a)(5)(i) would require that the clients be able
to withdraw securities or cash from their accounts. Paragraph
(a)(5)(ii) also would specify that clients must be able to pledge
the securities in their accounts.-[53]- Under some
circumstances, programs may require a client to withdraw the
securities from his or her account before using them as
collateral. Such a requirement would be consistent with the
rule.
ii. Right to Vote Securities
Paragraph (a)(5)(iii) would require that the client have the
right to vote the securities in his or her account. Implicit in
this requirement is the requirement that the client receive
proxies in sufficient time to permit the client to consider how
to vote and to submit the proxy. The provision would permit
clients to delegate the authority to vote securities to another
---------- FOOTNOTES ----------
-[51]-Proposed paragraph (c).
-[52]-The revised proposed rule would not require the client to
be the record owner of the securities held in its account. The
Division has taken the position that an investment advisory
program would not be deemed to be an investment company solely
because securities are held in nominee or street name. The
Division reasoned that placing securities in nominee or street
name is an administrative mechanism used to record and facilitate
the transfer of ownership. In addition, requiring securities to
be held in the client's name would be inconsistent with
Commission policy of encouraging the holding of securities in
nominee name to promote the establishment of centralized
clearance and settlement systems and the elimination of
certificated securities. UMB Bank, n.a. (pub. avail. Jan. 23,
1995) (investment company securities). See, e.g., Manning &
Napier Advisors, Inc., supra note 36 (non-investment company
securities). The recent enforcement action against Clarke Lanzen
Skalla Investment Firm, Inc., in which, among other things,
securities purchased on behalf of clients were held in nominee
name, was not inconsistent with the Division's position in the
UMB Bank no-action letter. See supra note 11.
-[53]-The proposed rule would have required that the client
maintain the right to "hypothecate" securities in its account.
That term is not included in the revised proposed rule because it
is generally considered to be synonymous with "pledge." See
BLACK'S LAW DICTIONARY 669 (5th ed. 1979).
-------------------- BEGINNING OF PAGE #17 -------------------
person, such as the portfolio manager or other fiduciary.-[54]-
However, the client must be permitted to revoke the delegation at
any time.-[55]-
iii. Right to Receive Confirmations and Other
Documents
Paragraph (a)(5)(iv) would provide, in part, that the client
must have the right to receive in a timely manner confirmations
of securities transactions of the type required by rule 10b-
10-[56]- under the Securities Exchange Act of 1934.-[57]-
Proposed rule 3a-4 would have required clients to receive a
"notification of each security transaction."-[58]- In subsequent
no-action letters, the Division modified this position,
permitting monthly account statements to be provided to clients
unless more frequent confirmations were requested.-[59]-
Under the revised proposal, clients could waive receipt of
individual confirmations to the extent the waiver would otherwise
be permitted under rule 10b-10. Thus, paragraph (a)(5)
effectively would provide a client in an investment advisory
program with the option to receive either individual
confirmations for each transaction or periodic statements,
delivered no less frequently than quarterly, that include the
information required by rule 10b-10 with respect to all
transactions that occurred within the period covered by the
statement.-[60]-
---------- FOOTNOTES ----------
-[54]-Any such delegation should be contained in the investment
advisory agreement or in another document and retained with the
records relating to the program. The procedures for delegation
may also be specified in the procedures adopted under the rule.
-[55]-The procedure for such revocation should be described in
the procedures for the program. See infra section II.A.4.
(Written Procedures and Agreements).
-[56]-17 CFR 240.10b-10. If a program is structured so that each
client's securities transactions are executed by a registered
broker-dealer, rule 10b-10 would govern the delivery of
confirmations. If client transactions are executed by an entity
that is not subject to rule 10b-10, the revised proposed rule
would require the delivery of confirmations in the manner
required by rule 10b-10, to the same extent as if the
transactions were executed by a registered broker-dealer.
-[57]-15 U.S.C. 78a et seq.
-[58]-Proposed paragraph (c)(2).
-[59]-See, e.g., Westfield Consultants Group, supra note 3;
Manning & Napier Advisors, Inc., supra note 36; Jefferies &
Company (pub. avail. June 16, 1989).
-[60]-The Commission has taken the view that, for purposes of
complying with rule 10b-10, a broker-dealer may provide a person
whose account is managed on a discretionary basis by a fiduciary,
such as a client in an investment advisory program, with a
periodic statement (delivered no less frequently than quarterly)
in lieu of the immediate confirmation for each transaction, if
the broker-dealer obtains from the person a written agreement
stating that the immediate confirmation will be provided to the
fiduciary. The periodic statement the broker-dealer sends to the
person must contain the same information that could have been in
the immediate confirmation for each transaction. Although the
(continued...)
-------------------- BEGINNING OF PAGE #18 -------------------
Paragraph (a)(5)(iv) also would require the client (or the
client's agent) to be provided with other documents that the
client (or its agent) would receive had the same securities been
owned by the client outside the program. These documents may
include prospectuses, periodic shareholder reports, proxies, and
any other information and disclosure required by applicable laws
or regulations.-[61]-
iv. Rights as Securityholders
Paragraph (a)(5)(v) would require that a client have the
right to proceed directly as a securityholder against the issuer
of any security in the client's account without having to join
any person involved in the operation of the program or any other
client of the program as a condition precedent to proceeding
against an issuer. This provision, which is based on conditions
in several no-action letters,-[62]- is intended to ensure that
the client would have the same rights as any person holding the
same securities outside an investment advisory program. The
right to proceed against an issuer of securities in a client's
account is another important difference between a client of an
investment adviser and an investment company shareholder, as the
latter generally would not be able to proceed directly against an
issuer of securities held by the investment company.
4. Written Procedures and Agreements
Paragraph (a)(6) contains four requirements regarding the
establishment of written procedures and agreements covering the
operation of the program and the maintenance of records related
to these procedures and agreements. These conditions and their
purposes are described in more detail below. The Commission,
however, is sensitive to imposing undue burdens on sponsors of
investment advisory programs. Comment is therefore requested
whether any of the conditions discussed below would impose an
undue burden on persons relying on the rule, or whether the
burden of any condition would outweigh its benefits. Comment is
specifically requested whether any of these conditions can be
eliminated, consolidated, or otherwise made less burdensome
without compromising investor protection.
Paragraph (a)(6)(i) would require the sponsor of the program
to establish and effect written policies and procedures that are
reasonably designed to ensure that each of the provisions of the
rule is implemented. The paragraph also would require that, to
---------- FOOTNOTES ----------
-[60]-(...continued)
person may waive his or her right to the immediate confirmation,
the person may not waive his or her right to the periodic
statement. Confirmation of Transactions, Securities Exchange Act
Release No. 34962, notes 34-36 and accompanying text (Nov. 10,
1994), 59 FR 59612 (Nov. 17, 1994). By reference to rule 10b-
10, the revised proposed rule would incorporate this position.
-[61]-The Commission recently approved a proposed amendment of a
rule of the National Association of Securities Dealers, Inc. to
permit beneficial owners of stock to designate a registered
investment adviser to receive and vote proxies on their behalf.
Self-Regulatory Organizations; Order Approving Proposed Rule
Change by National Association of Securities Dealers, Inc.
Relating to Interpretation of the Board of Governors ---
Forwarding of Proxy and Other Material Under Article III, Section
1 of the NASD Rules of Fair Practice, Securities Exchange Act
Release No. 35681 (May 5, 1995), 60 FR 25749 (May 12, 1995).
-[62]-E.g., Westfield Consultants Group, supra note 3; Manning &
Napier Advisors, Inc., supra note 36; Jefferies & Company, supra
note 59; Rauscher Pierce Refsnes, Inc., supra note 3.
-------------------- BEGINNING OF PAGE #19 -------------------
the extent that the sponsor designates another person to carry
out certain obligations under the rule, the sponsor must obtain
from that person an agreement in writing to carry out those
obligations. These provisions are designed to require the
sponsor to formalize the manner in which it intends to comply
with rule 3a-4, and, if the sponsor delegates its
responsibilities under the rule, to specifically record the
delegation and obtain from the other parties an agreement
acknowledging their responsibilities.-[63]- The requirement that
a sponsor establish and effect written procedures detailing
compliance with the conditions of rule 3a-4 also is intended to
provide the Commission with a readily available source of
information regarding the manner in which the rule is being
interpreted and applied by the investment advisory industry.
Paragraph (a)(6)(ii)(A) would require the sponsor to
maintain and preserve all written policies, procedures and
agreements that pertain to the operation of the investment
advisory program in its office for as long as it serves as the
sponsor of that program.-[64]- The paragraph also would require
the sponsor to maintain and preserve these documents in an easily
accessible place for not less than three years after the sponsor
ceases to serve as sponsor of the program. Given the importance
of these documents, the Commission believes that the documents
must be maintained and preserved in the office of the sponsor for
as long as the sponsor acts in that capacity, so that they are
available for easy reference. These documents also must be
retained in an easily accessible place for three years after the
sponsor of the program ceases to serve as the sponsor should any
questions later arise about the operation of the program.
Paragraph (a)(6)(ii)(B) would require the sponsor or another
person designated by the sponsor to maintain and preserve all
documents created pursuant to the policies and procedures
governing the operation of the program, such as client contracts,
client questionnaires, and copies of client statements, in an
easily accessible place for a period of not less than five years
from the end of the fiscal year during which the document was
created. Under this provision, these documents would be required
to be maintained and preserved in a manner similar to that
required for advisory books and records under paragraph (e)(i) of
rule 204-2.-[65]- Unlike rule 204-2, however, paragraph
---------- FOOTNOTES ----------
-[63]-In addition, because the procedures would be reasonably
designed to ensure that the provisions of the rule are
implemented, sponsors may wish to specify in the procedures the
persons other than the principal sponsor that are involved in the
operation of the program, and each person's duties. The
procedures need not, however, specify each individual by name.
-[64]-Because an adviser may have more than one office, paragraph
(a)(6)(ii)(A) would provide that these records should be kept "in
an appropriate office of the sponsor." This language is similar
to that used in paragraph (e)(i) of rule 204-2 under the Advisers
Act (15 CFR 275.204-2), which sets forth the recordkeeping
requirements for investment advisers.
-[65]-See supra note 64. Revised proposed rule 3a-4 would not
require the creation of any records other than the policies,
procedures, and written agreements if the sponsor designates
another person to perform obligations under the revised proposed
rule or to maintain and preserve certain books and records.
Paragraphs (a)(6)(i), (a)(6)(iii). Paragraph (a)(6)(ii)(B),
however, would specify how records that are created pursuant to
(continued...)
-------------------- BEGINNING OF PAGE #20 -------------------
(a)(6)(ii)(B) would not require the documents to be kept for the
first two years in the office of the person creating or receiving
the records (i.e., the sponsor). Rather, the paragraph would
permit the sponsor to designate another person to maintain and
preserve these documents.-[66]-
Paragraph (a)(6)(iii) would require the sponsor to enter
into a written agreement with any person designated to maintain
and preserve the books and records pertaining to the program
(other than the written policies, procedures and agreements).
The paragraph also would require that the agreement include a
list of the books and records maintained and preserved by that
person and a provision obligating the person maintaining the
books and records to provide the sponsor with copies of such
books and records within a reasonable time of the sponsor's
request.
These requirements are intended to avoid duplicative
recordkeeping by allowing the sponsor to designate another person
involved in the operation of the investment advisory program to
maintain copies of books and records provided that person has a
contractual obligation to provide the records to the sponsor upon
request. In addition, the requirement that each party's
recordkeeping responsibilities be included in the party's
agreement with the sponsor would help to ensure that each person
is aware of its responsibilities. Finally, since the provision
would require that the sponsor be able to request and obtain
promptly the books and records maintained by such persons, it
effectively would permit the sponsor to monitor more effectively
the person's performance of its duties under the contract, and
help facilitate Commission examinations.
Paragraph (a)(6)(iv) would require the sponsor to furnish to
the Commission upon demand copies of the policies, procedures,
all documents created pursuant to the policies and procedures,
and the written agreements with other persons involved in the
operation of the program. This provision is intended to
facilitate Commission examination of investment advisory programs
relying on rule 3a-4.
As discussed above, most sponsors of investment advisory
programs are required to be registered under the Advisers
Act.-[67]- Thus, these sponsors are already required under
section 204 of the Advisers Act to make advisory records
available to the Commission upon request.-[68]- Revised proposed
rule 3a-4, however, would be available to all sponsors of
---------- FOOTNOTES ----------
-[65]-(...continued)
the policies and procedures (whether or not also required by rule
204-2 under the Advisers Act) must be maintained. If records
pertaining to the program are required to be created under rule
204-2, but not under the policies or procedures, those records
would be required to be maintained in accordance with paragraph
(e) of rule 204-2. See National Regulatory Services, Inc., supra
note 7 (portfolio manager in an investment advisory program must
maintain records of brochure delivery at its office, even if
sponsor created such records).
-[66]-However, as discussed below, the sponsor would be required
to enter into a written agreement with the designated person that
specifies that documents to be maintained by that person and that
copies of such documents would be provided to the sponsor upon
request.
-[67]-See supra notes 5-8 and accompanying text.
-[68]-15 U.S.C. 80b-4.
-------------------- BEGINNING OF PAGE #21 -------------------
investment advisory programs, regardless of their status under
the Advisers Act. Accordingly, paragraph (a)(6)(iv) is intended
to ensure that the Commission would have access to certain
records with respect to investment advisory programs that are
sponsored by persons that are not subject to the Advisers Act.
B. Form N-3a4
Paragraph (a)(7) would require any sponsor of an investment
advisory program intending to rely on the safe harbor provided in
rule 3a-4 to file with the Commission Form N-3a4.-[69]- Form N-
3a4 would notify the Commission of investment advisory programs
that are intended to be organized and operated in compliance with
the rule's requirements.-[70]- The form would assist the
Commission in monitoring the use of rule 3a-4 and facilitate
Commission examination of persons involved in investment advisory
programs.
C. Advisers Act Issues Raised by Investment Advisory
Programs
Wrap fee and other investment advisory programs raise, in
addition to the Investment Company Act issues addressed in this
release, a number of issues under the Advisers Act. The
Commission expects to publish an interpretive release that would
address many of these issues.
In particular, the Commission expects that the release will
address the suitability obligations of sponsors and portfolio
managers to clients of the investment advisory program, including
suitability obligations regarding client participation in the
program, the selection of portfolio managers, and the selection
of investments. The release will discuss how an adviser's
obligation to seek best execution applies in the context of wrap
fee programs when brokerage commissions are not charged
separately for each transaction. In addition, the interpretive
release may discuss the application of the restrictions on
principal and agency cross transactions in section 206(3) of the
Advisers Act to investment advisory programs, including whether
these restrictions apply to transactions with a sponsor that is
unaffiliated with the portfolio manager recommending the
transactions. Finally, the release may address certain issues
unique to programs under which client assets are invested in
mutual funds, including the disclosure obligations of investment
advisers regarding the various fees associated with these
programs.-[71]-
The release will not be issued until after comments have
been received on revised proposed rule 3a-4. This timing would
---------- FOOTNOTES ----------
-[69]-In addition, in the event that another person had
previously served as principal sponsor of, and submitted Form N-
3a4 with respect to, an investment advisory program, the new
principal sponsor would be required to submit an amended Form N-
3a4 identifying itself as the new sponsor and specifying the name
of the prior principal sponsor.
-[70]-Paragraph (a)(7) also would require sponsors to file with
the Commission any amendments to the form. Thus, proposed Form
N-3a4 also would be used to change information included in a
prior filing, to notify the Commission that the sponsor no longer
intends to operate the program in reliance on the safe harbor, or
to notify the Commission that a program operating in reliance on
the safe harbor will cease operations.
-[71]-The recently adopted wrap fee disclosure requirements set
forth in Schedule H of Form ADV apply only to sponsors of wrap
fee programs and not to sponsors of mutual fund wrap programs.
-------------------- BEGINNING OF PAGE #22 -------------------
allow the interpretive release to reflect, where appropriate,
these comments. Such a time schedule will also permit the
consideration of comment from members of the investment advisory
program industry regarding the issues expected to be addressed in
the interpretive release. Commenters are urged to submit such
comments on these and any other issues investment advisory
programs raise under the Advisers Act. Comment is specifically
requested regarding how investment advisers participating in
investment advisory programs currently understand and comply with
their Advisers Act obligations. Commenters also are urged to
suggest specific factual situations that the release should
address.
III. COST/BENEFIT ANALYSIS
Revised proposed rule 3a-4 under the Investment Company Act
would provide a nonexclusive safe harbor from the definition of
investment company for investment advisory programs. Programs
that are organized and operated in a manner consistent with the
rule's conditions would not be required to register under the
Investment Company Act or comply with the Act's substantive
requirements. The revised proposed rule is intended to provide
guidance to persons operating investment advisory programs
regarding the status of these programs under the Investment
Company Act, and help to ensure that such programs do not operate
as investment companies without clients of the programs
benefitting from the Act's protections.
Proposed Form N-3a4 would be filed with the Commission by
sponsors of programs intending to rely on rule 3a-4. The
proposed form would help the Commission in monitoring the use of
rule 3a-4 and facilitate Commission examination of persons
involved in these programs.
The Commission anticipates that the cost of compliance with
revised proposed rule 3a-4 and the proposed form would be small.
In addition, the Commission does not believe that compliance with
any of the proposed provisions would be unduly burdensome.
Comment is requested, however, on the costs and benefits
associated with the revised proposed rule and proposed form.
Commenters should submit estimates for any costs and benefits
perceived, together with any supporting empirical evidence
available.
IV. SUMMARY OF INITIAL REGULATORY FLEXIBILITY ANALYSIS
The Commission has prepared an Initial Regulatory
Flexibility Analysis in accordance with 5 U.S.C. 603 regarding
revised proposed rule 3a-4 and proposed Form N-3a4. The Analysis
notes that the revised proposed rule is intended to provide a
nonexclusive safe harbor from the definition of investment
company for investment advisory programs organized and operated
in compliance with the conditions of the rule, and that the
proposed form would be filed with the Commission by sponsors of
investment advisory programs intending to rely on the rule. The
Analysis explains that the rule is intended to provide guidance
regarding the status of investment advisory programs under the
Investment Company Act, and that the rule and the form would
facilitate Commission examination of persons involved in the
operation of a program. The Analysis concludes that the rule
would not be overly costly or burdensome to sponsors of
investment advisory programs that intend to rely on the safe
harbor. A copy of the Initial Regulatory Flexibility Analysis
may be obtained from Rochelle Kauffman Plesset, at Mail Stop 10-
6, Securities and Exchange Commission, 450 Fifth Street, N.W.
Washington, D.C. 20549.
V. STATUTORY AUTHORITY
The Commission is publishing for public comment revised
proposed rule 3a-4 and Form N-3a4 pursuant to the authority set
forth in sections 6(c) and 38(a) of the Investment Company Act
-------------------- BEGINNING OF PAGE #23 -------------------
[15 U.S.C. 80a-6(c), -37(a)].
TEXT OF REVISED PROPOSED RULE AND PROPOSED FORM
List of Subjects in 17 CFR Parts 270 and 274
Investment companies, Reporting and recordkeeping
requirements, securities.
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:
PART 270 - RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
1. The authority citation for Part 270 continues to read,
in part, as follows:
AUTHORITY: 15 U.S.C. 80a-1 et seq., 80a-37, 80a-39 unless
otherwise noted;
* * * * *
2. By adding 270.3a-4 to read as follows:
270.3a-4 Status of Investment Advisory Programs.
Preliminary Note
This section is a nonexclusive safe harbor from the
definition of investment company for certain programs that
provide investment advisory services to clients. Interests in
programs that are organized and operated in compliance with the
conditions of 270.3a-4 also are not required to be registered
under section 5 of the Securities Act of 1933 [15 U.S.C. 77e].
The section is not intended, however, to create any presumption
about a program that is not organized and operated in compliance
with the conditions.
(a) Notwithstanding section 3(a) of the Act [15 U.S.C. 80a-
3], any program under which investment advisory services are
provided to clients will not be deemed to be an investment
company within the meaning of the Act, provided that:
(1) Each client's account in the program is managed on the
basis of the client's financial situation, investment objectives,
and instructions.
(2)(i) At the opening of the account, the sponsor or
another person designated by the sponsor obtains information from
the client regarding the client's financial situation and
investment objectives, and gives the client the opportunity to
provide specific instructions concerning the management of the
account;
(ii) At least annually, the sponsor or another person
designated by the sponsor contacts the client to determine
whether there have been any changes in the client's financial
situation, investment objectives, or instructions in the
preceding year;
(iii) At least quarterly, the sponsor or another person
designated by the sponsor notifies the client in writing to
contact the sponsor or such other person if there have been any
changes in the client's financial situation, investment
objectives, or instructions, and provides the client with a means
through which such contact is to be made; and
(iv) The sponsor and persons authorized to make investment
decisions for the client's account are reasonably available to
the client for consultation.
(3) Each client has the ability to impose reasonable
restrictions on the management of its account, including the
designation of particular securities or types of securities that
should not be purchased for the account, or that should be sold
if held in the account.
(4) The sponsor or person designated by the sponsor
provides each client with a quarterly statement containing a
description of all activity in the client's account during the
preceding quarter, including all transactions made on behalf of
the account, all contributions and withdrawals made by the
client, all fees and expenses charged to the account, and the
-------------------- BEGINNING OF PAGE #24 -------------------
value of the account at the beginning and end of the quarter.
(5) Each client retains indicia of ownership of all
securities and funds in the account, including the right to:
(i) Withdraw securities or cash;
(ii) Pledge securities;
(iii) Vote securities, or delegate the authority to vote
securities to another person;
(iv) Be provided in a timely manner with confirmations of
securities transactions of the type required by 240.10b-10 of
this chapter, and all other documents that would have been
provided to the client (or the client's agent) had the client
purchased or sold the same securities outside the program; and
(v) Proceed directly as a securityholder against the issuer
of any security in the client's account and not be obligated to
join any person involved in the operation of the program, or any
other client of the program, as a condition precedent to
initiating such proceeding.
(6)(i) The sponsor of a program relying on this section
must establish and effect written policies and procedures that
are reasonably designed to ensure that each of the conditions of
this section is met. To the extent that the sponsor designates
another person to carry out its obligations under this section,
the sponsor must obtain from that person an agreement in writing
to carry out those obligations.
(ii) Notwithstanding the requirements of paragraph (e) of
275.204-2 of this chapter as such requirements would apply to the
records set forth in paragraph (a)(6)(ii) of this section:
(A) The sponsor shall maintain and preserve in an
appropriate office of the sponsor during the period that it
serves as the sponsor of the program, and in an easily accessible
place for a period not less than three years after the sponsor
ceases to serve in that capacity, all written policies,
procedures and agreements required to be established under
paragraphs (a)(6)(i) and (a)(6)(iii) of this section; and
(B) The sponsor or another person designated by the sponsor
shall maintain and preserve in an easily accessible place for a
period of not less than five years from the end of the fiscal
year during which the document was created, all documents created
pursuant to the policies and procedures (including any client
contracts, client questionnaires, and copies of client
statements).
(iii) The sponsor shall enter into a written agreement with
any person designated by the sponsor to maintain and preserve the
books and records pertaining to the program (other than those
specified in paragraph (a)(6)(ii)(A) of this section). Such
agreement shall include a list of the books and records to be
maintained and preserved by that person and a provision that the
person will provide the sponsor copies of such books and records
within a reasonable time of the sponsor's request.
(iv) The sponsor shall furnish to the Commission upon
demand copies of all documents maintained under paragraph
(a)(6)(ii) of this section.
(7) The sponsor has filed with the Commission Form N-3a4
[17 CFR 274.222] and any amendments thereto.
(b) As used in this section, the term sponsor refers to any
person who receives compensation for sponsoring, organizing or
administering the program, or for selecting, or providing advice
to clients regarding the selection of, persons responsible for
managing the client's account in the program. If a program has
more than one sponsor, one person shall be designated the
principal sponsor, and such person shall comply with the
provisions of this section relating to the duties and
responsibilities of the sponsor.
PART 274 - FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT
OF
-------------------- BEGINNING OF PAGE #25 -------------------
1940
3. The authority citation for Part 274 continues to read as
follows:
AUTHORITY: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, and 80a-29 unless otherwise noted.
4. By adding 274.222 to read as follows:
274.222 Form N-3a4, Notification of reliance on rule 3a-4
under the Investment Company Act.
This form shall be filed with the Commission as required by
rule 3a-4 ( 270.3a-4 of this chapter) by sponsors of investment
advisory programs that intend to rely on the safe harbor provided
by that rule.
Editorial Note: The text of Form N-3a4 appears in the
Appendix to this document and will not appear in the Code of
Federal Regulations.
By the Commission
Jonathan G. Katz
Secretary
July 27, 1995
-------------------- BEGINNING OF PAGE #26 -------------------
Appendix
Note: The following Appendix will not appear in the Code of
Federal Regulations
OMB APPROVAL
OMB Number:
Expires:
Estimated
average burden
hours per
response:
Form N-3a4
U.S. Securities and Exchange Commission
Washington, D.C. 20549
Notification of Intention to Rely on Safe Harbor
Pursuant to Rule 3a-4 [17 CFR 270.3a-4]
[ ] Initial Filing [ ] Amendment [ ] Withdrawal
1. Full name of investment advisory program:
2. Full name of principal sponsor (as defined in rule 3a-4) of
investment advisory program:
3. Principal sponsor's status under the Investment Advisers Act
[ ] Principal sponsor is registered under that Act; its SEC
Investment Advisers Act file number is: 801-
[ ] Principal sponsor is not registered under that Act
4. Address of principal sponsor's principal place of business
(number, street, city, state, zip code):
5. Telephone number at this location (include area code):
6. If another person had previously served as principal sponsor
of, and filed Form N-3a4 with respect to, the investment
advisory program identified in Item 1:
-------------------- BEGINNING OF PAGE #27 -------------------
a. Full name of previous principal sponsor:
b. Previous principal sponsor's status under the
Investment Advisers Act
[ ] Previous principal sponsor is/was registered under
that Act; its SEC Investment Advisers Act file
number is/was:
801-
[ ] Previous principal sponsor is/was not registered
under that Act
7. The undersigned hereby notifies the Securities and Exchange
Commission, in its capacity as principal sponsor, that
[ ] it intends to operate the program in reliance on the
safe harbor provided in rule 3a-4 under the Investment
Company Act of 1940.
[ ] it no longer intends to operate the program in reliance
on the safe harbor provided in rule 3a-4 under the
Investment Company Act of 1940.
[ ] the program will cease operating as an investment
advisory program as of
(insert date in blank).
Signed by:
(Name of person signing
on behalf of principal
sponsor)
(title of person)
Date:
INSTRUCTIONS
1. This form is to be used to notify the Commission of the
intention of the principal sponsor of an investment advisory
program to operate the program in reliance on the safe
harbor in rule 3a-4 under the Investment Company Act. This
form also is to be used to amend a prior filing, to notify
the Commission that the sponsor no longer intends to operate
the program in reliance on the safe harbor, or to notify the
Commission that a program operating in reliance on the safe
harbor will cease operations.
2. This form shall be filed in triplicate with the Commission.
One copy shall be manually signed; the other copies may have
facsimile or typed signatures.
3. Under Item 1, insert name under which the investment
advisory program is marketed to clients. If no such name is
used, insert a name used to identify the program in internal
documents (e.g. contracts) or any other name that would
-------------------- BEGINNING OF PAGE #28 -------------------
clearly identify the program.
4. The principal sponsor of an investment advisory program
shall file this form promptly after becoming principal
sponsor of the program. In the event that the previously
submitted form becomes inaccurate, the principal sponsor
shall amend the form by submitting an amended form,
completed in its entirety, with the appropriate box checked
at the top of the form. If a previous principal sponsor of
the program had filed a Form N-3a4, the new principal
sponsor shall submit an amended form, completed in its
entirety including the information requested in Item 6.
5. If the principal sponsor no longer intends to operate the
program in reliance on rule 3a-4, or the program is ceasing
operations, the principal sponsor shall withdraw its
notification on Form N-3a4 by submitting another form,
completed in its entirety including the information required
in Item 7, and checking the appropriate box at the top of
the form.