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SEC Extends Temporary Rule for Principal Trades with Clients

January 4, 2010

On December 23, 2009, the Securities and Exchange Commission ("SEC") extended, on a temporary basis, Rule 206(3)-3T under the Investment Advisers Act of 1940, as amended (the "Advisers Act"), for principal trades with clients of investment advisers who are also registered broker-dealers. Originally adopted in 2007, Rule 206(3)-3T was set to expire on December 31, 2009. The SEC has adopted Rule 206(3)-3T in the same form as adopted in 2007, except that the rule will now expire on December 31, 2010, absent further action by the SEC.

Rule 206(3)-3T provides an alternative means for investment advisers who also are registered broker-dealers to meet the requirements of Section 206(3) of the Advisers Act when engaging in principal transactions with clients. Pursuant to Section 206(3), it is unlawful for any investment adviser "acting as a principal for his own account, knowingly to sell any security to or to 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." Rule 206(3)-3T permits investment advisers who are registered broker-dealers to comply with Section 206(3) by, among other things, meeting the following conditions:

  • providing written, prospective disclosure regarding the conflicts of interest arising from principal trades;
  • obtaining written, revocable consent from the client prospectively authorizing the adviser to enter into principal transactions;
  • making certain disclosures, either orally or in writing, and obtaining the client's consent before executing each principal transaction;
  • sending to the client at or before completion of each transaction written 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
  • delivering to the client an annual report itemizing the principal transactions made during the year. 

To rely on Rule 206(3)-3T, the investment adviser must be a broker-dealer registered under Section 15 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and each client account engaged in the transaction must be a brokerage account subject to the Exchange Act. Investment advisers relying on Rule 206(3)-3T are still obligated to act in the best interest of their clients, including satisfying the obligation of best execution. 

In its adopting release, the SEC states that it needs additional time to understand how, and in what situations, investment advisers are availing themselves of the rule. Taking seriously concerns raised by certain commenters, the SEC limited the duration of the extension to assess whether the rule is operating and whether firms are applying it in a manner consistent with protecting investors. Limiting the extension also provides the SEC with the opportunity to consider whether the financial reform bills currently pending in Congress will, if adopted, impact principal trading activities. Please refer to our October 28, 2009 and November 13, 2009 Alerts and November 3, 2009 and November 16, 2009 Publications for more information regarding the pending legislation.