Action taken in response to the February 2008 collapse of the market for auction rate preferred securities (“ARPS”) has increased this past week. The SEC indicated that regulatory relief intended to restore the market for ARPS by increasing demand was imminent. A number of closed-end funds announced plans to redeem a significant portion of the ARPS they issued and begin using alternative sources of leverage. And additional state investigations were launched into potential wrongdoing that may have contributed to the market’s collapse.

ARPS are long-term debt instruments or preferred stocks for which the interest rate or dividend is reset frequently by bidding at auction. Closed-end funds issue ARPS to create leverage, reinvesting the money they receive upon the issuance of ARPS in long-term, higher yielding investments while paying a lower, short-term rate set at frequent auctions on the ARPS. When a lack of bidders at the auction causes the interest or dividend rate to plummet, investors holding the ARPS are left with a security that pays little in the way of return and is difficult to sell at any price. This appears to be what happened in the collapse of the market for ARPS in February 2008.

Among this week’s responses to the ARPS market collapse, the most notable was imminent regulatory relief described by SEC Investment Management Division Chief Counsel Douglas Scheidt at the Mutual Fund Directors Forum. He suggested that regulatory relief would likely come in the form of a “No Action” letter permitting money market funds to purchase ARPS, thereby increasing demand and hopefully reviving the collapsed ARPS market.

Most ARPS are currently structured in such a way as to be ineligible for purchase by money market funds. Thus “No Action” relief would be conditioned on purchase by the money market funds of a put option on the ARPS, ensuring the fund’s ability to sell at a specified price and date, Chief Counsel Scheidt explained. He expressed hope that further assurances of liquidity would also result from the increase in demand for ARPS from money market funds, since increased demand would result in higher interest rates which in turn would increase demand further. He noted, however, that it was uncertain whether sufficient demand or liquidity would result from the proposed regulatory relief.

The restructuring of $1.9 of the $9.8 billion in ARPS issued by one family of closed-end funds was also announced last week. Each fund’s goal in restructuring would be to lower the cost of leverage for common shareholders and create liquidity at par value for preferred shareholders holding the ARPS. The general plan for restructuring involved redeeming a portion of each fund’s ARPS at par and replacing the leverage previously achieved by issuing ARPS with alternative sources of leverage, such as reverse repurchase agreements, tender option bond programs, credit facilities, and potentially bank financing. The potential for alternative sources of leverage to become unavailable or prohibitively expensive remains a key risk of the restructuring.

Additional investigations at the state level into persons who may have contributed to the collapse of the ARPS market were also launched last week. A number of the ARPS probes were initiated by state securities regulators in coordination with a North American Securities Administrators Association (“NASAA”) taskforce. Shortly thereafter, more than a dozen subpoenas were issued by New York Attorney General Andrew Cuomo to many of the largest Wall Street investment banks. More subpoenas from Attorney General Cuomo are expected on all aspects related to the auction rate securities market, from issuance of the securities to sales and marketing.

At this time, it is estimated that the total issuance of ARPS by closed-end funds is between $65 and $100 billion. These issues are concentrated in no more than several dozen fund families. Yet within these few fund families, the collapse of the ARPS market has created significant difficulty. The direction that responses to the ARPS market collapse will take in the weeks to come is unclear. However, the pace and variation of responses arising recently suggest that significant action is still to come.

The relevant BoardIQ article can be found at http://www.boardiq.com/articles/20080422/closed_funds_seek_auction_rate_solutions

The relevant CNN article can be found at http://money.cnn.com/2008/04/17/news/newsmakers/new_york_auction/index.htm
 

An early start and accelerated schedule for the annual review of the London Interbank Offered Rate (“Libor”) was announced on Thursday April 16, 2008 by the British Bankers’ Association (“BBA”) which administers it. The modified timing is intended to quiet growing concerns that Libor quotations may be artificially inflated by as much as 30 to 40 basis points (i.e., hundredths of a percentage point).

Libor is a measure of the interest rate that banks pay to borrow money from one another. Roughly $150 trillion in loans and derivatives are believed to be tied to Libor with respect to terms of payment. A divergence between Libor and other official interest rates set by major central banks like the U.S. Federal Reserve and the Bank of England has become increasingly apparent since August of 2007.

The difference or spread between such interest rates has been previously attributed to increased hoarding of cash by banks in response to financial market instability. However, concerns are growing that another cause may be the manipulation of Libor that results from banks under-reporting the rates paid to one another to avoid appearing financially weak or in need of money.

It is hoped that the audit component of the annual review will soon show that rates reported throughout 2007 by the lenders composing the Libor sample were indeed those actually paid, thereby dispelling concerns of manipulation. If not, the repercussions could be formidable, encompassing everything from re-negotiation of Libor-linked loans and derivatives to re-evaluation of the financial health of lenders shown under-reporting.

The relevant Market Watch article can be found at http://www.marketwatch.com/News/Story/review-libor-brought-forward-closely/story.aspx?guid=%7b1EFFA264-E385-4A90-8C5C-4E655A60A494%7d&print=true&dist=printTop 
 

The departure of SEC Deputy Chief of Staff and Counselor to the Chairman, Michael J. Halloran, was announced on April 21, 2008. Halloran played a key role in the strengthening of investor protections under Section 404 of the Sarbanes-Oxley Act as well as the reduction of unnecessary associated costs that resulted, particularly for small businesses. He helped draft the first rules put forth by the SEC under the Credit Rating Reform Act as well as additional rules for private equity fund advisers under the Investment Advisers Act, rules implementing recommendations from the SEC’s Advisory Committee on Smaller Public Companies, and proposals on director nomination access. He worked to establish the SEC’s online PAUSE program targeting fraudulent investment solicitation and the SEC’s Advisory Committee on Improvements in Financial Reporting. Halloran joined the SEC in 2006 and will return to the private sector in May 2008.

The SEC press release announcing the departure can be found at http://sec.gov/news/press/2008/2008-62.htm 
 

SEC Chairman Christopher Cox testified before Congress on April 16, 2008 regarding the President’s fiscal year 2009 budget. He noted that the requested increase in the SEC’s budget for fiscal year 2009, together with the increase received for fiscal year 2008, would approximate a 4% increase in the SEC’s budget over a two-year period. That 4% increase, he explained, would enable the SEC to maintain its 2007 staffing levels (after factoring in inflation and pay increases), and in fiscal year 2007, the SEC staff provided oversight for approximately $44 trillion in securities trading annually on U.S. equity markets, disclosures provided by roughly 13,000 public companies, and activities of nearly 11,000 investment advisers, 1,000 fund complexes, and 5,700 broker-dealers.

Chairman Cox elaborated on a number of the SEC’s key achievements in 2007, including the SEC Enforcement Division’s anti-spam initiative which resulted in a 30% reduction of stock market spam-emails and the SEC Office of Compliance, Inspections and Examinations’ examination of approximately 2,400 investment advisers, investment companies, broker-dealers, transfer agents, and self-regulatory organizations – of which 75% of investment adviser or company examinations and 82% of broker-dealer examinations revealed some type of deficiency or control weakness. Creation of an SEC Office of Policy and Investor Outreach to better assess and meet the needs of retail investors was another achievement of the SEC in 2007 that he cited, as was the disgorgement to injured investors of some $1 billion in illegal profits and $500 million in financial penalties. Reform of the implementation of Section 404 of the Sarbanes-Oxley Act, especially the adoption of a more cost-effective auditing standard and the provision of Section 404 guidance tailored to management, was noted as another accomplishment of the SEC in 2007.

Chairman Cox also reviewed many of the SEC’s goals for fiscal year 2008, some of which had already been achieved. He confirmed that an SEC program to oversee credit rating agencies had been launched and additional related initiatives would be proposed shortly. Some initiatives being considered included requiring better disclosure of past ratings, facilitating comparisons of rating accuracy, educating investors as to the differences in ratings among different types of securities, regulating and limiting conflicts of interest, reducing reliance on ratings in favor of reliance on the underlying data allegedly reflected in the ratings, and enhancing disclosure on the role of third-party due diligence in assigning ratings. He also noted that plans to double the size of the SEC Office of Risk Assessment had been announced and aggressive investigations by the SEC Enforcement Division’s subprime working group into possible fraud, market manipulation, and breaches of fiduciary duties were intended.

Additional investigations by the SEC Enforcement Division into insider trading by large institutional traders, wrongdoing in the municipal bond market, internet and microcap fraud, and scams against seniors were also planned for 2008, as was the distribution to injured investors of an additional $1 billion in disgorgements and fines collected from securities laws violators. Other goals for 2008 described by Chairman Cox included increasing collaboration with foreign financial markets’ regulatory authorities and the continued integration of domestic accounting standards with international financial reporting standards (“IFRS”). Expansion of the role of interactive data being reported by public companies, mutual funds and other market participants under the guidance of the SEC Office of Interactive Disclosure was a further goal cited by Chairman Cox, as was enhancement of investor protections in the municipal securities market and the secondary market for exchange-traded funds (“ETFs”).

The text of the testimony can be found at http://sec.gov/news/testimony/2008/ts041608cc.htm 
 

SEC findings of significant variation in how money market funds evaluate a subprime-related security for purchase and subsequently judge its liquidity were described by SEC Division of Investment Management Chief Counsel Douglas Scheidt at last week’s Mutual Fund Directors Forum annual policy conference.

The findings resulted from letters sent by the SEC to money market funds in January 2008 inquiring about the processes they used to evaluate an investment in subprime-related securities. Holding such securities in 2007 had been particularly disruptive for money market funds which emphasize liquidity and stability of value, given the difficulty the funds experienced in accurately pricing or selling these securities to anyone but affiliates for which special SEC approval was sometimes needed.

Chief Counsel Scheidt distilled the wide variation in processes used by money market funds to evaluate an investment in subprime-related securities into three categories: those that “plunged in headfirst,” those that were somewhat discriminating, and those that carefully reviewed available data on each investment and its issuer. He noted a roughly even distribution of money market funds over these three categories.

He reported that a logical correlation existed between the process used by a money market fund and the challenges faced by that fund when liquidity for subprime-related securities disappeared in 2007. The results of the letter sweep showed that, as a general matter, the more thorough the process being used to evaluate investments, the smaller the percentage of troubled subprime-related securities in a money market fund’s portfolio.

In light of these findings, Chief Counsel Scheidt recommended that money market fund directors begin obtaining information on how their portfolio managers and advisers evaluate a given investment’s creditworthiness and liquidity. He also reiterated the SEC’s intent to provide valuation guidance in 2008, hopefully by the end of the second quarter. This valuation guidance is expected to cover such topics as valuation of illiquid securities, a board’s responsibilities for valuation, special concerns regarding money market funds, pricing issues, and considerations for boards regarding derivatives.

The relevant BoardIQ article can be found at http://www.boardiq.com/articles/20080422/money_market_sweep_yields_lessons_directors 

A survey released on April 7, 2008 by the consulting firm Management Practice shows the rate at which fund directors’ compensation increased in 2007 as slowing, after 5 years of percentage increases in the double digits.

The survey reported compensation of fund directors increasing by 7% on average in 2007, as compared to 16% in 2006, 11% in 2005, and 13% in 2004. For context, the rate of inflation or the rate at which the average American’s compensation increased in 2007 was 4.1% and 3.4%, respectively. Increases in the compensation of fund directors are generally correlated with those of corporate directors.

The survey covered 406 fund families and 2,158 directors. The funds were grouped on the basis of assets under management, with the largest funds (defined as those overseeing $100 billion or more) paying median annual compensation of $194,500 in 2007 and the smallest funds (defined as those overseeing less than $300 million) paying median annual compensation of $5,500 in 2007. The largest funds’ directors generally received a much higher percentage increase in compensation in 2007 than did the smallest funds’ directors.

The double digit increases in fund director compensation for the 5 years following the 2003 trading scandal have been attributed to the resulting increases in fund directors’ liability and workload. This included responsibility for increasing oversight and disclosure of compliance programs, redemption fees, governance and operations policies, and advisory contract renewal processes.

The present increases in fund director compensation are generally attributed to a director’s service as committee chair, independent director, accounting expert, etc. or to discrete events such as the launch of additional funds, a substantial growth in assets, or the introduction of complicated investment strategies.

The relevant Board IQ article can be found at http://www.boardiq.com/articles/20080408/director_hikes_ease_study 
 

The auditor, portfolio managers and investment adviser of two large hedge funds that collapsed last year are the target of a lawsuit filed on Monday April 7, 2008 by the funds’ Cayman-appointed liquidators in the U.S. District Court for the Southern District of New York.

The complaint alleges that the funds’ portfolio managers, investment adviser and certain affiliates of the investment adviser “conceived, marketed and managed hedge funds that they knew would be viable so long as – but only so long as- the U.S. housing market continued to rise, and concealed the fact that these funds were never designed to withstand even a slight downtick in the housing market” but instead were intended “as dumping grounds for toxic investments” on the defendants’ books. The complaint also alleges that the funds’ auditor negligently prepared the funds’ audits and thereby misled investors who relied upon the audits.

The liquidators are seeking to recover $1 billion in losses and punitive damages, though investors are believed to have lost approximately $1.6 billion in the funds’ collapse. Formal allegations against the funds’ auditor, portfolio managers, investment adviser and certain of the investment adviser’s affiliates include “fraud, breach of fiduciary duty, breach of contract, inducing breach of contract, inducing breach of fiduciary duty, recklessness, gross negligence, negligence, accounting malpractice, conspiracy to commit fraud and breach of fiduciary duty, aiding and abetting fraud and breach of fiduciary duty and unjust enrichment.”

The funds were organized under the Cayman Island’s Companies Law as Cayman exempted companies with a principal place of business in New York. Liquidators of the funds were first appointed by the Grand Court of the Cayman Islands in March of 2007. Replacement of the original liquidators by those filing suit took place on March 20, 2008 in response to concerns about the former liquidators’ split loyalties. The funds’ are currently seeking appeal of a U.S. bankruptcy judge’s denial of U.S. protection to the funds while liquidating in the Cayman Islands.

Varga v. Bear Stearns Cos., 08-3397, U.S. District Court, Southern District of New York (Manhattan).

The relevant Bloomberg article can be found at http://www.bloomberg.com/apps/news?pid+20670001&refer=us&sid=a9vccSOvAwmc
 

SEC Chairman Christopher Cox announced the launch of a new SEC website on Monday April 7, 2008 to facilitate investors’ comparison and analysis of information across multiple mutual funds. The program is called the “Mutual Fund Reader” and available to the general public at http://www.sec.gov/xbrl on the internet.

The Mutual Fund Reader is designed to enable the comparison of costs, risks, historical performance, investment objectives and strategies of those mutual funds that have chosen to provide the SEC with risk/return summary information from their prospectuses in the interactive data format. Participation is voluntary on the part of a mutual fund, which may choose not to submit interactive data.

The program uses the computer software language XBRL to flag relevant pieces of information in each prospectus submitted in interactive format and then compare those data points across multiple prospectuses. At this time, up to 3 prospectuses may be compared at once.

The amendments enabling mutual funds to submit risk/return summary information from their prospectuses in interactive data format were passed by the SEC in June of 2007. Twenty mutual funds have since provided the necessary interactive data, and more are expected to do so in the near future.

The SEC press release can be found at http://www.sec.gov/news/press/2008/2008-55.htm 

A civil action alleging late trading and market timing was filed against a UK-based hedge fund adviser, its CEO and the offshore fund receiving the illicit profits on Thursday April 3, 2008 by the SEC in the U.S. District Court for the Southern District of New York.

The complaint states that the adviser and its CEO pursued a “scheme to defraud mutual funds in the United States and their shareholders through late trading and deceptive market timing.” It claims the adviser routinely placed orders for mutual fund shares after the market’s close, thus profiting from information not then reflected in the closing price at which the orders were executed. It also claims the adviser used deceptive techniques to market time U.S. mutual funds, including splitting trades among multiple U.S. broker-dealers to hide the extent of trading and shifting assets to new accounts to resume market timing when previous accounts were caught doing so. Prohibitions against late trading and market timing are intended to prevent the dilution of value for other shareholders in the mutual fund. Prohibitions against market timing are also intended to prevent the disruption of a mutual fund’s investment strategy that occurs when forced to meet excessive subscription and redemption requests.

U.S. mutual funds and shareholders are believed to have lost approximately $62 million as a result of alleged scheme between June of 1999 and September of 2003. The SEC is seeking disgorgement of all related ill-gotten gains, including performance and management fees paid to the adviser and its CEO as well as profits achieved by the offshore fund. The SEC is also seeking civil penalties against, and permanent enjoinment of, the adviser and its CEO. Formal allegations against the adviser and its CEO include violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.

It is estimated that roughly 20 firms have settled SEC allegations of late trading since 2003 with settlements totaling at least $4 billion in fines, penalties and fee cuts for investors. The intention to liquidate all funds advised by the adviser, estimated to amount to a total of $2 billion in assets, was announced last week in response to the suit.

SEC v. Pentagon Capital Management PLC, 08 CV 03324 (RWS) (SDNY).

The SEC litigation release (No. 20516: April 3, 2008) can be found at http://www.sec.gov/litigation/litreleases/2008/lr20516.htm  

Responses to the “Blueprint for a Modernized Financial Regulatory Structure” (“Blueprint”) issued by the US Department of Treasury (“Treasury”) on Monday March 31, 2008 have been extensive and varied. Many favor the sweeping regulatory changes for the reasons articulated by the Treasury in the Blueprint, as summarized in our April 4, 2008 Investment Management News Summary. Others have voiced concerns about implementing the Blueprint in the form proposed, as summarized here.

These concerns have come from a wide range of sources, spanning from legislators to trade advocacy and industry organizations to the states themselves. Some examples include legislators like Senate Banking, Housing and Urban Affairs Committee Chairman Christopher J. Dodd and House Financial Services Committee Chairman Barney Frank who have registered serious hesitations regarding the Blueprint. Trade advocacy groups and industry organizations like the Investment Advisers Association (“IAA”) have stated opposition to certain of the Blueprint’s proposals, such as creation of a self-regulatory organization (“SRO”) of investment advisers. States have also expressed hesitation at ceding regulatory authority of insurance companies and mortgage-bankers as provided under the Blueprint.

Of primary concern appears to be the perceived inability of the Blueprint to accomplish its stated goals. Former Director of the Treasury’s Office of Thrift Supervision Ellen Seidman explains the Blueprint “does not deal with the root causes of our current crisis: regulatory authority without the will to exercise it, information gathering without enforcement based on that information, risk-taking without consequences.” Mr. Dodd has similarly articulated the problem as, not a lack of regulatory authority, but rather “the failure of this administration to utilize the tools they’ve been given over the years to deal with the very practices that caused this problem.”

Doubts about whether additional regulation like the Blueprint can prevent periodic panics have been raised by Treasury Secretary Henry M. Paulson Jr. in stating “I am not suggesting that more regulation is the answer or even that more effective regulation can prevent the periods of financial market stress that seem to occur every five to ten years.” The need for the Blueprint has also been questioned on grounds that certain problems to be addressed by the Blueprint seem to be improving without it. A reduction in the regulatory bottleneck delaying new products and trading systems achieved during the tenure of Andrew Donohue, director of the Division of Investment Management at the Securities and Exchange Commission (“SEC”), has been cited as an example of this.

A greater concern being articulated is the potential for the Blueprint to undermine the competitiveness and stability of US capital market. For example, the proposal in the Blueprint encouraging the SEC’s adoption of core principals in place of rules has been described as removing the teeth from SEC regulation, given the greater room for interpretation associated with principal-based regulation. The Blueprint’s call for a SRO of investment advisers to regulate the industry has similarly faced criticism, most notably from the IAA, for imposing an additional layer of regulatory bureaucracy on investment advisers, the cost of which would be passed on to investors.

Repercussions of increasing the regulation of private equity and hedge funds with additional oversight by the Federal Reserve Board have also been cited. A number of industry participants have suggested that the result of increased regulation would be the flight of hedge funds and private equity funds to foreign jurisdictions with less regulation. On this point, however, opinions vary widely with some projecting a negligible impact on unregistered funds given the scarcity with which they are referenced in the Blueprint.

Additional considerations commonly cited as weighing against the Blueprint in its current form include the inability of a number of the initiatives being re-proposed in the Blueprint to pass in earlier rounds and the perceived unwillingness of the Federal Reserve Board to exercise the broad regulatory authority it already has. Congressmen Dodd and Frank in particular have stressed the unresponsiveness of the Federal Reserve Board to act in regulating questionable mortgage lending practices when so directed by the Congressmen last year, despite their warning that failure to do so would result in a loss of those powers.

Despite these specific concerns with the Blueprint as proposed, consensus seems to exist regarding the general necessity of improving financial services regulation in the United States. It is unclear whether such a sentiment will temper concerns and ultimately lead to the opinion that the Blueprint “deserves serious consideration as a way to better address the realities of today’s markets,” as stated by SEC Chairman Christopher Cox in the official “SEC Statement Regarding Blueprint for Financial Regulatory Reform.”

The April 4, 2008 Investment Management News Summary can be found at http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8290

The Blueprint can be found at http://www.whitehouse.gov/news/releases/2008/03/20080321-4.html

The SEC statement of SEC Chairman Cox regarding the Blueprint for Financial Regulatory Reform can be found http://www.sec.gov/news/press/2008/2008-53.htm
 

On March 21st, SEC Division of Investment Management Director Andrew “Buddy” Donohue addressed the IA Week and the Investment Adviser Association 10th Annual IA Compliance Best Practices Summit 2008. Donohue focused on compliance issues and regulatory initiatives that the Division is currently working on. He provided an overview of the Form ADV Part 2 proposal, the RAND Report, the temporary principal trading rule, and the proposed reinstatement of several interpretive provisions regarding the application of the Advisers Act to certain activities of broker-dealers that were vacated as part of the Financial Planning Association v. SEC decision. He noted that, in the wake of the decision, examiners are focusing on certain issues where a firm is a dual registrant, including how the firm conducts principal trades, what compliance procedures are in place to ensure that those trades are in a client’s best interest, and how firms advise clients about what type of account is appropriate for them.

Donohue also discussed the development of managed accounts and repeated his previously expressed concerns as to whether firms are complying with “all the conditions” contained in rule 3a-4 under the Investment Company Act. He added that, in line with the Division’s goal of periodically re-evaluating regulations, it is important that the conditions in rule 3a-4 be reviewed to consider whether they continue to provide an appropriate level of individualized treatment to support an exception from the definition of investment company for certain types of managed accounts or investment advisory programs.

Donohue mentioned upcoming plans to recommend additional guidance concerning soft dollar arrangements and amendments to the books and records requirements. He touched upon the need for adequate risk management, compliance, and back office resources to aid in the maintenance and oversight of derivatives and other new investment products.

The speech can be found at http://www.sec.gov/news/speech/2008/spch032108ajd.htm 

 

On March 24th, the SEC announced a series of actions it intends to take to further the implementation of the concept of mutual recognition for high-quality regulatory regimes in other countries. The SEC contemplates exploring initial agreements with one or more foreign regulatory counterparts, which would be based upon a comparability assessment by the SEC and by the foreign authority of one another’s regulatory regimes. The SEC is also considering the adoption of a formal process for engaging other national regulators on the subject of mutual recognition, as well as developing a framework for mutual recognition discussions with jurisdictions comprising multiple securities regulators tied together by a common legal framework, including Canada (which has no national securities regulator, but rather provincial regulators) and the European Union (whose national securities regulators are subject to supranational legislation and directives). In addition, the SEC is proposing reforms to Rule 15a-6 in order to improve the process by which U.S. investors have access to foreign broker-dealers.

The press release can be found at http://www.sec.gov/news/press/2008/2008-49.htm 
 

On March 16th, the Office of Chief Counsel for the Division of Investment Management provided assurances that it would not recommend enforcement action to the SEC under section 15(a) of the Company Act if Bear Stearns Asset Management (“BSAM”) acts as adviser to the registered investment companies for which BSAM currently acts as adviser or sub-adviser, notwithstanding the termination of the existing advisory contracts between such funds and BSAM, upon the change of control that would result from JPMorgan Chase’s proposed purchase of BSAM. The petitioners represented that, within ten days after the change of control, BSAM would enter into new written contracts with the funds, identical in their material terms to the present contracts. The Division based the relief on petitioners’ representations and the “extraordinary circumstances” presented by the takeover.

Of note, the Division indicated its belief that the Dean Witter, Discover & Co.; Morgan Stanley Group Inc. no-action letter (pub. avail. Apr. 18, 1997) (“Dean Witter”) relating to sections 202(a)(1) and 205(a)(2) of the Investment Advisers Act of 1940 also applied to the proposed change of control, such that no client consent was required under the Advisers Act in connection with the change of control. The Dean Witter letter involved the merger of two holding companies. There, the Division reasoned that there was no assignment because, after the merger, the advisory subsidiaries of the holding companies would continue to exist and be owned by a widely held public company with no controlling shareholder. The Division granted the relief in Dean Witter notwithstanding that one of the holding companies would issue stock equal to more than 25% of its outstanding stock to accomplish the merger and the other holding company would cease to exist.

Also on March 16th, the Division provided assurances that it would not recommend enforcement action under sections 17(a) and 17(d) of the Investment Company Act and rule 17d-1 thereunder, and under section 206(3) of the Advisers Act, if, following the change of control of BSAM, JPMorgan Chase and BSAM were to engage in certain principal transactions with their registered investment company and non-registered investment advisory clients. The petitioners requested relief for fifteen business days to enable trades to settle and to unwind certain transactions that were entered into between BSAM’s advisory clients and JPMorgan Chase before the change in control. As to the registered investment company transactions, the Division conditioned the relief upon disclosure of the material details of each transaction to the funds’ board of directors at the next scheduled board meeting and the representation that the transactions were consistent with the funds’ policies. For the non-registered investment advisory client transactions, the Division again conditioned the relief on the consistency of the transactions with the client’s policies and also the provision of appropriate section 206(3) disclosures to clients within fifteen business days after each transaction. In both instances, the Division required the maintenance and permanent preservation of a written copy of all records relating to each transaction.

The no-action letters can be found at http://www.sec.gov/divisions/investment/noaction/2008/jpmorgan031608-17a.pdf
 

On March 31st, the White House formally announced two Democratic nominees to fill empty seats at the SEC. The nominees are Elisse Walter, currently an executive vice president with the Financial Industry Regulatory Authority and a former deputy director of the SEC’s Division of Corporation Finance, and Luis Aguilar, a partner at the law firm McKenna Long & Aldridge and a former SEC lawyer.

The press release announcing the nominations can be found at http://www.whitehouse.gov/news/releases/2008/03/20080331-4.html
 

On March 31st, the Department of the Treasury released a proposal to make sweeping changes within the US financial regulatory system. Blueprint for a Modernized Financial Regulatory Structure (“Blueprint”) presents a series of short-, intermediate-, and long-term recommendations that cover commercial banks and other insured depository institutions, insurers, companies engaged in securities and futures transactions, finance companies, and government sponsored enterprises. The Blueprint’s executive summary explains Treasury’s view that the current system of functional regulation is “largely incompatible” with recent market developments. Separate regulatory agencies organized across segregated functional lines of financial services are limited by inherent inadequacies, particularly because “no single regulator possesses all the information and authority necessary to monitor systemic risk.” The inability of any single regulator to take coordinated action throughout the financial system makes it difficult to address systemic problems or to address unanticipated crises related to the stability of the US financial marketplace.

Among the Blueprint’s recommendations, which cover the entirety of the financial services industry, are several intermediate- and long-term proposals that would bear directly on the oversight exercised by the US Securities and Exchange Commission, including the regulation of the investment management industry. Treasury recommends a merger between the SEC and Commodities Futures Trading Commission. In connection with this proposal, the Blueprint notes that, while prior arguments against such a merger have pointed to the potential loss of the CFTC’s principles-based regulatory philosophy, Treasury recognizes the important market benefits achieved through this kind of regulation. Accordingly, the Blueprint proposes that the SEC “modernize” its own regulatory approach to make the merger more seamless. Specific steps would include using the SEC’s exemptive authority to adopt core principles to apply to securities clearing agencies and exchanges, and issuing a rule to update and streamline the self-regulatory organization rulemaking process. Other recommendations include a call for harmonization of various futures and securities rules, such as those relating to margin, segregation, insider trading, and implied private rights of action.

In its call for SEC modernization, the Blueprint also proposes that the SEC undertake general exemptive rulemaking under the Investment Company Act of 1940 to permit “the trading of those products already actively trading in the US or foreign jurisdictions,” such as exchange-traded funds (“ETFs”). It draws attention to the fact that the SEC only recently proposed a rule to codify exemptive orders issued to ETFs under the Investment Company Act, even though such products were first granted relief over fifteen years ago.

Additionally, the Blueprint recommends that the SEC propose legislation to permit the registration of a new “global” investment company under the Investment Company Act and to make necessary changes to the Internal Revenue Code in order to enable the marketing of shares of US-registered investment companies abroad. In connection with this proposal, the Blueprint notes how the SEC’s Division of Investment Management recognized the limitations to broad marketing of such securities in its 1992 study, Protecting Investors: A Half Century of Investment Company Regulation, but that beyond proposals offered in that study, no real efforts have been made to overcome many of the obstacles imposed by the Investment Company Act.

The Blueprint also proposes statutory changes to harmonize the regulation and oversight of broker-dealers and investment advisers offering similar services to retail investors. In connection with this recommendation, Treasury proposes the establishment of a self-regulatory framework for the investment advisory industry similar to that of broker-dealers. Beyond that, however, the Blueprint does not offer specific recommendations for harmonization.

The Blueprint’s long-term recommendation is to create an entirely new regulatory structure that follows on objectives-based approach to oversight of the financial services industry. That structure would consist of a market stability regulator, a prudential financial regulator, and a business conduct regulator with a focus on consumer protection. The Blueprint proposes that, instead of the SEC, the newly established business conduct regulator would regulate disclosures, business practices, chartering and licensing of all types of financial firms (including investment companies, investment advisers and broker-dealers), and enforcement. The SEC (newly merged with the CFTC) would continue to perform the function of a corporate finance regulator, responsible for general issues related to corporate oversight in public securities markets by all types of issuers. The Blueprint does not explain how the two regulators would reconcile their disclosure requirements for investment companies.

The Blueprint can be found at http://www.treas.gov/press/releases/reports/Blueprint.pdf