SEC Principal Trading Rule Exemption Set to Expire at Year’s End

November 21, 2016

The staff of the U.S. Securities and Exchange Commission (SEC) stated in August that it intends to permit the expiration of rule 206(3)-3T (Rule) under the Investment Adviser Act of 1940 (Advisers Act). The SEC originally adopted the Rule in 2007 to provide investment advisers with an alternative means to comply with the requirements of Section 206(3) of the Advisers Act, which generally prohibits an investment adviser from engaging in or effecting transactions on behalf of a client while acting as a principal for the adviser’s own account. 

The Rule was in effect for an initial 27 months, and then extended for successive one-year and two-year periods; it is currently set to expire at the end of 2016. David W. Grim, Director of the SEC’s Division of Investment Management (Division), indicated on August 19, 2016 that the Division would not recommend that the SEC extend the Rule beyond its set expiration on December 31, 2016.1 The expiration of the Rule would prevent investment advisers from effecting transactions with clients on a principal basis without obtaining prior written client consent for each trade. 

Background to the Rule 

The Rule was originally adopted as a response to a 2007 decision of the U.S. Court of Appeals for the DC Circuit in Financial Planning Association v. SEC (FPA Decision), which had invalidated former Rule 202(a)(11)-1 under the Advisers Act (Former Rule). The Former Rule had provided, among other things, that a broker-dealer that was not registered as an investment adviser, but received compensation as a result of giving customers investment advice (special compensation), would not be deemed to be an investment adviser, provided: (1) the special compensation was not in addition to a separate advisory fee; (2) the broker-dealer did not act as a financial planner or exercise investment discretion over customer accounts; and (3) the compensation was entirely incidental to the brokerage services provided. The FPA Decision effectively meant that certain broker-dealers that offered fee-based brokerage accounts needed to comply with the Advisers Act, including the Advisers Act’s limitations on principal trading. 

In response to industry comments that a number of broker-dealers had built business models around the exemption provided in the Former Rule, the SEC adopted the Rule in September 2007 as a means to temporarily alleviate concerns of potential harm to customers who depended on: access to principal transactions with their brokerage firms; and the protections associated with a fee-based compensation structure.2 In adopting the Rule, the SEC acknowledged that the principal trading prohibitions in the Advisers Act could pose a significant practical impediment to the operation of fee-based brokerage accounts. The SEC noted in the Rule’s adopting release that the Rule was intended to protect the interests of customers who, at that time, held fee-based brokerage accounts, and to avoid disruption or confusion among investors.3 The SEC also indicated that it would continue to observe whether the Rule allowed firms to serve their clients’ best interests.

SIFMA Letter 

In an August 8, 2016 letter to the SEC, the Securities Industry and Financial Markets Association (SIFMA) urged the SEC to continue to make the Rule available to the industry.5 SIFMA noted that a number of its member firms continue to rely on the Rule. In this regard, SIFMA indicated that the Rule offers benefits to investors by providing them with access to securities that would not otherwise be available on the open market, or that are available only at a higher price on an agency basis. SIFMA noted that the Rule allows “firms to offer investors a greater variety of securities from firm inventories, execute trades in such securities more quickly, and offer customers better prices on such securities.” 

SIFMA also provided results of a survey regarding the operation of the Rule over the past two years, which had shown that, during this period, SIFMA member firms had relied on the Rule with respect to 19,633 accounts, or approximately $13 billion of assets. SIFMA also noted that allowing the Rule to expire would encourage firms to reduce their offering of principal executions and would require firms to incur costs to implement changes to their systems and procedures, all of which would be detrimental to investors. SIFMA further stated that any expiration of the Rule would be premature, as new rules regarding principal trading are likely to be forthcoming in the near future, and the expiration of the Rule would potentially require firms to restructure their operations related to principal trading on two separate occasions. 

Although SIFMA’s arguments have not yet persuaded the Division to ask the SEC to extend the Rule, Mr. Grim stated the SEC will consider applications for exemptive orders under the Adviser Act that could provide a similar means to comply with Section 206(3) of the Advisers Act. 


1) Letter from David W. Grim, Director, SEC Division of Investment Management, to Ira D. Hammerman, Executive Vice President and General Counsel, SIFMA, Rule 206(3)-3T under the Investment Advisers Act of 1940 (Aug. 19, 2016).
2) See Temporary Rule Regarding Principal Trades with Certain Advisory Clients, Rel. No. IA-2653 (Sept. 24, 2007) at p.2. 
3) Id. at 4.
4) Id. at 4.
5) Letter from the Securities Industry and Financial Markets Association to the U.S. Securities and Exchange Commission, Temporary Rule Regarding Principal Trades with Certain Advisory Clients (Aug. 8, 2016).

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