Rule 3a-4 Supporting Statement 2018

SUPPORTING STATEMENT
For the Paperwork Reduction Act Information Collection Submission for
RULE 3a-4
A.

JUSTIFICATION
1.

Necessity for the Information Collection

Rule 3a-4 (17 CFR 270.3a-4) under the Investment Company Act of 1940 (15 U.S.C. 80a)
(“Investment Company Act” or “Act”) provides a nonexclusive safe harbor from the definition of
investment company under the Act for certain investment advisory programs.

These programs,

which include “wrap fee” programs, generally are designed to provide professional portfolio
management services on a discretionary basis to clients who are investing less than the minimum
investments for individual accounts usually required by the investment adviser but more than the
minimum account size of most mutual funds.

Under wrap fee and similar programs, a client's

account is typically managed on a discretionary basis according to pre-selected investment
objectives.

Clients with similar investment objectives often receive the same investment advice

and may hold the same or substantially similar securities in their accounts.

Because of this

similarity of management, some of these investment advisory programs may meet the definition
of investment company under the Act.
In 1997, the Commission adopted rule 3a-4, which clarifies that programs organized and
operated in accordance with the rule are not required to register under the Investment Company
Act or comply with the Act's requirements. 1

These programs differ from investment companies

because, among other things, they provide individualized investment advice to the client.

1

The

Status of Investment Advisory Programs Under the Investment Company Act of 1940, Investment
Company Act Rel. No. 22579 (Mar. 24, 1997) [62 FR 15098 (Mar. 31,1997)] (“Adopting
Release”). In addition, there are no registration requirements under section 5 of the Securities
Act of 1933 for programs that meet the requirements of rule 3a-4. See 17 CFR 270.3a-4,
introductory note.

rule’s provisions have the effect of ensuring that clients in a program relying on the rule receive
advice tailored to the client’s needs.
For a program to be eligible for the rule’s safe harbor, each client’s account must be
managed on the basis of the client’s financial situation and investment objectives and in
accordance with any reasonable restrictions the client imposes on managing the account.

When

an account is opened, the sponsor 2 (or its designee) must obtain information from each client
regarding the client’s financial situation and investment objectives, and must allow the client an
opportunity to impose reasonable restrictions on managing the account. 3

In addition, the

sponsor (or its designee) must contact the client annually to determine whether the client’s
financial situation or investment objectives have changed and whether the client wishes to impose
any reasonable restrictions on the management of the account or reasonably modify existing
restrictions.

The sponsor (or its designee) must also notify the client quarterly, in writing, to

contact the sponsor (or its designee) regarding changes to the client’s financial situation,
investment objectives, or restrictions on the account’s management. 4
Additionally, the sponsor (or its designee) must provide each client with a quarterly
statement describing all activity in the client's account during the previous quarter.

The sponsor

and personnel of the client’s account manager who know about the client’s account and its
management must be reasonably available to consult with the client.

Each client also must

2

For purposes of rule 3a-4, 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.

3

Clients specifically must be allowed to designate securities that should not be purchased for the
account or that should be sold if held in the account. The rule does not require that a client be
able to require particular securities be purchased for the account.

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retain certain indicia of ownership of all securities and funds in the account.
2.

Purpose and Use of the Information Collection

The requirement that the sponsor (or its designee) obtain information about each new
client’s financial situation and investment objectives when their account is opened is designed to
ensure that the investment adviser has sufficient information regarding the client’s unique needs
and goals to enable the portfolio manager to provide individualized investment advice.

The

sponsor is required to contact clients annually and provide them with quarterly notices to ensure
that the sponsor has current information about the client’s financial status, investment objectives,
and restrictions on management of the account.

Maintaining current information enables the

portfolio manager to evaluate each client’s portfolio in light of the client’s changing needs and
circumstances.

The requirement that clients be provided with quarterly statements of account

activity is designed to ensure each client receives an individualized report, which the Commission
believes is a key element of individualized advisory services.
3.

Consideration Given to Information Technology

Quarterly statements to clients are generally in paper form and are mailed to clients, and
quarterly notices must be provided in writing.

However, rule 3a-4 gives sponsors flexibility in

the manner in which they comply with the requirements for the initial information collection or
annual client contact.

The Adopting Release specifically notes that the initial information

collection and annual client contact can be done in-person, by telephone or through
questionnaires. 5

4
5

The sponsor also must provide a means by which clients can contact the sponsor (or its designee).
See Adopting Release, supra note 1, at n.33 and text following n.36.

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4.

Duplication

The Commission periodically evaluates rule-based reporting and recordkeeping
requirements for duplication, and reevaluates them whenever it proposes a rule or a change in a
rule.

Rule 3a-4 does not require duplicative reporting or recordkeeping.
5.

Effect on Small Entities

The Commission does not believe that compliance with rule 3a-4 is unduly burdensome
for large or small entities.
investment advice. 6

The rule’s requirements are consistent with providing individualized

Moreover, sponsors that find the requirements of the rule to be overly

burdensome are not required to operate their investment advisory programs in reliance on the safe
harbor provided by the rule.

Failure to operate an investment advisory program in accordance

with rule 3a-4 does not necessarily indicate that the program is an investment company.
6.

Consequences of Not Conducting Collection

Rule 3a-4’s requirement for sponsors to obtain information regarding each new client’s
financial situation and investment goals is a one-time obligation incurred when a new client opens
an account.

The requirements for annual and quarterly client contact reflect the view that

without regular contact with clients, portfolio managers are unlikely to have current information
regarding each client’s financial situation and investment objectives, which the managers need in
order to provide individualized investment advice.

The requirement for quarterly account

activity statements also enables the portfolio manager to be familiar with the client’s account and
its

6

Rule 3a-4 is also consistent with a series of no-action letters the Commission’s staff issued before
the rule was adopted. Compliance with the rule generally should not be burdensome to those
sponsors that operated their programs in a manner consistent with these previously issued noaction positions. In addition, sponsors typically already provide quarterly statements to clients,
so the burden of the quarterly activity report is likely limited.

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management.

This requirement also provides current information to clients about their accounts,

which might prompt them to update the sponsor regarding changing financial situations or goals.
7.

Inconsistencies with Guidelines in 5 CFR 1320.5(d)(2)

None.
8.

Consultation Outside the Agency

The Commission proposed rule 3a-4 for public comment before its adoption and made
rule changes based on the comments it received from the public. 7 The Commission also
requested public comment on the collection of information requirements in rule 3a-4 before it
submitted this request for extension and approval to OMB.

The Commission received no

comments in response to this request.
The Commission and staff of the Division of Investment Management also participate in
an ongoing dialogue with representatives of the investment company industry through public
conferences, meetings, and informal exchanges.

These forums provide the Commission and the

staff useful means to identify and address paperwork burdens that may confront the industry.
9.

Payment or Gift

Not applicable.
10.

Confidentiality

Not applicable.
11.

Sensitive Questions

No information of a sensitive nature will be required under this collection of information.

7

See Status of Investment Advisory Programs under the Investment Company Act of 1940,
Investment Company Act Rel. No. 20260 (July 27, 1995) [60 FR 39574 (Aug. 2, 1995)]
(proposing release); Adopting Release, supra note 1.

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The information collection collects basic Personally Identifiable Information (“PII”) that may
include financial accounts and financial transactions.

However, the agency has determined that

the information collection does not constitute a system of record for purposes of the Privacy Act.
Information is not retrieved by a personal identifier. A System of Records Notice has been
published in the Federal Register at (SEC-69) 83 FR 6892 and can also be found at
https://www.sec.gov/about/privacy/secprivacyoffice.htm.. .
12.

Burden of Information Collection

The Commission staff estimates that 19,618,731 clients participate each year in
investment advisory programs relying on rule 3a-4. 8

Of that number, the staff estimates that

3,531,372 are new clients and 16,087,359 are continuing clients. 9

The staff estimates that each

year under the rule, investment advisory program sponsors engage in the following collections of
information and associated burden hours: 10
•

To prepare, conduct and/or review initial interviews with new clients:
1.5 hours:
80 minutes of professional time;
10 minutes of staff time.

•

To prepare, conduct and/or review annual interviews with continuing clients:
1 hour:
50 minutes of professional time;

8

These estimates are based on an analysis of the number of individual clients from Form ADV Item
5D(a)(1) and (b)(1) of advisers that report they provide portfolio management to wrap programs as
indicated in Form ADV Item 5I(2)(b) and (c), and the number of individual clients of advisers that
identify as internet advisers in Form ADV Item 2A(11). From analysis comparing reported
individual client assets in Form ADV Item 5D(a)(3) and 5D(b)(3) to reported wrap portfolio
manager assets in Form ADV Item 5I(2)(b) and (c), we discount the estimated number of
individual clients of non-internet advisers providing portfolio management to wrap programs by
10%.

9

These estimates are based on the number of new clients expected due to average year-over-year
growth in individual clients from Form ADV Item 5D(a)(1) and (b)(1) (about 8%) and an assumed
rate of yearly client turnover of 10%.

10

These estimates are based upon consultation with investment advisers that operate investment
advisory programs that rely on rule 3a-4.

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10 minutes of staff time.
•

To prepare and mail each quarterly client account statement, including the notice to update
information:
15 minutes: 15 minutes of staff time. 11
Based on the estimates above, the Commission estimates that the total annual burden of

the rule’s paperwork requirements is 41,003,148 hours. 12

We estimate that professional staff

performs approximately 17,943,292 of these burden hours at a total cost of $2.4 billion, 13 while
support staff performs approximately 23,059,856 of these burden hours at a total cost of $1.4
billion. 14

Thus, the Commission estimates the aggregate annual cost of the burden hours

associated with rule 3a-4 is $3.8 billion. 15
The estimate of average burden hours is made solely for the purposes of the Paperwork
Reduction Act.

The estimate is not derived from a comprehensive or even a representative

survey or study of Commission rules.

11

The staff bases this estimate in part on the fact that, by business necessity, computer records
already will be available that contain the information in the quarterly reports.

12

This estimate is based on the following calculation: (16,087,359 continuing clients x 1 hour) +
(3,531,372 new clients x 1.5 hours) + (19,618,731 total clients x (0.25 hours x 4 statements)) =
41,003,148 hours. We note that the breakdown of burden hours between professional and staff
time discussed below may not equal the estimate of total burden hours due to rounding.

13

The professional staff estimates are based on the following calculations: 17,943,292 hours =
(3,531,372 new clients x 1.3 hours) + (16,087,359 continuing clients x 0.83 hours); and
17,943,292 hours x $132/hour = $2,368,514,540. The per hour cost estimates are based on
figures for operations specialist positions found in SIFMA’s Management & Professional Earnings
in the Securities Industry 2013, modified to account for an 1800-hour work-year and inflation, and
multiplied by 5.35 to account for bonuses, firm size, employee benefits and overhead.

14

The support staff estimates are based on the following calculations: 23,059,856 hours = (3,531,372
new clients x 0.2 hours) + (16,087,359 continuing clients x 0.17 hours) + (19,618,731 total clients
x (0.25 hours x 4 statements); and 23,059,856 hours x $60/hour = $1,383,591,362. The per hour
cost estimates are based on figures for general clerk positions found in SIFMA’s Office Salaries in
the Securities Industry 2013, modified to account for an 1800-hour work year and inflation, and
multiplied by 2.93 to account for bonuses, firm size, employee benefits and overhead.

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Table 1: Summary of Revised Annual Responses, Burden Hours, and Burden Hour Costs
Estimates for Each Information Collection
IC

IC Title

IC1

Interview new
clients
IC2
Interview
continuing
clients
IC3
Prepare and
mail quarterly
account
statements
Total for all ICs

13.

Annual No. of Responses (in thousands)
Previously
Requested
Change
approved
0
3,531
3,531

Annual Time Burden (thousands of hrs)
Previously
Requested
Change
approved
7,377
5,297
-2,080

0

16,087

16,087

11,620

16,087

4,468

66,153

78,475

12,322

16,538

19,619

3,081

66,153

98,094

31,940

35,535

41,003

5,469

Cost to Respondents

Rule 3a-4 does not impose any paperwork related cost burden not discussed in item 12
above.

We expect that sponsors mail quarterly account statements to their clients in the ordinary

course of business and therefore we do not believe the requirement in rule 3a-4 to mail quarterly
client account statements or quarterly notices would impose additional postage or printing costs.
14.

Cost to the Federal Government

The rule imposes no costs on the federal government.
15.

Changes in Burden

The total annual hour burden of 41,003,148 hours represents an increase of 5,468,554
hours from the prior estimate of 35,534,594 hours.

This increase is a result of the increase in the

estimated number of clients, which was due to a change in the way the staff has made its
estimates as a result of recent changes in Form ADV that provide more detailed information about
this issue.

15

16.

Information Collection Planned for Statistical Purposes

This estimate is based on the following calculation: $3,752,105,902 = $2,368,514,540+
$1,383,591,362.

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Not applicable.
17.

Approval to Omit OMB Expiration Date

Not applicable.
18.
Exceptions to Certification Statement for Paperwork Reduction Act
Submissions
Not applicable.
B.

COLLECTIONS OF INFORMATION EMPLOYING STATISTICAL METHODS
Not applicable.

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