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.
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SEC staff concurs that non-U.S. investments are “capital preservation” investments for purposes of the research and development company exemption
April 22, 2007 1:08 PM
In a recent no-action letter, the staff of the SEC’s division of investment management concurred that certain non-U.S. investments are “capital preservation” investments for purposes of Rule 3a-8 under the Investment Company Act of 1940 (the “1940 Act”).
In granting the no-action relief, the SEC staff noted that:
Ark Therapeutics Group plc; SEC No Action Letter, Ref. No. 20045251958; File No. 132-2
SEC Brings Administrative Proceedings Against Broker-Dealer Based on Failure to File Suspicious Activity Reports Required by Bank Secrecy Act
April 20, 2007 10:54 AM
The SEC has begun an administrative proceeding against a registered broker-dealer firm and its principal alleging that the parties aided and abetted and caused a pump-and-dump scheme involving the securities of a non-U.S. corporation (the Company), and failed to file Suspicious Activity Reports (“SARs”) reporting suspicious transactions, in violation of the firm’s record-keeping obligations. The Commission has already obtained injunctive relief against the former chief executive officer of the Company that was the subject of the alleged scheme for violations of the antifraud, registration and reporting provisions of the federal securities laws in connection with his role in the pump and dump scheme. According to press reports, this case marks the first time the SEC has brought an action alleging a violation of the Patriot Act for failure to report suspicious transactions.
The SEC asserts that between February 2002 and July 2003, the broker-dealer and its principal executed numerous trades in Company stock for three companies located in the British Virgin Islands (BVI Companies), despite obvious red flags. Specifically, on several occasions, the CEO of the Company allegedly gave the broker-dealer and its principal orders for the BVI Companies’ accounts, and the orders were filled, even though the foreign-based accounts required the written approval of at least two authorized individuals before any transaction could occur, and the CEO was not an authorized signatory. According to the SEC, during the relevant time period, the broker-dealer and its principal executed more than 200 trades in Company stock for the BVI Companies’ accounts, which generated approximately $2.5 million in proceeds. The SEC also alleges that the broker-dealer failed to report suspicious transactions in the Company stock by filing SARs with the FinCEN as required by regulations implementing the Bank Secrecy Act, as amended by the USA Patriot Act.
In the Matter of Park Financial Group, Inc. and Gordon C. Cantley, Sec. Exch. Act Rel. No. 55614 (Apr. 11, 2007) available at http://www.sec.gov/litigation/admin/2007/34-55614.pdf
SEC Begins Administrative Proceedings Against Manager for Failure to Disclose Personal Stock Trades
April 20, 2007 10:51 AM
The SEC has instituted administrative and cease-and-desist proceedings against a former portfolio manager of a registered investment adviser. The SEC alleges that, from 1999 to 2003, the former manager concealed his personal securities trading, including trading in stocks held by mutual funds he managed at the time, by failing to disclose his trades and falsifying internal reports. According to the SEC, during the period in question, the former manager executed but failed to disclose approximately 3,500 trades in public company stocks and made about $410,000 in profit from these trades. The SEC asserts that through this conduct the manager willfully violated Section 17(j) of the Investment Company Act of 1940 and Rules 17j-1(b) and 17j-1(d). A hearing is to be scheduled before an administrative law judge.
In the Matter of Geoffrey Brod, Inv. Adv. Act Rel. No. 2600 (Apr. 9, 2007) available at http://www.sec.
No-Action Letter Regarding Soft Dollar Arrangement
April 20, 2007 10:47 AM
The Staff of the SEC’s Division of Market Regulation has said that it would not object if certain research vendors participating in a broker-dealer’s client commission arrangements receive compensation for research services from credits derived from client commissions without registering as broker-dealers.
The Staff’s no-action position was based on a number of facts and representations set forth no-action request, particularly the following:
The SEC Staff no-action letter is available at http://www.sec.gov/divisions/marketreg/mr-noaction/
SEC Staff Announces Availability of Anti-Money Laundering Compliance Tool
April 20, 2007 10:42 AM
On April 16, 2007, the Securities and Exchange Commission's staff announced the availability of a new compliance tool to assist anti-money laundering (“AML”) compliance efforts by broker-dealers. The “AML Source Tool” is a research guide developed by the SEC's Office of Compliance Inspections and Examinations (“OCIE”), compiles and organizes key AML laws, rules and related guidance applicable to broker-dealers and provides links to these materials to promote easy accessibility. The Commission acknowledged assistance from the staff of the U.S. Treasury Department's Office of the Financial Crimes Enforcement Network (“FinCEN”) and Office of Foreign Assets and Control (“OFAC”), as well as from the NASD and NYSE, in creating the tool.
The "AML Source Tool" is on the Commission's website at http://www.sec.gov/about/
The SEC’s announcement concerning the new tool appears at http://www.sec.gov/news/
MSRB Issues Reminder of Supervision Obligations When Sponsoring Meetings Involving Issuer Officials
April 13, 2007 11:03 AM
On March 26, 2007, the Municipal Securities Rulemaking Board (“MSRB”) published a notice to remind brokers, dealers and municipal securities dealers (“dealers”) of the potential application of Rule G-37, when dealers sponsor meetings and conferences where issuer officials are invited to attend or are featured as speakers.
Rule G-37 prohibits dealers from engaging in municipal securities business with issuers for a two-year period if certain political contributions have been made to officials of such issuers by the dealer or a municipal finance professional (“MFP”). The rule requires dealers to record and disclose certain political party payments and municipal securities business to assist in severing the connection between contributions and the awarding of municipal securities business. The rule also includes a prohibition on dealers and their MFPs from soliciting any person (including, but not limited to, any affiliated entity of the dealer) or political action committee to make any contribution, or coordinating any contributions to an official of an issuer with which the dealer is engaged or seeks to engage in business. Dealers and MFPs are prohibited from engaging, directly or indirectly, in anything that would result in violation of the rule’s ban on business or prohibition on soliciting and coordinating (bundling) contributions.
The MSRB reminder states that a dealer sponsoring a meeting or conference where an issuer official is invited to attend or is a featured speaker should be mindful of Rule G-37, including the prohibitions on soliciting and coordinating contributions. For example, if the issuer official or staff solicits contributions in connection with the event, or dealer personnel solicit or coordinate contributions, such activities may constitute fundraising activities. If it is determined that the event is a fundraising event for the issuer official, then expenses incurred by the dealer for hosting the event may be deemed a contribution, thereby triggering the two-year ban on municipal securities business with that issuer. The reminder states that expenses may include the cost of the facility, refreshments; or any expenses paid for administrative staff, as well as the payment or reimbursement of any of the issuer official’s expenses for the event. The notice further explains that dollar amount of an expense incurred by the dealer for hosting the event is not dispositive of whether the expense constitutes a contribution under Rule G-37. If the event is a fundraising event, then any expense incurred by the dealer may be deemed a contribution to the issuer official.
The notice also discusses certain obligations under Rule G-27, which requires that dealers supervise the conduct of their municipal securities activities, and that of their associated persons, to ensure compliance with MSRB rules. Rule G-27 also requires that dealers adopt, maintain and enforce written supervisory procedures reasonably designed to ensure such compliance. The MSRB underscored the importance of appropriate supervisory procedures in place to review the nature of, and activities surrounding, the types of events discussed in this notice to ensure that Rule G-37 is not violated. The notice suggests taking appropriate steps to ensure that such events are not fundraising events by, among other things, ensuring that: (i) contributions are not solicited by the issuer official or staff; (ii) any attendee contact information provided by the dealer is not used by the issuer official or staff to solicit contributions; and (iii) contributions are not solicited, coordinated or made by dealer personnel in connection with the event.
MSRB Notice 2007-13 (March 26, 2007) is available at http://ww1.msrb.org/msrb1/whatsnew/2007-
New Division of Investment Management Chief Accountant Named
April 13, 2007 11:01 AM
On April 3, 2007, the Securities and Exchange Commission announced the appointment of Richard F. Sennett as Chief Accountant of the Division of Investment Management. As Chief Accountant, Mr. Sennett will be primarily responsible for oversight of the financial reporting and accounting practices of registered investment companies. Since 2002, Mr. Sennett has been an Assistant Chief Accountant in the Division of Investment Management where he has worked on a variety of accounting issues related to investment companies and worked on the development and implementation of the Division's Sarbanes-Oxley annual report review process. Before coming to the Commission, Sennett was Vice President and Senior Manager for Fund Accounting at Deutsche Bank Global Fund Services.
The SEC release on Mr. Sennett’s appointment appears at http://www.sec.gov/news/press/2007/
SEC Endorses Implementation of Sarbanes-Oxley Improvements To Ease Smaller Company Burdens
April 13, 2007 10:56 AM
At an April 4, 2007 open meeting, the SEC endorsed its staff’s recommendations intended to eliminate “waste and duplication” under Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). Section 404 requires issuers to annually assess the effectiveness of their internal controls, and their auditors to attest to the effectiveness of those internal controls. Chairman Cox noted that the Public Company Accounting Oversight Board (“PCAOB”) was working to replace the existing Section 404 audit standard with a more risk-based, top-down approach. The Commission directed its staff to focus its collaboration with PCAOB on several areas: aligning the PCAOB's new auditing standard (AS-5) with the SEC's proposed new management guidance under Section 404; scaling the Section 404 audit to account for the particular facts and circumstances of companies going through the process, particularly smaller companies; encouraging auditors to use professional judgment in the Section 404 process; and following a “principles-based approach” to determining when and to what extent the auditor can rely on the work of others.
Under Sarbanes-Oxley, PCAOB audit standards must first be approved by the SEC and cannot take effect without a vote of the Commission. The Commission expects the new PCAOB standard will be submitted for SEC review by the end of May or early June.
The SEC release on the Commission’s endorsement appears at http://www.sec.gov/news/
Chairman Cox’s Remarks at the Open Meeting appear at http://www.sec.gov/news/speech/
Goldstein Files Emergency Motion Against Massachusetts Securities Regulators
April 10, 2007 12:50 PM
On March 23, 2007, hedge fund manager Phillip Goldstein and others (“Plaintiffs”), filed an emergency motion in Suffolk Superior Court in Boston, MA, seeking a preliminary injunction against the Commonwealth’s securities regulators. In January 2007, the Massachusetts Securities Division had filed an administrative complaint against Goldstein’s firm alleging that it illegally made an unregistered offering of securities when it sent brochures and performance information relating to certain hedge funds in response to an inquiry it received on its website. Plaintiffs argue that the regulators are violating their constitutional rights by preventing an individual from obtaining and reading truthful information about the funds.
Federal District Court Dismisses Claims Alleging Excessive Advisory and Distribution Fees
April 10, 2007 12:48 PM
On March 13, 2007, the District Court for the District of New Jersey dismissed a case involving state and federal claims alleging that a group of mutual funds were charged excessive advisory and distribution fees. The Court held that the plaintiffs’ entire class action suit must be dismissed because certain state law claims alleged in the suit were preempted by the Securities Litigation Uniform Standards Act (“SLUSA”). The Court further held that even if the plaintiffs’ claims were not subject to dismissal under SLUSA, the plaintiffs nonetheless had failed to state a claim under Section 36(b) of the 1940 Act. In addition, the Court held that Section 48(a) of the 1940 Act does not confer any right of action upon private plaintiffs.
In re Franklin Mutual Funds Fee Litig., 2007 U.S. Dist. LEXIS 17353 (D.N.J. 2007).
Second Circuit Affirms Dismissal of Claims Involving Mutual Fund Marketing Practices
April 10, 2007 12:45 PM
On March 15, 2007, the Second Circuit Court of Appeals for the Southern District of New York issued a decision affirming the dismissal of various claims against a mutual fund adviser, board of trustees, and affiliated distributor involving allegations that the defendants had breached their fiduciary duties by improperly charging fund investors marketing fees and by drawing on fund assets to make improper revenue sharing payments. The Court held that there is no private right of action under Sections 34(b), 36(a), and 48(a) of the 1940 Act. The Court also held that the plaintiffs’ claims under Section 36(b) of the 1940 Act were insufficient as a matter of law, because the adviser and trustee defendants were not the recipients of the fees and commissions in question, and, with respect to the distributor defendant, the plaintiffs had failed to specifically allege that the advisory fees were so disproportionately large that they bore no relationship to the services rendered.
Bellikoff v. Eaton Vance Corp., 2007 U.S. App. LEXIS (2d Cir. 2007). A copy of the Court’s opinion is available at http://www.ca2.uscourts.gov:8080/isysnative/RDpcT3BpbnNcT1BOXDA1LTY5NT
Fee-Based Brokerage Rule Vacated by Court
April 10, 2007 12:41 PM
On March 30, 2007, the U.S. Court of Appeals for the District of Columbia (“D.C. Circuit”) ruled in a 2-1 decision that the SEC exceeded its authority when it adopted Advisers Act Rule 202(a)(11)-1 (the “Rule”), which expanded the scope of the statutory broker-dealer exception by excluding certain broker-dealers that provide fee-based brokerage services from regulation as investment advisers. The Rule will remain in effect until the date the court issues a mandate, which is expected to occur shortly after: (1) the expiration of the period to seek rehearing (May 14, 2007), or (2) the disposition of the petition for rehearing, if rehearing is sought.
Section 202(a)(11)(C) of the Advisers Act excludes from the definition of “investment adviser” “any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.” The Rule generally provides that a broker-dealer who receives “special compensation” will not be deemed an investment adviser if its investment advice is solely incidental to the brokerage services it provides to a customer’s account and certain disclosure is provided to the customer. The Rule also specifically provides that a broker-dealer will not be deemed to have received special compensation merely because it charges one customer more or less for brokerage services than in charges another brokerage customer. The Rule also lists three non-exclusive circumstances in which a broker-dealer’s investment advice would not be deemed “solely incidental to” brokerage: (1) charging a separate fee or separately contracting for advice; (2) providing financial planning services; and (3) exercising investment discretion over a client’s account. Further, the Rule codified a longstanding SEC staff position that a registered broker-dealer is an investment adviser only for those accounts for which it provides services or receives compensation that subjects it to the Advisers Act.
The SEC originally proposed the Rule in November 1999 in response to the introduction and growth of fee-based brokerage and discount brokerage programs and questions they raised about the broker-dealers’ status under the Advisers Act. In the proposing release, the SEC stated that the staff would not recommend the SEC take action against a broker-dealer for failing to treat any non-discretionary account as subject to the Advisers Act, based solely on the form of compensation received. The Financial Planning Association (“FPA”) filed a petition for review of the SEC’s action in July 2004, arguing that the SEC had violated the Administrative Procedures Act by embedding the no-action position in the proposing release. The FPA also argued that the SEC had exceeded its rulemaking authority by exempting broker-dealers that offer fee-based brokerage accounts from the definition of “investment adviser.” In January 2005, the SEC reproposed the rule, withdrew the no-action position, and adopted a temporary rule exempting from the Advisers Act broker-dealers providing non-discretionary advice solely incidental to its brokerage service, regardless of the form of compensation. In April 2005, the SEC adopted the Rule in final form, after which the FPA again petitioned the D.C. Circuit for review.
The court found that SEC exceeded its authority in adopting the Rule because Congress had already unambiguously addressed the status of broker-dealers by enacting Section 202(a)(11)(C). The court stated that an exception adopted under Section 202(a)(11)(F) must be consistent with intent of the rest of Section 202(a)(11), and that the relief provided must apply to other persons not already addressed in other parts of that section. The majority determined that, because broker-dealers are addressed in subsection (C) and because the subsection refers to “any broker-dealer” (emphasis added), the SEC could not use subsection (F) to broaden the exception for broker-dealers. The court observed that the SEC has historically used subsection (F) to exclude persons that are not addressed in any of the five listed exceptions under Section 202(a)(11)(A) through (E), and that the SEC’s arguments as to its authority to create an additional broker-dealer exception under subsection (F) were at odds with prior SEC interpretations. Finally, although the court’s reasoning focused on the fee-based brokerage aspect of the Rule, because of the absence of a severability clause in the Rule, the court’s decision has the effect of vacating the entire Rule.
By contrast, the dissenting judge deemed that subsection (F) is sufficiently ambiguous to enable the court to defer to the SEC’s interpretation of its authority to grant additional exceptions to broker-dealers. The dissent further observed that subsection (C) should be read to apply to only a certain category of broker-dealers, and that the Rule reasonably exempts a new category of persons not in Congress’s contemplation when subsection (C) was drafted.
Is it not immediately clear what the SEC will do in response to the opinion, though it is expected that the SEC will grant temporary relief to financial services firms that have fee-based brokerage programs to permit an orderly response.
The Court opinion is available at http://pacer.cadc.uscourts.gov/docs/common/opinions/200703/04-1242a.pdf.
SEC Division of Investment Management’s Chief Counsel Discusses Pending No-Action Letter on Segregation of Investment Company Assets Against Derivatives Positions
April 10, 2007 12:38 PM
At the 2007 Mutual Funds and Investment Management Conference in Palm Desert, California, Chief Counsel Douglas Scheidt stated at a panel discussing complex financial instruments that the Division of Investment Management is working on a no-action letter that would address the amount of assets that must be segregated or earmarked when an investment company invests in certain types of derivative instruments. Since 1979, the SEC and the Division of Investment Management have stated that certain types of derivatives that expose an investment company to financial obligations raise the leverage concerns that underlie the limitations on investment company issuance of debt instruments and other “senior” securities. In one release and many no-action letters, the SEC and the Division of Investment Management have said that investment companies may avoid senior securities limitations by segregating or earmarking assets to cover the obligations embedded in those derivatives. The letters, however, do not address many commonly-used types of derivatives, and the amount of asset segregation required for many instruments is not clear. Chief Counsel Scheidt said the contemplated no-action letter would rationalize these requirements. He emphasized that the Division of Investment Management is studying the issue carefully to make sure the interpretive position has broad application and makes sense.
SEC Joins Interagency Proposal for Model Privacy Notice under Gramm-Leach-Bliley Act
April 10, 2007 12:36 PM
On March 21, 2007, the SEC and seven other federal regulators proposed amendments to their rules that implement the privacy provisions of the Gramm-Leach-Bliley Act (the “GLB Act”). The GLB Act requires financial institutions to provide initial and annual privacy notices to their customers, which describe the institution’s information sharing practices and, for certain types of information sharing, give consumers the opportunity to opt out. The proposed model privacy form is intended to provide consumers with a succinct and comprehensible format that is designed to help consumers compare the privacy practices of various financial institutions. The proposed rule would permit financial institutions that use the model privacy form to rely on a safe harbor for purposes of complying with the privacy rules, and would eliminate the safe harbors currently available to financial institutions that use the “sample clauses” under the existing privacy rules.
Comments on the proposal must be submitted by May 29, 2007. The full proposed rulemaking is available at http://www.sec.gov/rules/proposed/2007/34-55497.pdf .
SEC Division Directors’ Remarks at 2007 IA Compliance Best Practices Summit
April 10, 2007 12:26 PM
In speeches at the March 2007 IA Compliance Best Practices Summit, SEC Directors discussed 2006 investment adviser compliance examination results and recent enforcement actions.
Remarks by Andrew J. Donohue, Director of the Division of Investment Management (“IM”).
Mr. Donohue reviewed the Division’s regulatory priorities, including his plans to initiate an ongoing review of regulations governing both investment companies and investment advisers to determine whether any need to be revised, updated or eliminated. He specifically noted that the books and records requirements, many of which were adopted in the early 1960s, are in need of reform. In addition to a wholesale re-evaluation of recordkeeping requirements, Donohue singled out e-mail retention as an area where he has asked his staff to focus attention. Donohue also expects to recommend that the SEC re-propose amendments to Form ADV, Part 2, which has been in limbo since 2000.
Remarks by Lori A. Richards, Director of the SEC Office of Compliance and Examinations (“OCIE”).
Ms. Richards noted that, of the 1,300 examinations of investment advisers conducted by OCIE during 2006, around six percent gave indications of very serious violations that resulted in referrals to Enforcement staff, including referrals resulting from undisclosed side arrangements relating to distribution, insider trading involving PIPE deals, service arrangements benefiting an adviser at a fund’s expense, cherry picking by advisers, gifts to fund traders in exchange for business, undisclosed soft dollar usage, revenue sharing through fund brokerage, and failure to obtain best execution. In all, nearly 81 percent of investment adviser examinations resulted in findings of one or more deficiencies. Richards noted that the most commonly cited areas were:
In addition to the areas listed above, Ms. Richards stated that OCIE staff expects to review during its 2007 examinations possible issues related to insider trading, brokerage arrangements, best execution, soft dollars, trade allocations, personal/proprietary trading by advisers, pricing and valuation, and controls to prevent the theft of client funds and information.
Remarks by Linda Chatman Thomsen, Director of the SEC Division of Enforcement (“Division”).
Ms. Thomsen discussed various conflicts of interest faced by investment advisers and enforcement cases brought by the Division in recent years relating to:
The speeches are available at http://www.sec.gov/news/speech/2007/spch032207ajd.htm, http://
Donohue Outlines IM Division's Agenda for Upcoming Year
April 10, 2007 12:16 PM
In his March 26, 2007 keynote address at the ICI 2007 Mutual Funds and Investment Management Conference, Division of Investment Management Director Andrew J. Donohue outlined plans for the Division's regulatory agenda for the upcoming year. Donohue discussed how certain of the regulations administered by the Division are in need of reform, noting that the books and records rules under both the Investment Company Act of 1940 (“1940 Act”) and the Investment Advisers Act of 1940 (“Advisers Act”) need an overhaul, particularly with respect to e-mail retention requirements. Donohue emphasized that the staff’s recordkeeping modernization initiative will require thorough study and review of current requirements as well as of new technological practices that support the investment management industry.
Donohue also discussed plans for a thorough review of mutual fund director responsibilities under the 1940 Act to identify areas where rule revisions might help fund directors better focus their attention on areas of the most significance for fund management and oversight. Donohue also discussed the Division’s plan to review fund disclosures that investors receive, encouraged funds to participate in the SEC’s program to voluntarily file their prospectus risk/return summaries using interactive data, and noted the staff’s plans to recommend to the SEC a streamlined, short-form disclosure document for mutual fund investors.
Finally, Donohue discussed several areas that he views as emerging areas of concern. He announced that the staff would make the reconsideration of Rule 12b-1 a high priority for this year, both the rule itself and the factors that fund boards must consider when deciding whether to approve or renew a Rule 12b-1 plan. Donohue also indicated concern about the appropriateness of certain yield-based investment products being offered to investors and funds’ use of derivatives and other sophisticated financial instruments. Although Donohue did not describe any immediate steps to be taken in regard to these areas, he indicated that these are areas that require further investigation and that they should not be ignored by fund groups.