[Federal Register Volume 63, Number 125 (Tuesday, June 30, 1998)]
[Rules and Regulations]
[Pages 35508-35515]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-17387]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 240, 270, and 275
[Release Nos. 33-7548, 34-40122, IC-23272, and IA-1727; File No. S7-4-
97]
RIN 3235-AG62; 3235-AH01
Definitions of ``Small Business'' or ``Small Organization'' Under
the Investment Company Act of 1940, the Investment Advisers Act of
1940, the Securities Exchange Act of 1934, and the Securities Act of
1933
AGENCY: Securities and Exchange Commission.
ACTION: Final rules.
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SUMMARY: The Securities and Exchange Commission is amending the
definitions of ``small business'' and ``small organization'' that are
used in connection with Commission rulemaking under the Investment
Company Act of 1940, the Investment Advisers Act of 1940, the
Securities Exchange Act of 1934, and the Securities Act of 1933
regarding regulatory requirements applicable to investment companies,
investment advisers, exchanges, securities information processors,
transfer agents and issuers, and broker-dealers. These definitions are
used specifically for purposes of the Regulatory Flexibility Act, which
requires the Commission to consider the impact of its regulations on
small entities. The amendments to these definitions reflect recent
changes in the law as well as changes in the securities markets over
the past decade, including technological innovations and increased
business relationships among participants in the securities industry.
EFFECTIVE DATE: The rule amendments will become effective July 30,
1998.
FOR FURTHER INFORMATION CONTACT:
General
Christopher Gilkerson, Assistant General Counsel at (202-942-0929),
or Anne H. Sullivan, Senior Counsel at (202-942-0954), Office of the
General Counsel, Securities and Exchange Commission, 450 Fifth Street,
N.W., Mail Stop 6-6, Washington, D.C. 20549.
Divisions with Particular Responsibility
Thomas M.J. Kerwin, Senior Counsel, Division of Investment
Management, (definitions applicable to investment companies and
investment advisers) (202-942-0690).
Glenn J. Jessee, Special Counsel, Office of the Chief Counsel,
Division of Market Regulation (definitions applicable to brokers,
dealers, exchanges, transfer agents and issuers, securities information
processors, and broker-dealers) (202-942-0073).
SUPPLEMENTARY INFORMATION: The Commission is amending the definitions
of ``small business'' and ``small organization'' (together, ``small
business'') set forth in Rule 0-10 (17 CFR 270.0-10) under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) (``Investment
Company Act''), Rule 0-7 (17 CFR 275.0-7) under the Investment Advisers
Act of 1940 (15 U.S.C. 80b-1 et seq.) (the ``Advisers Act''), Rule 0-10
(17 CFR 240.0-10) under the Securities Exchange Act of 1934 (15 U.S.C.
78a et seq.) (the ``Exchange Act''), and Rule 157 (17 CFR 230.157)
under the Securities Act of 1933 (15 U.S.C. 77a et seq.) (the
``Securities Act'') as those terms are used for purposes of Chapter Six
of the Administrative Procedure Act, 5 U.S.C. 601 et seq. (the
Regulatory Flexibility Act, Pub. L. No. 96-354, 94 Stat. 1164 (1980),
as amended, Pub. L. No. 104-
[[Page 35509]]
121, Title II, Subtitle D, 110 Stat. 864 (1996) (the ``Reg. Flex.
Act'')).
The Reg. Flex. Act, enacted in 1980, requires federal agencies,
among other things, to consider the impact of rulemaking on entities
that qualify as ``small'' under applicable standards in the Reg. Flex.
Act,1 the Small Business Act,2 or regulations
promulgated by the Small Business Administration (``SBA'').3
In 1982, the Commission adopted definitions that it considered
appropriate for issuers and other entities subject to its regulation.
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\1\ 5 U.S.C. 603, 604.
\2\ 15 U.S.C. 631 et seq.
\3\ 13 CFR Part 121.
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On January 22, 1997, the Commission published for comment proposed
amendments to its definitions of ``small business'' for purposes of the
Reg. Flex. Act, when used in connection with rulemaking affecting
investment companies, investment advisers, exchanges, securities
information processors, transfer agents and issuers, and broker-
dealers.4 In addition to publishing the rule proposal in the
Federal Register, the Commission posted the proposed rule changes on
the small business page of the Commission's Website.5 To
give the public additional time to comment, the Commission extended the
comment period for the proposed amendments.6 The Commission
received no comments on the proposal. The Commission is adopting the
amendments to the ``small business'' definitions as
proposed.7 The Commission is, however, making some
modifications to the ``small business'' definition of investment
adviser to reflect amendments to the Investment Advisers Act enacted
under the National Securities Markets Improvement Act of 1996 (the
``Improvement Act'') 8 and to simplify the definition. As
required under the Reg. Flex. Act, the Commission has consulted with
the SBA Office of Advocacy regarding the amendments it is
adopting.9
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\4\ Securities Act Release No. 7383, Exchange Act Release No.
38190, Investment Company Act Release No. 22478, Investment Advisers
Act Release No. 1609, 62 FR 4106 (Jan. 28, 1997) (the ``Proposing
Release'').
\5\ The Commission's Website is located at http://www.sec.gov.
\6\ Securities Act Release No. 7404, Exchange Act Release No.
38401, Investment Company Act Release No. 22566, Investment Advisers
Act Release No. 1619, 62 FR 13356 (Mar. 20, 1997).
\7\ The Commission intends to maintain its current definitions
of ``small business'' as they relate to small business issuers,
clearing agencies, bank municipal securities dealers, and public
utility holding company systems.
\8\ Pub. L. No. 104-290, 110 Stat. 3416 (1996).
\9\ See 5 U.S.C. 601(3), 601(4).
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I. Background
The Reg. Flex. Act defines the term ``small entity'' as a ``small
business,'' ``small organization,'' or ``small governmental
jurisdiction.'' 10 The definition of ``small business''
incorporates the Small Business Size Regulations (``SBA size
standards'') 11 established by the SBA under the Small
Business Act.12 In addition, the Reg. Flex. Act definition
of ``small business'' authorizes agencies to establish their own
definitions if they determine that specialized definitions are more
appropriate to the activities of the agency.13
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\10\ Id. Sec. 601(6).
\11\ 13 CFR Part 121.
\12\ 15 U.S.C. 632(a)(2)(A) (SBA authority to establish
standards for determining ``small business concern'').
\13\ 5 U.S.C. 601(3), 601(4).
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As discussed in greater detail in the Proposing Release, the
Commission has a longstanding commitment to understanding and
addressing the concerns of small business.14 Consistent with
this commitment, in 1982, the Commission chose to adopt its own
definitions of ``small business'' for purposes of Commission rulemaking
after reviewing size standards adopted by the SBA.15
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\14\ See Proposing Release, supra note 4.
\15\ The SBA adopted its size standards in 1980. Small Business
Size Standards, Revisions of Methods of Establishing Size Standards
and Definitions of Small Business, 45 FR 15442 (Mar. 10, 1980). The
Commission determined that the SBA size standards were generally
inappropriate in the context of regulations affecting securities
issuers and reporting companies. See Proposed Definitions of ``Small
Business'' and ``Small Organization'' for Purposes of the Regulatory
Flexibility Act, Securities Act Release No. 6302, Exchange Act
Release No. 17645, PUHCA Release No. 21970, Trust Indenture Act
Release No. 619, Investment Company Act Release No. 11694,
Investment Advisers Act Release No. 754, 46 FR 19251 (Mar. 30, 1981)
(``1981 Proposing Release''); see also Final Definitions of ``Small
Business'' and ``Small Organization'' for Purposes of the Regulatory
Flexibility Act, Securities Act Release No. 6380, Exchange Act
Release No. 18452, PUHCA Release No. 22371, Trust Indenture Act
Release No. 693, Investment Company Act Release No. 12194,
Investment Advisers Act Release No. 791, 47 FR 5215, 5216 (Feb. 4,
1982) (``1982 Adopting Release'').
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As discussed in the Proposing Release, the Commission's definitions
adopted in 1982 were, in many ways, more expansive than the statutory
definitions of ``small business'' and ``small organization'' in the
Reg. Flex. Act. Under the Reg. Flex. Act, a business is not considered
``small'' if it is not ``independently owned and operated.''
16 The Commission's definitions went beyond the Reg. Flex.
Act requirements because, for the most part, the Commission's
definitions did not limit ``small businesses'' to those that were
independently owned and operated. The Commission's original definitions
also were broader in certain respects than the SBA size standards,
which consider various limiting factors when determining if an entity
is ``small.'' 17 For example, the SBA size standards
aggregate the interests of affiliated entities for the purpose of
determining whether an entity is ``independently owned and operated,''
and thus, ``small.'' 18 In determining whether entities are
affiliated, the SBA size standards consider such factors as control,
management, ownership, and contractual relationships.19 In
addition, the SBA may treat multiple entities that have identical or
substantially identical business or economic interests as a single
entity.20 Although the Commission's current definitions in
some cases address the concept of control,21 none of the
other affiliation concepts set forth in the SBA size standards were
considered when the Commission originally adopted its definitions of
``small business'' in 1982.
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\16\ See 5 U.S.C. 601(4) (``small organization'' under the Reg.
Flex. Act means an entity that is ``independently owned and operated
and is not dominant in its field''); 15 U.S.C. 632(a)(1) (definition
of ``small-business concern'' under the Small Business Act (as
incorporated in the Reg. Flex. Act definition of ``small business,''
5 U.S.C. 601(3)) means an entity that is ``independently owned and
operated and * * * is not dominant in its field'').
\17\ See SBA size standards, 13 CFR 121.102 (size eligibility
provisions and standards).
\18\ Id. Sec. 121.103.
\19\ Id. Sec. 121.103(a)(1) (describing control relationships
that constitute affiliation); id. Sec. 121.103(a)(2) (describing
factors such as ownership, management, previous relationships with
or ties to another concern, and contractual relationships that SBA
considers in determining whether affiliation exists).
\20\ See id. Sec. 121.103(a)(3).
\21\ Under certain of the current definitions of ``small
business'' under the Exchange Act (broker, dealer, clearing agency,
municipal securities dealer, securities information processor,
transfer agent), the Commission has considered control interests in
determining whether an entity was ``small.'' Exchange Act Rule 0-10
(17 CFR 240.0-10). The SBA regulations also address factors of
control. 13 CFR 121.103(a)(1).
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Under the Commission's current definitions, a majority of broker-
dealers and investment advisers qualify as small.22 Some of
those ``small'' broker-dealers handle customer orders in excess of $200
million from which they earn more than $6 million per year in
[[Page 35510]]
revenue.23 These entities are classified as ``small'' under
current Commission rules even though they may be affiliated with larger
entities that are responsible for many of the smaller firms' securities
functions. Similarly, today most mutual funds are affiliated with large
mutual fund families, and many investment advisers are affiliated with
larger financial services firms. These relationships allow the
``small'' affiliates to rely on a larger entity that centralizes
administrative and compliance systems for all affiliates, significantly
reducing regulatory burdens for each individual affiliate.
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\22\ Under the current definitions, approximately 75 percent of
investment advisers and 60 percent of registered broker-dealers
qualify as ``small.'' The number of ``small'' investment advisers
registered with the Commission was significantly reduced as of July
8, 1997, however, as a result of legislation that reallocated
primary responsibility for regulating most smaller investment
advisers to the states. See infra notes 45-47 and accompanying text.
\23\ The revenue amount is based on information provided by
broker-dealers in quarterly FOCUS reports. The amount of customer
order flow is derived using revenue data in the FOCUS reports.
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A similar relationship exists between introducing broker-dealers
and the large firms through which they clear securities trades.
Although introducing and clearing firms share responsibility for
ensuring that a customer's account is handled properly, introducing
firms typically depend on clearing firms to execute customer trades, to
handle customer funds and securities, and to handle many back-office
functions, including issuing the confirmation of the customer's trade.
The increase in these affiliations since 1982 occurred along with
tremendous growth and significant technological changes in the
securities industry that facilitate such arrangements.24
These changes in the securities industry prompted the Commission to
begin reviewing certain of its ``small business'' definitions in
1995.25
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\24\ Between 1980 and 1996, the value of public offerings
(including debt and equity, but not investment company securities)
increased from $58 billion to over $1 trillion. Between 1990 and
1996, the dollar volume of equity securities traded on registered
national securities exchanges and Nasdaq grew 277 percent, with over
$7.8 trillion traded in 1996. Assets under management by investment
advisers (excluding bank advisers to registered investment
companies) rose from $205 billion to over $10 trillion (a 4,778
percent increase) between 1980 and 1996. Over the same period,
assets of investment companies increased 1,514 percent from $235
billion to $3.794 trillion. The number of securities firms and
professionals registered with the Commission or with self-regulatory
organizations has also surged. The number of broker-dealers grew,
over the same period, from around 5,200 to approximately 7,760 (a 49
percent increase). In addition, technological progress has changed
the securities industry. For example, advances in information
technology have resulted in the proliferation of information vendors
and electronic trading systems not contemplated in 1982. Since 1982,
the markets have seen the development of fully automated electronic
broker-dealers and exchanges, improved electronic order execution
systems at broker-dealers, exchanges, and national securities
associations, and improved electronic linkages among markets and
between broker-dealers and their customers. These changes have
created substantially deeper and more liquid markets and have made
trading more immediate and less expensive for both institutional and
retail customers.
\25\ See Introduction to the Regulatory Plan and the Unified
Agenda of Federal Regulations, 60 FR 59503, 61073 (Nov. 28, 1995)
(noting Division of Investment Management's consideration whether to
recommend that the Commission propose amended definition of ``small
entity'' in Rule 0-10 (17 CFR 270.0-10) under the Investment Company
Act).
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The Commission expanded its review of ``small business''
definitions in 1996, after Congress enacted the Small Business
Regulatory Enforcement Fairness Act of 1996 (``SBREFA'').26
Among other things, SBREFA (i) imposed new obligations on the
Commission and other agencies to assist small entities in understanding
and complying with regulatory requirements,27 (ii) amended
the Reg. Flex. Act to allow small entities to seek judicial review of
agency compliance with the Reg. Flex. Act,28 and (iii)
amended the Equal Access to Justice Act (``EAJA'') 29 by
expanding the class of litigants eligible to receive EAJA awards to
include small entities as defined under the Reg. Flex.
Act.30 In view of the Commission's expanded obligations
under SBREFA,31 and changes in the securities industry
discussed above, the Commission is adopting amendments to certain of
its ``small business'' definitions to take into account more of the
factors suggested by SBA size standards in determining whether an
entity qualifies as ``small.'' 32 The following sections of
this release describe the amendments to specific ``small business''
definitions. The release also discusses how the amended definition of
``small business'' as it relates to investment advisers differs from
the proposal and the reasons for the changes.
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\26\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996).
\27\ Id. Secs. 212, 213(b), 110 Stat. 858, 859.
\28\ Id. Sec. 242, 110 Stat. 865.
\29\ 5 U.S.C. 504; 28 U.S.C. 2412.
\30\ Pub. L. No. 104-121, Sec. 232(b)(2), 110 Stat 863.
\31\ The Commission is concerned that, as a result of the
Commission's existing broad definitions of ``small business,''
certain of the amendments made by SBREFA could result in a
significant increase in the Commission's exposure to litigation
beyond that reasonably contemplated by the Reg. Flex. Act. The
Commission's enforcement litigation and other litigation matters
have increased in recent years. In light of increased exposure to
litigation under SBREFA, which could further strain the Commission's
limited budget, the Commission believes it is appropriate to revise
certain small business definitions under its own rules to reflect
better the policies underlying the Reg. Flex. Act and the SBA size
standards.
\32\ In instances where the Commission has already instituted a
rulemaking proceeding and prepared an Initial Regulatory Flexibility
Analysis (IRFA) under the old small business definitions, those
definitions will apply for purposes of any final rulemaking and the
Commission's preparation of the required Final Regulatory
Flexibility Analysis (FRFA).
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II. Discussion of Amendments
A. Investment Companies
The Commission is adopting, as proposed, amendments to the rule
under the Investment Company Act that defines ``small business'' as
applied to investment companies.33 The current rule treats
as a small business each investment company (``fund'') that has $50
million or less in assets as of the end of its fiscal
year.34 As amended, the rule generally treats a fund as a
small business only if it and any group of related funds have aggregate
net assets of $50 million or less.35 The Commission
estimates that approximately 400 funds will be treated as small
businesses under the amended rule.
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\33\ See amended Rule 0-10 (17 CFR 270.0-10); Proposing Release,
supra note 4.
\34\ Rule 0-10 (17 CFR 270.0-10).
\35\ Amended Rule 0-10. Conforming amendments to Rule 157(b) (17
CFR 230.157(b)) under the Securities Act and Rule 0-10(b) (17 CFR
240.0-10(b)) under the Exchange Act adopt the same small business
definition of an investment company. To facilitate the efficient
computation of net assets, the amended rule provides that the
Commission may base its count of the assets of any group of related
funds on the net assets of each fund (or series) in the group at the
end of each fund's fiscal year, as generally reported in Form N-SAR.
Amended Rule 0-10(c) (17 CFR 270.0-10(c)); see 17 CFR 274.101; Form
N-SAR, Item 74T. As under the current rule, small business status
will be determined on a company-by-company basis rather than a
series-by-series basis (even in the unusual circumstances when some
series of a multi-series company may not constitute a group of
related funds with respect to other series).
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The amended rule defines a group of related funds to include two or
more management companies (including any series of such a company) that
hold themselves out to investors as related companies for purposes of
investment and investor services, and share either a common investment
adviser (or affiliated advisers) or a common
administrator.36 In the case of a unit investment trust
(``UIT''), a group of related funds means two or more UITs that have a
common sponsor.37
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\36\ Amended Rule 0-10(a)(1) (17 CFR 270.0-10(a)(1)). Under this
definition, the assets to be aggregated for a multi-series company
would include those of all series of the company, and of any
separately organized company (and its series) in a related group.
\37\ Amended Rule 0-10(a)(2) (17 CFR 270.0-10(a)(2)). A UIT
holds a fixed portfolio of securities deposited by its sponsor, and
does not have an investment adviser. See generally Section 4(2) of
the Investment Company Act (15 U.S.C. 80a-4(2)). The amended rule
does not define a group of related funds as applied to a face amount
certificate company, another type of fund, which will continue to be
subject to the $50 million test on a company-by-company basis.
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There is a special rule applicable to insurance company separate
accounts.38
[[Page 35511]]
Because state law generally treats separate account assets as the
property of the sponsoring insurance company, the amended rule
aggregates each separate account's assets with the assets of its
sponsor, including other sponsored accounts.39 As a result,
the Commission expects few, if any, separate accounts to be treated as
small businesses.
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\38\ Separate accounts contain assets used to fund certain
insurance and investment contracts between the sponsoring insurance
company and contract owners. Each account typically is organized as
a UIT, or in some cases as a management company having a sponsor-
affiliated investment adviser. See generally Section 2(a)(37) of the
Investment Company Act (15 U.S.C. 80a-2(a)(37)).
\39\ Amended Rule 0-10(b) (17 CFR 270.0-10(b)).
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B. Investment Advisers
The Commission is adopting proposed amendments to the rule under
the Advisers Act that defines ``small business'' as applied to
investment advisers, with changes designed to reflect recent
legislation and to simplify the proposed amendments.40 The
current rule defines as a small business each investment adviser that
either (i) manages assets (``client assets'') with a total value of $50
million or less as of the end of its most recent fiscal year, and
performs no other advisory services; or (ii) performs other advisory
services, manages client assets of $50 million or less if it manages
client funds, and has assets related to its advisory business
(``business assets'') that do not exceed $50,000.41 As
amended, Rule 0-7 treats an adviser as a small business if (i) neither
the adviser nor an adviser it controls, is controlled by, or is under
common control with has $25 million or more of assets under management,
and (ii) neither the adviser nor any person it controls, is controlled
by, or is under common control with has $5 million or more of total
assets.42
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\40\ See amended Rule 0-7 (17 CFR 275.0-7); Proposing Release,
supra note .
\41\ Rule 0-7 (17 CFR 275.0-7).
\42\ Amended Rule 0-7. ``Total assets'' is a broader and simpler
term than ``business assets.'' See amended Rule 0-7(b)(2) (total
assets means total assets as shown on the balance sheet of
investment adviser or other ``person'' in a control relationship
with the adviser). It includes business assets, such as leases and
equipment, as well as other types of assets, such as cash and
accounts receivable. Total assets should be easier for advisers to
calculate than business assets, since the information on total
assets is readily available on the balance sheets of advisers and
their affiliates.
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In the Proposing Release, the Commission requested comment whether,
in light of the Improvement Act's transfer of primary responsibility
for regulating small advisers to the states, a threshold of $25 million
for client assets under management would be more appropriate than the
$50 million threshold.43 The Commission also requested
comment whether the $50,000 threshold for business assets continued to
be appropriate.44 The Commission has now determined that the
$25 million client asset threshold coupled with a $5 million total
assets test more appropriately reflects the Improvement Act's
allocation of regulatory responsibilities between the Commission and
the states.
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\43\ See Proposing Release, supra note , at text accompanying
n.60.
\44\ Id. As noted above, the Commission received no comments.
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The Improvement Act reallocated regulatory responsibility over
investment advisers between the Commission (which is now responsible
for larger advisers with national businesses) and state securities
regulators (which are now responsible for smaller advisers with
essentially local businesses).45 To effect this division of
responsibility, Congress generally prohibited advisers with less than
$25 million of assets under management from registering with the
Commission after July 8, 1997.46 Thus, Congress viewed
``small advisers'' as those having less than $25 million of assets
under management.47 The Commission believes that the
definition of small business as applied to investment advisers for Reg.
Flex. Act purposes should be revised to reflect the threshold that
Congress used in the Improvement Act for similar purposes. Therefore,
the Commission is reducing the threshold to $25 million of assets under
management.48
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\45\ See Rules Implementing Amendments to the Investment
Advisers Act of 1940, Investment Advisers Act Release No. 1633 (May
15, 1997) at text accompanying note 5 (62 FR 28112 (May 22, 1997))
(``Adviser Registration Release'').
\46\ See Section 203A(a)(1) of the Advisers Act (15 U.S.C. 80b-
3a(a)(1)) (prohibiting an adviser from registering with the
Commission if it is subject to regulation by its home state unless
it has assets under management of $25 million or more). The
Commission retains primary responsibility for larger advisers,
advisers to investment companies, advisers whose principal office
and place of business is located in one of the four states that do
not regulate advisers or is located overseas, and advisers exempted
by rule from the prohibition on registration with the Commission.
See Section 203A(a)(1) and (c) of the Advisers Act (15 U.S.C. 80b-
3a(a)(1) and (c)); Rule 203A-2 (17 CFR 275.203A-2) (exempting
nationally recognized statistical rating organizations, certain
pension consultants, any smaller adviser having the same principal
office and place of business as a registered adviser affiliated with
it through a control relationship, and any new firm reasonably
expecting to have $25 million or more of assets under management).
\47\ See Report on S. 1815, ``The Securities Investment
Promotion Act of 1996,'' S. Rep. No. 293, 104th Cong., 2d Sess. 1-4
(1996) (legislation would focus SEC supervision ``on investment
advisers most likely to be engaged in interstate commerce'' and
focus state supervision ``on advisers whose activities are most
likely to be centered in their home state''; ``legislation allows
states to assume the primary role with respect to regulating
advisers that are small, local businesses, managing less than $25
million in client assets, while the Commission's role is focused on
larger advisers with $25 million or more in client assets under
management'').
\48\ The Advisers Act permits the Commission to increase (but
not to reduce) the $25 million minimum threshold for registration
with the Commission. See Section 203A(a)(1)(A) of the Advisers Act
(15 U.S.C. 80b-3a(a)(1)(A)). To coordinate amended Rule 0-7 with
future Commission rulemaking in this regard, the amended rule
provides that the maximum threshold for a small business will
increase in tandem with any increase in the minimum threshold for
Advisers Act registration. Amended Rule 0-7(a)(1) and (3) (17 CFR
275.0-7(a)(1) and (3)). Rule 203A-1 (17 CFR 275.203A-1), which gives
an adviser discretion whether to register with the Commission
instead of a state if the adviser has between $25 million and $30
million of assets under management, does not affect the definition
of small business for purposes of amended Rule 0-7. See Adviser
Registration Release, supra note 45, at text accompanying nn.48-49
(Rule 203A-1 merely makes registration optional within a specified
range without raising the minimum threshold for registration).
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Under the proposed amendments, an adviser having less than $50
million of client assets would not have been considered a small
business if the adviser (i) had substantial business assets or (ii) was
affiliated with a large firm.49 Amended Rule 0-7 reflects
the policy of extending an asset test to all investment advisers, but
substantially simplifies the proposed amendments and reduces the amount
of information the Commission must collect to determine whether an
adviser is a small business.50 As adopted, the rule excludes
from the definition of small business an adviser having less than $25
million of assets under management if, based on information filed with
the Commission, the adviser (i) has $5 million or more of ``total
assets,'' or (ii) controls, is controlled by, or is under common
control with (a) another adviser that has $25 million or more of assets
under management or (b) any person (other than a natural person) that
[[Page 35512]]
has $5 million or more of total assets.51 The Commission
estimates that under amended Rule 0-7, approximately 1,500 registered
advisers will be treated as small businesses, approximately 500 fewer
than under the proposed amendments.52 Most of this change is
attributable to reducing the threshold for client assets to less than
$25 million of assets under management. The advisers considered small
businesses under the amended rule will consist primarily of the
advisers that have less than $25 million of assets under management but
are registered with the Commission because they have a principal office
and place of business in one of the four states that does not regulate
advisers.53
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\49\ See Proposing Release, supra note , at nn.51-58 and
accompanying text (proposing to extend current Rule 0-7's $50,000
business asset test to all advisers; proposing not to treat adviser
as small entity if affiliated with large adviser or fund or entity
deemed large under Rule 0-10 under the Exchange Act (17 CFR 240.0-
10)).
\50\ See 1981 Proposing Release, supra note 15 at 19257, 19263
(two attributes desirable in size standards are capacity to
differentiate the small members of an industry from other members
and the use of readily available information to derive standards).
Under the amended rule, the determination of the adviser's small
status will be based on information reported by the adviser about
its size and the size of its affiliates under two tests, as
explained below. In contrast, the proposed amendments would have
applied two size tests to the adviser and several other tests to
affiliates. The Commission expects to propose to amend Form ADV to
add questions needed to obtain the information.
\51\ See amended Rule 0-7(a) (2) and (3) (17 CFR 275.0-7(a)(2)
and (3)). The $5 million total assets test is one measure of a small
entity under Rule 0-10 (17 CFR 240.0-10(a)) under the Exchange Act.
Amended Rule 0-7(b)(1) defines control consistent with Rule 203A-
2(c) under the Advisers Act (17 CFR 275.203A-2(c)).
\52\ The number of small businesses for which the Commission has
primary regulatory responsibility has dropped sharply as a result of
the Improvement Act's prohibiting most small advisers from
registering with the Commission. See supra text accompanying notes
45-47. Following the final de-registration of those advisers no
longer eligible to register with the Commission, there will be
approximately 7,600 Commission-registered advisers. In contrast,
prior to July 8, 1997 there were approximately 23,000 advisers
registered with the Commission.
\53\ See supra note 46. When one or more of these four states
institutes a registration scheme for advisers with assets under
management of less than $25 million, the number of small business
advisers registered with the Commission will decrease. See also
Adviser Registration Release, supra note 45, at n.42 (``Commission
data suggests that most advisers that will remain registered with
the Commission have assets under management well in excess of $25
million'').
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C. Definitions Under the Exchange Act
1. Exchanges
As discussed in the Proposing Release, the Commission is expanding
the definition of ``small business'' as it applies to exchanges to
include a requirement that an exchange also not be affiliated with any
person (other than a natural person) that is not a small business as
defined in Rule 0-10.54 Under the amended rule, an exchange
is ``affiliated'' with another entity when the exchange controls, is
controlled by, or is under common control with the other entity. This
change will conform the definition applicable to exchanges with other
definitions of ``small business'' under the Exchange Act by applying
the affiliation standard already applicable to broker-dealers, clearing
agencies, bank municipal securities dealers, securities information
processors, and transfer agents.55
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\54\ The term ``exchange'' is defined in Section 3(a)(1) of the
Exchange Act (15 U.S.C. 78c(a)(1)). The Commission is retaining the
existing provisions of Rule 0-10 that define as ``small'' those
exchanges that are exempt from the requirements of rule 11Aa3-1 (17
CFR 240.11Aa3-1) regarding the dissemination of transaction reports
and last sale data with respect to transactions in securities.
Currently, none of the eight registered exchanges is fully exempted
from the requirements of Rule 11Aa3-1 and, consequently, none is
considered a ``small business'' under Rule 0-10.
\55\ This amendment is consistent with the Commission's belief
that it is appropriate to exclude entities with significant economic
and financial resources from regulatory treatment as small
businesses under the Reg. Flex. Act. See 1981 Proposing Release, 46
FR at 19257.
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2. Securities Information Processors
The Commission is retaining in substantially the same form the
existing criteria for determining whether a securities information
processor is a ``small business.'' This includes the requirement that,
to be considered small, a securities information processor must have
serviced less than 100 interrogation devices or moving tickers during
the preceding fiscal year.56 As proposed, the Commission
also is modifying the definition of ``interrogation device'' for
purposes of Rule 0-10 to take into account new technologies used to
disseminate securities industry information to markets and market
participants through increasingly diverse methods. Accordingly, for
purposes of the amended small business definition, ``interrogation
device'' includes any device that may be used to read or receive
electronic information, including proprietary terminals or personal
computers via computer-to-computer interfaces, or gateway access. This
will include electronic devices that display securities information
such as quotations and indications of interest, as well as those that
display only last sale data or transaction reports.
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\56\ The term ``securities information processor'' is defined in
Section 3(a)(22) of the Exchange Act (15 U.S.C. 78c(a)(22)).
Currently, neither of the two registered exclusive securities
information processors is designated as a ``small business'' under
Rule 0-10.
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3. Transfer Agents and Issuers
The amended small business definition for transfer agents retains
the existing criteria based on volume of transfer business and number
of shareholder accounts.57 As discussed in the Proposing
Release, however, the Commission is adding a third criterion: whether a
transfer agent transfers only the items of ``small issuers,'' as
defined under Exchange Act Rule 0-10.58 The shares of small
issuers, as opposed to those of large publicly-traded companies,
typically are held by a small portion of the investing public and are
less likely to be the subject of a substantial amount of trading
activity. Thus, the activities of small transfer agents, many of which
are not subject to registration under Section 17A of the Exchange Act,
are not likely to have a substantial effect on the investing public or
the operation of the national clearance and settlement system. In
contrast, transfer agents for large companies whose shares are heavily
traded are likely to have a far greater effect on securities
processing, generally, and on the operation of the national clearance
and settlement system.59
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\57\ The term ``transfer agent'' is defined in Section 3(a)(25)
of the Exchange Act (15 U.S.C. 78c(a)(25)).
\58\ Small issuers, for this purpose, are issuers with total
assets of $5 million or less.
\59\ See Securities and Exchange Commission, Study of Unsafe and
Unsound Practices of Broker and Dealers 37-39 (1971).
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The Commission also is deleting language in Rule 0-10(a) that
currently limits the definition of small business, as it refers to
``issuer'' or ``person,'' to Sections 12, 13, 14, 15(d), or 16 of the
Exchange Act.60 This deletion reflects that, under the
amended rule, transfer agents who transfer items of issuers with total
assets greater than $5 million will not be considered small for
purposes of the Reg. Flex. Act. In addition, no transfer agent, broker-
dealer, exchange, clearing agency, securities information processor, or
bank municipal securities dealer will be classified as small if it is
affiliated with an issuer that does not qualify as small under Rule 0-
10. This change is consistent with the intent of the Reg. Flex. Act
that only businesses and organizations that are ``independently owned''
may qualify as small entities.61
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\60\ 15 U.S.C. 78l, 78m, 78n, 78o(d), and 78p.
\61\ See supra note 16. As noted above, amended Rule 0-10
provides that only those transfer agents that limit the number of
items they transfer, handle a limited number of shareholder
accounts, and transfer small issuer securities are considered small
businesses. Because this category is limited to those transfer
agents that would generally be exempt from registration under
Exchange Act Section 17A, the Commission believes that there will be
few, if any, registered transfer agents that qualify as small
businesses for purposes of the Reg. Flex. Act.
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4. Broker-Dealers
As discussed in the Proposing Release, the Commission is retaining
the capital standard currently set forth in Rule 0-10 that is used for
determining whether a broker 62 or dealer 63 is
deemed a ``small business.'' 64 The
[[Page 35513]]
Commission, however, is expanding the affiliation standard applicable
to broker-dealers. Under the amended definition, the Commission
estimates that approximately 13 percent of all registered broker-
dealers will be characterized as ``small.''
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\62\ The term ``broker'' is defined in Section 3(a)(4) of the
Exchange Act (15 U.S.C. 78c(a)(4)).
\63\ The term ``dealer'' is defined in Section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
\64\ Rule 0-10 under the Exchange Act (17 CFR 240.0-10(c))
currently defines ``small business'' to include any broker or dealer
that has total capital of less than $500,000 and that is not
affiliated with any person (other than a natural person) that is not
a small business under the rule.
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The affiliation test currently only looks to whether a broker-
dealer controls, is controlled by, or is under common control with, an
entity other than a small business or small organization. This test
focuses primarily on relationships between broker-dealers based on
voting control or the sharing of profits. As discussed in the Proposing
Release, the structure and operation of broker-dealer activities
suggest that other kinds of business relationships, such as the
contractual relationship between an introducing broker and its clearing
firm, can give rise to an opportunity by which a clearing firm can
exercise substantial influence over the business of its introducing
brokers. In order to conform better its affiliation standard to the
nature of business relationships that exist between broker-dealers, the
Commission is expanding the definition of affiliation applicable to
broker-dealers under Rule 0-10 to include arrangements whereby one
broker-dealer introduces transactions in securities to
another.65
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\65\ From a functional perspective, introducing and clearing
brokers act as a unit in handling a customer's account. In most
respects, introducing brokers are dependent on clearing firms to
clear and to execute customer trades, to handle customer funds and
securities, and to handle many back-office functions, including
issuing confirmations of customer trades and customer account
statements. The clearing agreement outlining the respective duties
and obligations of an introducing broker and its clearing firm
typically contains various requirements imposed by the clearing firm
with respect to the handling of customer accounts by the clearing
and introducing brokers, and the clearing firm's maintenance of
customer assets. Although the customer places its order directly
with the introducing firm, the Commission considers the account to
be an account of the clearing firm, which has primary legal
responsibility with respect to the handling of customer funds and
securities, and for sending account statements to the customer.
Thus, both introducing and clearing firms have a shared
responsibility for ensuring that a customer's account is handled
properly.
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This new affiliation standard is consistent with SBA regulations
addressing affiliation that consider whether individuals or firms have
identical or substantially identical business interests, as in the case
of firms that are economically dependent through contractual or other
relationships.66 As a practical matter, clearing and
introducing firms have identical business interests. In fact, most
introducing brokers could not be in business without the capital,
technology, and back-office support provided by the clearing firm.
Introducing and clearing brokers also have a shared legal
responsibility for ensuring that a customer's account is handled
properly.67
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\66\ See supra notes 19-20 and accompanying text (SBA size
standard considerations in determining ``small business concern'').
See also Report to Accompany H.R. 4660, H.R. Rep. No. 96-519, pt.1,
at 19 (1979) (suggesting that the definition of ``small businesses''
was intended to encompass businesses that are independently owned
and operated and not dominant in their field of operation).
Consistent with the Reg. Flex. Act definitions of small business,
SBA regulations that address affiliation consider whether
individuals or firms have identical or substantially identical
business interests, as in the case of firms that are economically
dependent through contractual or other relationships. 13 CFR
121.103(a).
\67\ As a legal matter, for purposes of the Securities Investor
Protection Act of 1970 (15 U.S.C. 78aaa et seq.) and the
Commission's financial responsibility rules, a customer is the
customer of the clearing firm. See Exchange Act Release No. 31511,
57 FR 56973 (Dec. 2, 1992).
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Under amended Rule 0-10, an introducing broker that introduces
transactions to a large clearing firm generally will not be considered
a ``small business'' for purposes of the Reg. Flex. Act. The Commission
acknowledged in the Proposing Release, however, that certain broker-
dealers that limit their activities to handling only investment company
securities or interests or participations in insurance company separate
accounts typically are small, sometimes one-person operations that
combine limited securities activities with broader tax, financial
planning, and insurance services. Accordingly, the Commission is
providing an exception from the affiliation standard for these broker-
dealers.
III. Effects on Competition and Regulatory Flexibility
Considerations
Section 23(a)(2) of the Exchange Act 68 requires the
Commission, in adopting rules under the Exchange Act, to consider the
impact a rule would have on competition and to refrain from adopting a
rule that would impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act. The
Commission is of the view that the amendments to Exchange Act Rule 0-10
will not impose any burden on competition. The rule changes will not
affect the manner in which any regulated entity conducts its business.
Moreover, entities that will no longer be classified as small
businesses for Reg. Flex. Act purposes should suffer no resulting
competitive disadvantage. Although the Commission considers the impact
of its rules and rule proposals on small entities, any modification or
accommodation relating to size is based on objective criteria such as
net assets and not whether an entity meets a ``small business''
definition under the Commission's Rules.
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\68\ 15 U.S.C. 78w(a)(2).
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As discussed in the Proposing Release, the Commission has conferred
with the SBA and the SBA concurs that no regulatory flexibility
analysis is required for the amendments.69 The definitions
of the terms ``small business'' do not impose any requirements on small
businesses. The definitions are interpretations of terms that identify
those entities that the Commission will study for Reg. Flex. Act
purposes when proposing and adopting rules, and are rules of agency
practice and procedure.
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\69\ See Proposing Release, 62 FR at 4113.
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IV. Statutory Authority
The Commission is amending Rule 157 (17 CFR 230.157), Rule 0-10 (17
CFR 240.0-10), Rule 0-10 (17 CFR 270.0-10), and Rule 0-7 (17 CFR 275.0-
7) pursuant to chapter 6 of title 5 of the United States Code
(particularly Section 601 thereof (5 U.S.C. 601)), and pursuant to
Section 19 of the Securities Act of 1933 (15 U.S.C. 77s), Section 23 of
the Securities Exchange Act of 1934 (15 U.S.C. 78w), Section 38 of the
Investment Company Act of 1940 (15 U.S.C. 80a-37), and Section 211 of
the Investment Advisers Act of 1940 (15 U.S.C. 80b-11).
Text of Rule Amendments
List of Subjects
17 CFR Parts 230 and 270
Investment companies, Reporting and recordkeeping requirements,
Securities.
17 CFR Part 240
Brokers, Reporting and recordkeeping requirements, Securities.
17 CFR Part 275
Investment advisers, Reporting and recordkeeping requirements,
Securities.
For the reasons set out in the preamble, Title 17, Chapter II of
the Code of Federal Regulations is amended as follows:
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
The authority citation for Part 230 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77s, 77sss, 78c,
78d, 78l, 78m, 78n, 78o, 78w,
[[Page 35514]]
78ll(d), 79t, 80a-8, 80a-24, 80a-29, 80a-30, and 80a-37, unless
otherwise noted.
* * * * *
Section 230.157 is amended by revising the section heading and
paragraph (b) to read as follows:
Sec. 230.157 Small entities under the Securities Act for purposes of
the Regulatory Flexibility Act.
* * * * *
(b) When used with reference to an investment company that is an
issuer for purposes of the Act, have the meaning ascribed to those
terms by Sec. 270.0-10 of this chapter.
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
3. The authority citation for Part 240 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee,
77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k,
78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d),
78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and
80b-11, unless otherwise noted.
* * * * *
4. Section 240.0-10 is amended to revise the section heading and
paragraphs (a), (b), (e), (g)(2), (g)(3), and (i); redesignate
paragraphs (h)(2) and (h)(3) as paragraphs (h)(3) and (h)(4),
respectively; and add paragraphs (h)(2), (j) and (k) to read as
follows:
Sec. 240.0-10 Small entities under the Securities Exchange Act for
purposes of the Regulatory Flexibility Act.
* * * * *
(a) When used with reference to an ``issuer'' or a ``person,''
other than an investment company, mean an ``issuer'' or ``person''
that, on the last day of its most recent fiscal year, had total assets
of $5 million or less;
(b) When used with reference to an ``issuer'' or ``person'' that is
an investment company, have the meaning ascribed to those terms by
Sec. 270.0-10 of this chapter;
* * * * *
(e) When used with reference to an exchange, mean any exchange
that:
(1) Has been exempted from the reporting requirements of
Sec. 240.11Aa3-1; and
(2) Is not affiliated with any person (other than a natural person)
that is not a small business or small organization as defined in this
section;
* * * * *
(g) * * *
(2) Provided service to fewer than 100 interrogation devices or
moving tickers at all times during the preceding fiscal year (or in the
time that it has been in business, if shorter); and
(3) Is not affiliated with any person (other than a natural person)
that is not a small business or small organization under this section;
and
(h) * * *
(2) Transferred items only of issuers that would be deemed ``small
businesses'' or ``small organizations'' as defined in this section; and
* * * * *
(i) For purposes of paragraph (c) of this section, a broker or
dealer is affiliated with another person if:
(1) Such broker or dealer controls, is controlled by, or is under
common control with such other person; a person shall be deemed to
control another person if that person has the right to vote 25 percent
or more of the voting securities of such other person or is entitled to
receive 25 percent or more of the net profits of such other person or
is otherwise able to direct or cause the direction of the management or
policies of such other person; or
(2) Such broker or dealer introduces transactions in securities,
other than registered investment company securities or interests or
participations in insurance company separate accounts, to such other
person, or introduces accounts of customers or other brokers or
dealers, other than accounts that hold only registered investment
company securities or interests or participations in insurance company
separate accounts, to such other person that carries such accounts on a
fully disclosed basis.
(j) For purposes of paragraphs (d) through (h) of this section, a
person is affiliated with another person if that person controls, is
controlled by, or is under common control with such other person; a
person shall be deemed to control another person if that person has the
right to vote 25 percent or more of the voting securities of such other
person or is entitled to receive 25 percent or more of the net profits
of such other person or is otherwise able to direct or cause the
direction of the management or policies of such other person.
(k) For purposes of paragraph (g) of this section, ``interrogation
device'' shall refer to any device that may be used to read or receive
securities information, including quotations, indications of interest,
last sale data and transaction reports, and shall include proprietary
terminals or personal computers that receive securities information via
computer-to-computer interfaces or gateway access.
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
5. The authority citation for Part 270 continues to read, in part,
as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39,
unless otherwise noted;
* * * * *
6. Section 270.0-10 is revised to read as follows:
Sec. 270.0-10. Small entities under the Investment Company Act for
purposes of the Regulatory Flexibility Act.
(a) General. For purposes of Commission rulemaking in accordance
with the provisions of Chapter Six of the Administrative Procedure Act
(5 U.S.C. 601 et seq.) and unless otherwise defined for purposes of a
particular rulemaking, the term small business or small organization
for purposes of the Investment Company Act of 1940 shall mean an
investment company that, together with other investment companies in
the same group of related investment companies, has net assets of $50
million or less as of the end of its most recent fiscal year. For
purposes of this section:
(1) In the case of a management company, the term group of related
investment companies shall mean two or more management companies
(including series thereof) that:
(i) Hold themselves out to investors as related companies for
purposes of investment and investor services; and
(ii) Either:
(A) Have a common investment adviser or have investment advisers
that are affiliated persons of each other; or
(B) Have a common administrator; and
(2) In the case of a unit investment trust, the term group of
related investment companies shall mean two or more unit investment
trusts (including series thereof) that have a common sponsor.
(b) Special rule for insurance company separate accounts. In
determining whether an insurance company separate account is a small
business or small entity pursuant to paragraph (a) of this section, the
assets of the separate account shall be cumulated with the assets of
the general account and all other separate accounts of the insurance
company.
(c) Determination of net assets. The Commission may calculate its
determination of the net assets of a group of related investment
companies based on the net assets of each investment company in the
group as of the end of such company's fiscal year.
[[Page 35515]]
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
7. The authority citation for Part 275 continues to read, in part,
as follows:
Authority: 15 U.S.C. 80b-2(a), 80b-3, 80b-4, 80b-6(4), 80b-6A,
80b-11, unless otherwise noted.
* * * * *
8. Section 275.0-7 is revised to read as follows:
Sec. 275.0-7. Small entities under the Investment Advisers Act for
purposes of the Regulatory Flexibility Act.
(a) For purposes of Commission rulemaking in accordance with the
provisions of Chapter Six of the Administrative Procedure Act (5 U.S.C.
601 et seq.) and unless otherwise defined for purposes of a particular
rulemaking proceeding, the term small business or small organization
for purposes of the Investment Advisers Act of 1940 shall mean an
investment adviser that:
(1) Has assets under management, as defined under Section
203A(a)(2) of the Act (15 U.S.C. 80b-3a(a)(2)) and reported on Form
ADV-T (17 CFR 279.3) or its most recent Schedule I to Form ADV (17 CFR
279.1), having a total value of less than $25 million, or such higher
amount as the Commission may by rule deem appropriate under Section
203A(a)(1)(A) of the Act (15 U.S.C. 80b-3a(a)(1)(A));
(2) Did not have total assets of $5 million or more on the last day
of the most recent fiscal year; and
(3) Does not control, is not controlled by, and is not under common
control with another investment adviser that has assets under
management of $25 million or more (or such higher amount as the
Commission may deem appropriate), or any person (other than a natural
person) that had total assets of $5 million or more on the last day of
the most recent fiscal year.
(b) For purposes of this section:
(1) Control means the power to direct or cause the direction of the
management or policies of a person, whether through ownership of
securities, by contract, or otherwise. Any person that directly or
indirectly has the right to vote 25 percent or more of the voting
securities, or is entitled to 25 percent or more of the profits, of
another person is presumed to control the other person.
(2) Total assets means the total assets as shown on the balance
sheet of the investment adviser or other person described above under
paragraph (a)(3) of this section, or the balance sheet of the
investment adviser or such other person with its subsidiaries
consolidated, whichever is larger.
Dated: June 24, 1998.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-17387 Filed 6-29-98; 8:45 am]
BILLING CODE 8010-01-M
