Investment Management Industry News Summary - April 2001

Investment Management Industry News Summary - April 2001

Publications

This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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SEC announces launch of web-based investor survey

April 30, 2001 2:39 PM

The SEC recently announced the launch of a web-based survey to learn more about how investors are using electronic media, including the Internet, to make investment decisions. The SEC survey will also explore investor knowledge and experience, investor expectations of brokerage firms, trading frequencies, and how investors analyze risk. The survey results are intended to provide the SEC with insights as it continues to develop programs and policies to help investors profit from technology while avoiding potential pitfalls. The survey, which takes about 15 minutes to complete, will be available until July 1, 2001. The survey will also be available on the websites of more than a dozen leading government, investor education, and financial services industry organizations to ensure the survey’s widest possible distribution among investors. The SEC retained an independent research firm to conduct the survey and to tabulate the responses for SEC analysis. Information from investors will be maintained on a strictly confidential and anonymous basis, and will not be used for any other purpose. Investors will not be asked to provide their names, addresses or any brokerage account information. The SEC will issue a report on the survey’s findings.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC issues further guidance on valuation of portfolio securities

April 30, 2001 2:31 PM

In a recent letter to the Investment Company Institute, the SEC’s chief counsel set forth the SEC staff’s views on the obligations of funds and their directors under the Investment Company Act of 1940 (the "1940 Act") to determine, in good faith, the fair value of a fund’s portfolio securities when market quotations are not readily available. The letter also provides the staff’s views on other topics, such as the valuation of securities traded on certain foreign exchanges and the inappropriate use of fair value pricing for securities for which market quotations are readily available.

Fair Value Pricing

  • The letter stated that funds may dilute the value of their shareholders' interests if they calculate their NAVs using closing prices that were established before a significant event has occurred. The letter emphasized the staff’s view that fair value pricing can protect long-term fund investors from short-term investors who seek to take advantage of funds as a result of significant events occurring after a foreign exchange or market closes, but before the funds' NAV calculation. In particular, the letter emphasized the following points with respect to fair value pricing:
  • For both exchange-traded and over-the-counter securities, if sales have been infrequent or there is a thin market in the security, further consideration should be given to whether, in fact, market quotations are "readily available." If it is decided that they are not readily available, the alternative method of valuation prescribed by the 1940 Act – "fair value as determined in good faith by the board of directors" – should be used.
  • Emphasis should be placed on foreign securities. Low trading volume of securities in some foreign markets raises issues as to the reliability of the market quotations and can trigger the requirement to fair value price those securities. Additionally, a fund must value a security using a fair value pricing methodology if a significant event (i.e., an event that will affect the value of a portfolio security) has occurred after the foreign exchange or market has closed, but before the fund's NAV calculation.
  • Similarly, if a U.S. market closes early on a given day, or if the market regularly closes before a fund's NAV calculation, and an event occurs that affects the value of a fund's portfolio security subsequent to that closing, but before the fund's NAV calculation (or, if trading in a security is halted during the trading day, and trading in that security does not resume prior to the close of the exchange or market) the last quotations prior to the trading halt would not be considered "readily available."
  • Funds are required under the 1940 Act to monitor continuously for events that might necessitate the use of fair value prices. Funds also should establish criteria for determining whether market quotations are readily available. Whether a particular event is a significant event depends on whether the event will affect the value of a fund's portfolio securities. Such events may relate to a single issuer or to an entire market sector, may include significant fluctuations in domestic or foreign markets, or may stem from occurrences not tied directly to the securities markets, such as natural disasters, armed conflicts, or significant governmental actions. Funds may consider establishing milestones or trigger points which also may signal that significant events have occurred since the close of the foreign exchange or market on which their portfolio securities trade.
  • Funds that automatically use market quotations to calculate their NAVs, without first verifying that the market quotations are readily available (by reviewing various factors, including whether the securities are thinly traded, sales have been infrequent, or other data exist that may call into question the reliability of the market quotations) cannot be assured that the resulting NAVs are accurate.
  • Funds are required to disclose the method used to value their portfolio securities (i.e., market value, fair value, or amortized cost) and the circumstances and effects of its use. Disclosure of fair value pricing procedures would be enhanced if funds followed the principles of plain English. Funds that are more likely to use fair value pricing should consider providing additional information to their shareholders (e.g., in shareholder reports) about the circumstances and effects of using fair value pricing. Such disclosure may result in fewer shareholder complaints and also may discourage arbitrage activity.

Other Valuation Matters

The letter also issued the following guidance on several other valuation matters:

  • Ongoing pricing responsibilities. Funds and their boards should regularly evaluate whether their pricing methodologies continue to result in values that funds might reasonably expect to receive upon a current sale, including assessing the availability and reliability of market quotations, regularly testing the accuracy of their fair value prices by comparing them with values that are available from other sources and making any appropriate adjustments to their fair valuation methodologies. Funds should evaluate the appropriateness of their fair value methodology for foreign securities by reviewing next-day opening prices or actual sales of the securities on the foreign exchange or market.
  • The "good faith" requirement. In previous guidance, it has been established that fund boards must determine, in "good faith," the fair value of portfolio securities for which market quotations are not readily available. A board acts in good faith when its fair value determination is the result of a sincere and honest assessment of the amount that the fund might reasonably expect to receive for a security upon its current sale, based upon all of the appropriate factors that are available to the fund. Furthermore, a board acts in good faith when it continuously reviews the appropriateness of the method used in determining the fair value of the fund's portfolio securities. However, a fund’s board generally would not be acting in good faith if the board knows or has reason to believe that its fair value determination does not reflect the amount that the fund might reasonably expect to receive for the security upon its current sale (or if the board acts with reckless disregard as to whether the determination reflects such amount).
  • Trading limits on individual foreign securities. Certain foreign securities exchanges have mechanisms in place that confine any one day's price movement in an individual security to a pre-determined range, based on that day's opening price. These mechanisms prevent the price for that security from moving outside of two, pre-determined prices ("limit down" and "limit up") on any given day. These limitations may effectively end trading in a security on a given day because they restrict the price of the security from rising or falling beyond the limit up or limit down price. The collars could prevent a security from trading for days or even weeks. Under these circumstances, funds must determine the fair values of their portfolio securities if the limit up or limit down prices of those securities have been reached, and no trading has taken place at those prices. The fact that trading has not yet resumed and that no two-sided market exists demonstrates that market quotations are not readily available. If trading has taken place at the limit down or limit up price, funds should consider whether market quotations are readily available for those securities by evaluating, among other things, the frequency of those trades and other factors that may call into question the validity and reliability of the prices at which those trades occurred.
  • The inappropriate use of fair value pricing when market conditions are readily available. Funds must exercise reasonable diligence to obtain market quotations for their portfolio securities before they may properly conclude that market quotations are not readily available. If, for example, a fund obtains market quotations for a portfolio security from one source and determines that they are unreliable, the fund should diligently seek to obtain market quotations from other sources, such as other dealers or other pricing services, before concluding that market quotations are not readily available.
 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

ICI issues comments on SEC electronic recordkeeping proposal

April 26, 2001 2:45 PM

The ICI filed a comment letter on the SEC’s proposal to amend rules under the 1940 Act and the Investment Advisers Act of 1940 to expand the circumstances under which funds and advisers may use electronic storage media to maintain and preserve records. The letter generally supports the SEC’s proposal, but makes several technical recommendations to make the rules more workable and to ensure consistency in the recordkeeping process.

The ICI’s letter points out that the SEC’s proposal does not address recordkeeping requirements contained in other rules under the Investment Company Act, such as rules relating to money market funds and mutual fund codes of ethics. The letter cautions that if the SEC intends that its proposed standards be the exclusive means by which funds and advisers could comply with the E-SIGN legislation’s standards of accuracy and accessibility, then it is all the more imperative that it clarify the status of such other recordkeeping requirements.

The letter also reminds the SEC of its previously proposed amendments (never adopted) to a rule under the Securities Exchange Act of 1934 which would have allowed registered transfer agents to use micrographic or electronic storage media to produce and preserve required records. Since E-SIGN will permit transfer agents to use electronic storage media as of June 1, 2001, the letter encourages the SEC to clarify what standards will apply to such recordkeeping, adding that any such standards should be consistent with those for fund and adviser records. ICI Comment Letter dated April 19, 2001 re: Electronic Recordkeeping by Investment Companies and Investment Advisers (File No. S7-06-01).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Federal district court enjoins fund complexes from launching S&P 500 exchange-traded funds

April 26, 2001 2:42 PM

The U.S. District Court for the Southern District of New York granted a request by the parent of Standard & Poor’s, for a permanent injunction to bar the launch of a fund company’s exchange traded fund (EFT) products based on the S&P indexes. Standard & Poor’s parent company argued successfully that the company did not have the right under existing license agreements to use the S&P name and underlying data on the new products. The judge noted that the issuance of the EFTs would go "beyond the terms and scope" of the license, thereby breaching the contract and infringing Standard & Poor’s trademark rights. The decision casts doubt on whether a fund company can add an exchange-traded share class to an existing mutual fund without the approval of the index provider. Such approvals are likely to require renegotiating licensing deals and possibly higher fees paid by the money manager to the index provider. The Wall Street Journal, April 26, 2001 (p. C15).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Investment Counsel Association of America ("ICAA") seeks SEC clarification of proposed access to adviser firm computers

April 23, 2001 2:59 PM

On April 17, 2001, the ICAA asked the SEC for a clarification of proposed rule changes that, without further interpretation, could give the SEC examination staff unlimited access to an adviser firm’s computers.

The ICAA made the statement in a comment letter to the SEC regarding the proposed amendments to rule 204-2 under the Investment Advisers Act of 1940, as amended (the "Advisers Act"). The amendments, which were authorized by the Electronic Signatures in Global and National Commerce Act enacted on June 30, 2000, would expand the ability of advisers to maintain records electronically, with certain safeguards.

A proposed new condition of maintaining electronic records, the ICAA explained, would be a requirement to provide the SEC examination staff with means to access, search, view, sort, and print the records. The condition, if adopted, would apply to both electronic storage and micrographic storage.

Given confidentiality and privacy concerns, the ICAA stated that it was uncomfortable with the notion of providing SEC examination staff with unlimited access to firm computers. The group sought clarification regarding the limited nature of this condition, and clarification that the proposed condition would not implicitly require investment advisers to program special functionality into existing computer systems.

The ICAA also raised concerns about a proposed amendment to rule 204-2 that would require advisers who maintain electronic records to provide those records within one business day after a request for them by SEC examination staff. Currently, the standard, under SEC no-action letters, is "promptly," which is interpreted to mean within 24 hours. However, the ICAA emphasized that adviser firms generally work cooperatively with the SEC examiners to discuss which documents will be produced immediately or on the first day of the exam and which documents will require additional time. Arguing that this practice is reasonable, appropriate, and well-established, the ICAA asked that the one-business-day turnaround requirement be dropped from the proposed rule.

In other comments, the ICAA generally lauded the proposed amendments to the recordkeeping rules because the changes would explicitly permit advisers to convert paper records into electronic format and to retain them electronically. The ICAA found the proposed changes would make document storage more convenient, efficient, and effective, as well as potentially providing greater record security than paper storage and providing a collateral environmental benefit.

Finally, the ICAA concurred with the SEC position in omitting any requirement that advisers preserve electronic records in non-rewriteable, non-erasable ("WORM") format. According to the ICAA, most investment advisers would have to make substantial investments in new technology to preserve documents in a WORM format. Securities Regulation & Law Report, April 23, 2001.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC approves proposed changes to National Association of Securities Dealers, Inc. ("NASD") rule 2330(f)(2) relating to performance fees

April 21, 2001 3:10 PM

On February 15, 2001, the SEC approved amendments to NASD rule 2330(f)(2), to permit NASD members and associated persons that act as investment advisers to share in customer account profits and gains, subject to the provisions of rule 205-3 under the Advisers Act. The amendments are effective as of April 21, 2001.

NASD rule 2330(f) prohibits members and persons associated with members from sharing in customer account profits and gains except under certain conditions. Subparagraph (f)(1) permits sharing in customer account profits and gains if the member has authorized it and the sharing is proportionate to the member’s or associated person’s contributions to the account.

Subparagraph (f)(2) also permits members or registered representatives to charge a performance fee (an advisory fee based on a percentage of the capital gains or capital appreciation of an account), under the conditions provided for in rule 2330(f)(2). The conditions provided in rule 2330(f)(2) have always closely tracked the requirements of rule 205-3 under the Advisers Act. However, effective August 20, 1998, the Commission amended rule 205-3 to provide greater flexibility in structuring performance fee arrangements with clients who are financially sophisticated or have the resources to obtain sophisticated financial advice regarding these arrangements. Generally, rule 205-3 permits an investment adviser to enter into an investment advisory contract that provides for compensation to the investment adviser on the basis of a share of the capital gains or the capital appreciation of the client’s funds, provided that the client entering into the contract is a "qualified client." Because NASD had specifically incorporated the requirements of rule 205-3 into NASD rule 2330(f)(2) rather than only referencing the rule generally, upon the amendment of rule 205-3, NASD rule 2330(f)(2) and rule 205-3 were no longer consistent.

To restore consistency under current requirements and ensure consistency in the future if rule 205-3 is amended, the NASD has amended rule 2330(f)(2) to permit members and their associated persons that act as investment advisers (whether or not registered as such) to share in customer account profits and gains if the member or person associated with a member seeking such compensation (1) obtains prior written authorization from the member carrying the account and (2) complies with the provisions of rule 205-3 under the Advisers Act. Accordingly, rule 2330(f)(2) is amended to eliminate the specific conditions of rule 205-3 set forth previously in the rule and to incorporate, by reference, the terms of rule 205-3, as it may be amended from time to time. Thus, in the future, rule 2330(f)(2) will automatically conform to any subsequent amendments by the Commission to rule 205-3.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Paul Roye addresses new fund directors

April 13, 2001 3:49 PM

In an April 13, 2001 address to an Investment Company Institute ("ICI") workshop for new fund independent directors, Paul Roye, director of the SEC's Division of Investment Management, told his audience that they were the principal guardians of investors'trust in the fund industry. He reminded them that fund directors are there to ensure that mutual funds earn acceptable returns, that their fees are reasonable, that fund assets are safe and that investors receive the reliable services promised.

In addition, Mr. Roye said the independent directors are responsible for monitoring conflicts between the interests of a fund's investment adviser and shareholders, and representing the interest of shareholders. To the extent that fund directors fail to perform their "watchdog" duties, Mr. Roye warmed, there would be less flexibility and more government intervention in the regulatory regime.

Mr. Roye praised the ICI's best practice recommendations for fund governance, strongly urging the independent directors to embrace them in reviewing their fund governance framework. He exhorted them to consider carefully the ICI recommendation that they have independent legal counsel. Mr. Roye noted that SEC rules on fund governance adopted last year do not require that independent directors have counsel; rather, that if they have counsel that counsel must be independent.

Mr. Roye also suggested that the independent directors focus on the important issues, such as the impact of fees and expenses on shareholders, and compliance and internal controls.

With respect to fees, Mr. Roye related that the results of the division’s recent report on mutual fund fees suggest that, in certain instances, economies of scale may be experienced primarily at the fund family level and only to a lesser extent or not at all the fund level. Mr. Roye stressed that if a fund or fund family is experiencing economies of scale, fund directors have an obligation to ensure that fund shareholders share in the benefits of the reduced costs. For example, fund directors could attempt to satisfy this obligation by requiring that he adviser's fees be lowered, breakpoints be included in the adviser’s fees, or that the adviser provide additional services under the advisory contract.

In addition, Mr. Roye underscored the conflict of interest for which independent directors provide an independent check upon fund management: an investment adviser has an incentive to charge the highest possible fee for its services, while the fund and its shareholders wish to pay the lowest amount of fees possible because the fees directly reduce a fund’s return on its investments.

Accordingly, the 1940 Act requires that the majority of a fund’s independent directors the approval and renewal of advisory contracts rule 12b-1 plans.

Another item that fund directors have a duty to monitor Mr. Roye said, is the cost of the fund's portfolio transactions, which are reflected in the amount paid when the fund buys or sells portfolio securities. In reviewing these costs directors should pay particular attention to soft dollar practices and directed brokerage arrangements. Although directed brokerage does not involve the conflicts posed by soft dollars, it does raise issues related to how a fund’s assets are being expended and other issues, including disclosure.

On the topic of internal controls, Roye urged fund directors to talk with compliance personnel and the fund’s independent accountants to gain an understanding of how the fund’s compliance program is structured and the nature of the internal controls system.

According to Mr. Roye good internal controls are exceedingly important in the area of valuation and pricing. Under the 1940 Act, when market quotes are not readily available for the fund's portfolio securities, the fund board must determine the fair value of the securities. In this area fund directors should:

  • receive periodic reports from fund management that discuss the functioning of the valuation process and that focus on issues and valuation problems that have arisen,
  • ensure that appropriate operational procedures and supervisory structures are in place with respect to both "market value" and "fair value" determinations,
  • ensure that even pricing data received from third party sources, such as pricing services and dealers, are subject to appropriate controls,
  • ensure the incorporation of controls at each level of the valuation process and
  • ensure that periodic cross-checks or prices received from pricing services are conducted.
 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC staff provides guidance on Regulation S-P

April 11, 2001 3:41 PM

The Division of Investment Management has issued interpretive guidance to investment companies and investment advisers with respect to Regulation S-P, which governs the privacy of consumer financial information. The guidance is in question and answer format.

The staff advised that Regulation S-P does not apply to hedge funds or other financial institutions that are excluded from regulation under sections 3(c)(1) or (c)(7) of the Investment Company Act of 1940 (the "1940 Act").

A wrap account client having a written contract with the account sponsor will be deemed to have a customer relationship with the account’s investment adviser also under Regulation S-P. An investment adviser that has institutional clients, such as pension plans, does not have to provide privacy notices to such clients under Regulation S-P. References to "customers" or "consumers" in Regulation S-P relate only to individuals.

An individual who purchases fund shares through a broker-dealer is considered a customer of the fund under Regulation S-P even if the fund has no direct contact with the individual, unless the broker-dealer is the record holder of the shares for the benefit of the individual.

Initial or annual privacy notices may be sent with other documents as long as the notices are clear and conspicuous and not hidden in other information. A privacy notice that is provided jointly by multiple financial institutions in a fund complex need not separately name each institution to which the privacy policy applies. However, the notice must identify those financial institutions that are covered by the policy as members of the fund complex. For example, the staff notes that a privacy policy for the "ABC fund complex" could state that it applies to all funds with the ABC name. A fund may satisfy the annual privacy notice requirement by delivering the notice with documents that are delivered to multiple shareholders at the same address, even if those documents are not covered by the SEC’s "householding" rules. However, the fund must first obtain consent to "household" those documents in the same manner as required under the "householding" rules.

A fund may, in certain circumstances, household the initial privacy notice that must be sent to existing customers by July 1, 2001. The staff advised that it would not recommend enforcement action if, prior to July 1, 2001, a fund households initial privacy notices in the manner provided for householding annual privacy notices or for documents that do not fall under the householding rules. A fund may also deliver an annual notice with its annual report or proxy statement.

A fund may deliver to a customer with multiple accounts a single initial or annual privacy notice that applies to all accounts as long as the notice makes clear to which accounts it applies, is accurate with respect to the privacy policies applicable to each account and the customer can reasonably be expected to receive actual notice in writing with respect to each account.

The Gramm-Leach Bliley Act of 1999 requires, after July 1, 2001, that a fund provide an initial notice to customers no later than the time the customer relationship is established. A fund may not provide the initial notice after a customer invests. A notice that is provided with a prospectus and confirmation would have to be provided to the investor no later than the trade date.

Regulation S-P provides certain exceptions to the delivery rule to provide that a fund may provide the initial privacy notice within a reasonable time after it establishes a customer relationship if the establishment of the relationship is not at the customer’s election, the notice would substantially delay the transaction and the customer has agreed to receive the notice at a later time, or a nonaffiliated broker or dealer establishes a customer relationship between the fund and a customer without the fund’s prior knowledge. SEC Today, April 11, 2001.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

National Adjudicatory Council ("NAC") revises the NASD Sanction Guidelines

April 10, 2001 3:37 PM

The National Adjudicatory Council (NAC) has revised the NASD Sanction Guidelines (the "Guidelines"). The various bodies that adjudicate disciplinary matters use the Guidelines to determine appropriate remedial sanctions. The NASDR, SEC staff and respondents also use the Guidelines to craft settlements in disciplinary matters. The NAC revised the introductory section, amended individual guidelines, and added several new guidelines. As with prior versions of the Guidelines, in this edition, the NAC does not prescribe fixed sanctions for particular violations. Rather, the NAC encourages adjudicators to exercise discretion and consider the unique facts and circumstances of each particular case.

The revised Guidelines supersede guidelines previously published by the NAC and referenced in prior NASD Notices to Members. The revised Guidelines are effective as of April 10, 2001, and apply to all actions as of that date, including pending disciplinary actions.

The revised Guidelines will be available on the NASD Regulation web site. The Guidelines will also be available, within the next two months, for purchase in hard-copy format for $35 by calling NASD MediaSource at (240) 386-4200.

Questions concerning this Notice may be directed to Carla Carloni, Associate General Counsel, Office of General Counsel, NASD Regulation, at (202) 728-8019. NASD Notice to Members, April, 2001.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC to consider ICI’s petition on the definition of "Investment Company"

April 9, 2001 2:49 PM

On April 5, 2001, SEC Acting Chairman Laura Unger said that the SEC staff most likely will present a petition by the Investment Company Institute ("ICI") concerning the definition of investment company to the SEC for consideration in the next month or so.

At issue is whether the definition of investment company encompasses FOLIOfn ("Folio") and any similar companies that sell baskets or portfolios of stocks. Ms. Unger pointed out that Folio is registered as a broker-dealer. She added that the question is whether the Folio has investment company or investment adviser characteristics.

The ICI petitioned the commission on March 28, 2001 to adopt a specific definitional rule clarifying that certain portfolio investment programs form "investment companies" within the meaning of the Investment Company Act of 1940 (the "1940 Act") (see below Industry News Summary, week of 04/07/01-04/13/01).

The rule advanced by the ICI would define an investment company to be any group of persons who purchase a pre-selected portfolio of securities with characteristics demonstrating investment management by others. The rule would require that such companies be registered and regulated under the 1940 Act and that the offering and sale of their shares be registered under the Securities Act of 1933 (the "Securities Act").

Folio has argued that its "folio" product is distinguishable from a mutual fund. Folio claims that, unlike a mutual fund, with a folio:

  • investors own the individual stocks comprising the folio,
  • investors can buy and sell the stocks to customize the folio,
  • investors can vote their shares.

In addition, Folio charges no loads and no commissions, offering folios only on a flat fee basis.

While the ICI petition is recent, Ms. Unger stated that the SEC has been looking at this issue for some time. She also indicated that the SEC is likely to focus on investor protection issues in this matter. Securities Regulation and Law Report, April 9, 2001.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

ICI submits rulemaking petition to regulate portfolio investment programs

April 9, 2001 8:45 AM

The ICI has submitted a rulemaking petition to the SEC seeking the adoption of a rule to clarify that portfolio investment programs are investment companies for purposes of the 1940Act. The proposal is aimed at sponsors such as FOLIOfn Investments, Inc., Netfolio, Inc. and others that are expected to launch similar portfolio investment programs. The ICI maintains that, without appropriate regulation, this new wave of investment vehicles could undermine the investor protections provided by the regulatory framework for investment companies and their investment advisers.
The ICI believes that these investment programs pose the same risks that investment company regulation is intended to prevent such as self-dealing, overreaching in fees and abuses in disclosure and advertising. Future sponsors may not have the same level of integrity as the current sponsors, the ICI observed. The ICI urges the SEC to assert jurisdiction over these programs under both the Securities Act of 1933 and the 1940 Act while they are in an early state. By acting now, the ICI said the SEC can avoid trying to re-regulate this "sub-industry" at a later date when it is more entrenched in opposition to investor protections.

The ICI included a draft rule along with its petition. The draft rule would include within the definition of investment company any group of persons that purchase a preselected portfolio of securities from a program that includes certain features. Those features include the offering of a pre-selected portfolio of securities that reflect a model portfolio based on stated investment objectives, policies or criteria.

The definition also includes programs that periodically review the model portfolio to determine whether changes should be made to satisfy a stated investment objective or strategy and either add or subtract securities or change the relative weighting of securities within the portfolio. The third feature of the proposed rule’s definition is the provision of a service that lets investors execute transactions in securities to purchase the pre-selected portfolios and to incorporate periodic changes in their portfolios.

The ICI added that the requirements of the 1940 Act might have to be revised through exemptions to permit these portfolio investment programs to operate. The rule is not intended as an exclusive definition, according to the ICI, so an investment program that does not meet all of the conditions of the rule may still qualify as an investment company.

To bolster its argument that these programs should be regulated, the ICI noted that the pre-packaged portfolios use names and investment objectives that mirror traditional investment companies. The sponsors periodically update the portfolios as do professional investment managers and promote the performance of the portfolios. None of the sponsors’ sites states that holders of the portfolios do not receive the regulatory protections provided to mutual fund investors, according to the ICI.

The ICI notes that other investment vehicles, such as variable insurance products, have adapted to the 1940 Act. The burdens of complying with the 1940 Act are borne by the rest of the investment company industry, the ICI stated, and these portfolio investment programs should do the same in order to prevent the erosion of the statutory protections for investors who rely upon professional management. SEC Today, April 3, 2001.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Trade group pushes SEC to allow hedge fund advertising

April 8, 2001 3:04 PM

The Managed Funds Association ("MFA") is finalizing a proposal to the SEC that would enable hedge funds to advertise. The proposal, which is expected to be submitted mid-May, 2001 and is the MFA’s first attempt to open the advertising door for hedge funds, revisits Regulation D under the Securities Act, which prevents hedge funds and private placement vehicles from advertising in the mass media. MFA’s proposal would allow hedge fund managers to place tombstone-like ads, which would consist of the name of the fund, minimum for investment, strategy and sector of investing. The bare-bones tombstones would contain a warning stating that, "This is a limited offering. Shares will only be given to accredited investors." The MFA emphasizes that it is not seeking permission to allow hedge fund managers to launch print and television campaigns. SEC officials offered no comments on this proposal. Fund Action, April 8, 2001.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

NASDR issues policy statement regarding general suitability rule 2310 and online communications

April 6, 2001 9:15 AM

In light of the dramatic increase in the use of the Internet for communication between brokers/dealers and their customers, NASDR issued a policy statement on March 19, 2001 to provide members with guidance concerning their obligations under the National Association of Securities Dealers, Inc. ("NASD") general suitability rule, rule 2310, in the current electronic environment.

The policy statement briefly discusses some of the issues created by the intersection of online activity and the suitability rule. The policy statement then provides examples of electronic communications that NASDR considers to be either within or outside the definition of "recommendation" for purposes of the suitability rule. In addition, the policy statement sets forth guidelines to assist members in evaluating whether a particular communication could be viewed as a "recommendation," thereby triggering application of the suitability rule.

  • NASDR emphasizes, however, that this current policy statement does not
  • alter member obligations under the suitability rule or
  • establish a "bright line" test for determining whether a communication does or does not constitute a "recommendation" for purposes of the suitability rule.
  • The policy statement emphasizes that no single factor discussed below, standing alone, necessarily dictates the outcome of the analysis.

There has been much debate recently about the application of the suitability rule to online activities. Two major questions have arisen: first, whether the current suitability rule should even apply to online activities, and, second, if so, what types of online communications constitute "recommendations" for purposes of the rule.

In answer to the first question, NASDR believes that the suitability rule applies to all "recommendations" made by members to customers—including those made via electronic means' to purchase, sell, or exchange a security. Electronic communications from broker/dealers to their customers clearly can constitute "recommendations." The suitability rule, therefore, remains fully applicable to online activities in those cases where the member "recommends" securities to its customers.

With regard to the second question, NASDR does not seek to identify in this policy statement all of the types of electronic communications that may constitute "recommendations." As NASDR has often emphasized, the test for determining whether any communication (electronic or traditional) constitutes a "recommendation" remains a "facts and circumstances" inquiry to be conducted on a case-by-case basis.

NASDR also recognizes that many forms of electronic communications defy easy characterization. The policy statement emphasizes that the determination of whether a communication is a "recommendation" depends on the content, context and presentation of the particular communication or set of communications. An important factor in this regard is whether - given its content, context, and manner of presentation - particular communication from a broker/dealer to a customer reasonably would be viewed as a "call to action" or suggestion that the customer engage in a securities transaction. Members should bear in mind that an analysis of the content, context and manner of presentation of a communication requires examination of the underlying substantive information transmitted to the customer and consideration of any other facts and circumstances, such as any accompanying explanatory message from the broker/dealer. Another principle that members should keep in mind is that, in general, the more individually tailored the communication to a specific customer or a targeted group of customers about a security or group of securities, the greater the likelihood that the communication may be viewed as a "recommendation." NASD Notice to Members 01-23, April 2001.

 

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC emphasizes that investment advisers must keep examiners informed during compliance examinations

April 2, 2001 3:07 PM

On March 27, 2001, John Walsh, chief counsel in the SEC’s Office of Compliance Inspections and Examinations ("OCIE") advised firms that, when an investment adviser firm is undergoing a compliance examination by SEC staff, it is critical for the firm to keep the staff well informed on how document production and other aspects of the exam are progressing. Speaking at the Investment Adviser Compliance Summit in Washington, D.C., Mr. Walsh elaborated that employees of an adviser firm should view the examination—also called an "inspection"—as a dialogue between the firm and the SEC staff.

Mr. Walsh explained that OCIE inspects investment advisers and investment company complexes on a five-year cycle. OCIE’s first visit to an adviser firm comes without notice. For later inspections, the firm is often given advance notice, but not necessarily, depending on what has prompted the inspection. An inspection that is prompted by suspicion of wrongdoing, for instance, is more likely to be done without notice than an exam that is part of the regular exam cycle.

Mr. Walsh suggested that an adviser should document the entire internal audit process, including discussing which recommendations that emerged from it were followed and which were not followed. Mr. Walsh stated that the SEC is very interested in internal audit reports, noting that the SEC staff looks at documents produced in internal audits because the staff views an internal audit as part of the adviser’s compliance program. He told the audience that an internal audit is defined broadly and would include anything that is done voluntarily to test internal compliance systems.

Mr. Walsh also said that, if the SEC staff sees in an internal audit report that a firm had securities law violations, but also sees that the violations have been corrected, the staff will not cite the firm for the violation in a deficiency letter. Such a letter is the SEC’s post-examination notice to an adviser of deficiencies found in an exam.

Mr. Walsh noted that the SEC does try to respect the attorney-client privilege. When the privilege is claimed by an adviser, he said, the SEC will look at the firm’s claim on a document-by-document basis. Securities Regulation and Law Report, April 2, 2001.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.