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Univ. of Toledo College of Law

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Thursday, September 20, 2007

SEC Adopts Temporary Rule for Principal Trades

The SEC yesterday voted to adopt, on an interim-final basis, a temporary rule that will establish an alternative means for investment advisers who are registered as broker-dealers to meet the requirements of Section 206(3) of the Advisers Act when they act in a principal capacity in transactions with certain of their advisory clients.  The temporary rule is being adopted on an interim final basis in response to the decision by the U.S. Court of Appeals for the District of Columbia Circuit in Financial Planning Association v. SEC. As a result of the Court's decision, which takes effect as early as October 1, fee-based brokerage customers must decide whether they will convert their accounts to fee-based accounts that are subject to the Advisers Act or to commission-based brokerage accounts. The temporary rule is designed to enable investors to continue to have access to many of the securities held by the firms providing advisory accounts. Compliance with the temporary rule will not relieve an investment adviser from its fiduciary obligations imposed by the Advisers Act or by other applicable provisions of federal law. These obligations include fulfilling the duty to seek best execution of client transactions, as well as the duty to disclose material facts necessary to alert clients to the adviser's potential conflicts of interest.

Temporary Rule 206(3)-3T permits an adviser, with respect to a non-discretionary advisory account, to comply with Section 206(3) of the Advisers Act by, among other things, (i) providing written prospective disclosure regarding the conflicts arising from principal trades; (ii) obtaining written, revocable consent from the client prospectively authorizing the adviser to enter into principal transactions; (iii) making certain disclosures either orally or in writing and obtaining the client's consent before each principal transaction; (iv) sending to the client confirmation statements disclosing the capacity in which the adviser has acted and disclosing that the adviser informed the client that it may act in a principal capacity and that the client authorized the transaction; and (v) delivering to the client an annual report itemizing the principal transactions. The rule also requires that the investment adviser be registered as a broker-dealer under Section 15 of the Exchange Act and that each account for which the adviser relies on this rule be a brokerage account subject to the Exchange Act, and the rules thereunder, and the rules of the self-regulatory organization(s) of which it is a member.

The temporary rule will expire and no longer be effective on Dec. 31, 2009.

The Commission invites comments on all aspects of the temporary rule. The Commission should receive comments by Nov. 30, 2007.

The Commission also voted to propose rule amendments that would reinstate three interpretive provisions of a rule that was vacated by the Court of Appeals for the District of Columbia Circuit in Financial Planning Association v. SEC. Those interpretations relate to the application of the Advisers Act to certain activities of broker-dealers.

The proposed rule amendments would re-codify guidance as to when advice is "solely incidental" to the conduct of business as a broker-dealer within the meaning of Section 202(a)(11)(C) of the Advisers Act.

Separate Fee or Contract. When a broker-dealer charges a separate fee or separately contracts for advisory services, its advice would not be considered "solely incidental" to the business of brokerage.

Discretionary Asset Management. When a broker-dealer exercises investment discretion it would not be considered to be providing advice that is "solely incidental" to the business of brokerage.

The proposed rule amendments would also re-codify guidance as to when a broker-dealer receives "special compensation" for providing investment advice within the meaning of Section 202(a)(11)(C) of the Advisers Act.

Discount Brokerage. Under the proposal, a broker-dealer does not receive "special compensation" solely because it charges a commission for discount brokerage that is less than it charges for full-service brokerage.

Finally, the proposed rule amendments would re-codify an interpretation that dually-registered broker-dealers and investment advisers are considered investment advisers solely with respect to those accounts for which they provide services that subject them to the Advisers Act.

Comments on these proposed amendments should be received by the Commission by Nov. 2, 2007.

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