Investment Management Industry News Summary - August 2002

Investment Management Industry News Summary - August 2002

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 staff allows feeder mutual fund to also invest directly in foreign currency and foreign currency-related instrument

August 26, 2002 10:38 AM

The SEC staff granted no-action relief to a master-feeder arrangement in which the feeder fund would invest directly in certain foreign currency contracts and instruments, while also investing in shares of the master fund.

Under the proposed arrangement, the master fund would calculate its net asset value based on the U.S. dollar, but shares of a newly established feeder fund would be offered through distribution channels principally in non-U.S. securities markets where there is demand for shares denominated in a particular foreign currency. To facilitate distribution in non-U.S. markets, the feeder fund would accept purchase requests and pay redemption proceeds in the applicable foreign currency.

In addition to investing in the master fund, the feeder fund would enter into certain foreign currency and foreign currency-related contracts, which may include foreign currency futures contracts, options on foreign currency futures contracts, forward foreign currency contracts, options on foreign currency, and foreign currency swap agreements ("Foreign Currency Contracts"). The feeder fund would enter into these Foreign Currency Contracts solely to permit it to effect purchase and redemption transactions for shareholders in the applicable foreign currency and to hedge the value of its assets against exchange rate fluctuations, reducing the impact of exchange rate fluctuations on shareholder returns relative to the return of the master fund. The feeder fund would use Foreign Currency Contracts only with respect to a single foreign currency, although such contracts may be denominated in other currencies whose exchange rates are positively correlated with the applicable currency. The feeder fund would not enter into Foreign Currency Contracts for speculative purposes. Also, to the extent that a position in a Foreign Currency Contract creates a senior security of the feeder fund, the position would be covered by segregating an appropriate amount of shares of the master fund.

Section 12(d)(1)(E) of the 1940 Act, in effect, permits a feeder fund to own shares of a master fund in excess of the limits otherwise imposed by the 1940 Act so long as those shares are the only investment securities that are owned by the feeder fund. Nevertheless, in granting the requested no-action relief, the SEC staff that stated that it agreed that the feeder fund's proposed use of the Foreign Currency Contracts under the circumstances would be consistent with the purposes underlying Section 12(d)(1) of the 1940 Act. (The feeder fund's proposed use of the Foreign Currency Contracts would not create any incentive to exercise any improper influence over the master fund because the same investment adviser advises both of these funds, and would not create a complex pyramidal structure). Moreover, the SEC staff acknowledged that the only apparent way for the feeder fund to accomplish its foreign currency management objectives is for the feeder fund, rather than the master fund, to enter into the Foreign Currency Contracts.

In granting the requested no-action relief under Section 12(d)(1) of the 1940 Act, the SEC staff relied on the following representations:

  • The board of trustees of the feeder fund, including a majority of the independent trustees, will authorize the feeder fund to enter into the Foreign Currency Contracts only for the purposes of hedging its assets against the risk of fluctuations in the U.S. dollar against the applicable foreign currency and to effect purchase and redemption transactions in that currency. The board of trustees will review at least annually the continuing appropriateness of this authorization.
  • The same entity will be the investment adviser for the feeder fund and the master fund.
  • The master fund will not acquire the securities of any other investment company in excess of the limits contained in the 1940 Act.
  • The board of trustees of the feeder fund will not authorize the payment of any investment advisory fee by the feeder fund to its investment adviser unless it is based on the provision of services that are in addition to, rather than duplicative of, the services that the investment adviser provides to the master fund.
  • The master fund and the feeder fund will comply with all of the provisions of Section 12(d)(1)(E), except for Section 12(d)(1)(E)(ii), which requires that the only investment securities held by the feeder fund be shares of the master fund.

The SEC staff did not, however, concur with the view that, solely for purposes of Section 12(d)(1)(E), the term "investment security does not include the Foreign Currency Contracts under these same circumstances. The SEC staff stated that:

  • whether any particular instrument is a "security" is an inherently factual determination which, as a matter of policy, the staff generally will not make in the context of a no-action request; and
  • among other things, there is no clear evidence of Congressional intent to support the view that the term "investment security" does not include the Foreign Currency Contracts under these circumstances.
 
 
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 adopts new rule and proposes rule amendments requiring certification of financial reports and implementing intent of Sarbanes-Oxley legislation

August 26, 2002 10:33 AM

The SEC adopted new rule 30a-2 under the Investment Company Act of 1940 (the "1940 Act") requiring the principal executive and financial officers of a registered investment company to certify the company's semi-annual reports on Form N-SAR, as well as the financial statements on which the financial information in Form N-SAR is based. The new rule implements Section 302 of the Sarbanes-Oxley Act of 2002, which was enacted into law on July 30, 2002. Section 302 directed the SEC to adopt, by Aug. 29, 2002, rules requiring issuers' principal executive and financial officers to certify their quarterly and annual reports. Concurrently with adopting new Rule 30a-2, the SEC issued a companion release proposing rule amendments to require registered investment companies to file certified shareholder reports with the SEC on new Form N-CSR and would designate these certified shareholder reports as reports that are required under Sections 13(a) and 15(d) of the Securities Exchange Act of 1934.

New Rule 30a-2

As adopted, new Rule 30a-2 requires the signing officers of a registered investment company to certify that the financial information included in the report and the financial statements on which the financial information is based fairly present, in all material respects, the financial condition, results of operations, changes in net assets and cash flows (if the financial statements are required to include a statement of cash flows) of the investment company. The SEC also amended the instructions to Form N-SAR to require the specified certification to be filed as an exhibit to that form. The certification required by new Rule 30a-2 must be in the exact form set forth in the amendments to Form N-SAR. The wording of the required certification may not be changed in any way (even if the change would appear to be inconsequential in nature).

 

New Rules under the Securities Exchange Act of 1934 (the "Exchange Act")

Concurrent with new Rule 30a-2 under the 1940 Act, the SEC adopted new Exchange Act Rules 13a-15 and 15d-15. These rules will require that investment companies:

  • maintain disclosure controls and procedures.
  • conduct an evaluation, under the supervision and with the participation of the principal executive and financial officers, of the effectiveness of the design and operation of the investment company's disclosure controls and procedures within 90 days before the filing date of each report requiring certification under Rule 30a-2

Proposed Rule Amendments

The SEC proposed amendments designed to better implement the intent of Section 302 of the Sarbanes-Oxley Act with respect to registered investment companies. These proposed amendments would:

  • require registered management investment companies, including mutual funds, to file certified shareholder reports with the Commission, on a new Form N-CSR. These certified shareholder reports would consist of a copy of any required shareholder report, information regarding the company's disclosure controls and procedures, and the certifications required by Section 302;
  • require all registered investment companies to maintain, and regularly evaluate, disclosure controls and procedures designed to ensure that the information required in all its disclosure documents is collected, processed, and disclosed on a timely basis; and
  • (unlike Rule 30a-2) uniformly apply to all registered investment companies, and not just those required to file periodic reports under the Exchange Act.

SEC Release Nos. 33-8124, 34-46427, IC-25722; File No. S7-21-02; and SEC Release Nos. 34‑46441; IC-25723; File No. S7-33-02

 
 
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 allows hedge fund managers to provide limited information to databases used by broker-dealers to market the funds

August 5, 2002 11:03 AM

The sponsor of certain databases used by institutional broker-dealers to market services to funds sought no-action assurance from the SEC staff that the staff would not recommend enforcement action if hedge fund managers were to provide certain information to be included in these databases, including:

  • contact data such as the names, phone numbers, fax numbers and e-mail addresses of portfolio managers, analysts and traders,
  • manager biographical data, and
  • firm profile data such as the year a fund started, total assets, investment philosophy, industry focus, market focus, securities selection strategy and breakdown of assets (e.g., percentage of equity, fixed-income, cash, etc.).

Many hedge fund advisers are not registered under the Investment Advisers Act of 1940 (the "Advisers Act") in reliance upon Section 203(b)(3), which exempts from registration anyone who, during the preceding twelve months, has had fewer than fifteen clients and who neither holds himself out generally to the public as an adviser nor acts as an adviser to a registered investment company. The SEC staff noted if an adviser uses a publicly available electronic medium such as a website to provide information about its services, the adviser would not qualify for the exception from registration in Section 203(b)(3) of the Advisers Act. Conversely, however, the SEC staff stated that an adviser cannot be said to hold itself out to the public where it communicates through a medium that is not foreseeably available to potential advisory clients.

In granting the no-action relief, the SEC staff stated that including limited information about private funds and their managers in these databases would not cause unregistered fund managers to hold themselves out to the public as investment advisers. The staff reasoned that:

  • The databases are not even available, much less directed, to consumers of advisory services. On the contrary, the databases are available exclusively to the institutional sales and trading desks of broker-dealers to streamline communications with institutional investors for brokerage services, and to a handful of fund managers to monitor their competition.
  • The sponsor of the databases has implemented procedures to effectively prevent persons who may be seeking advisory services from gaining access to the databases. These procedures include password-protection and requiring subscribers to enter into a license agreement that prohibits redistribution.
 
 
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.

The SEC adopts amendments to Rule 17a-8 under the Investment Company Act of 1940

August 4, 2002 12:51 PM

The SEC adopted amendments to Rule 17a-8 under the Investment Company Act of 1940 (the “1940 Act”), the rule that permits mergers and other business combinations between affiliated investment companies in certain circumstances. The amendments (1) codify the relief provided in prior SEC exemptive orders, (2) expand the types of business combinations permitted by the rule and (3) make the rule applicable to mergers between registered investment companies and certain unregistered entities.

As amended, Rule 17a-8 permits affiliated funds to engage in mergers and other business combinations, regardless of the nature of their affiliation, provided that each fund’s board (including a majority of disinterested directors) determines that the merger is in the best interests of the fund and will not dilute the interests of shareholders. In making these determinations, fund boards are required to consider, if relevant, the following factors, among others:

  • any fees or expenses that will be borne directly or indirectly by the fund in connection with the merger;
  • any effect of the merger on annual fund operating expenses and shareholder fees and services;
  • any change in the fund’s investment objectives, restrictions, and policies that will result from the merger; and
  • any direct or indirect federal income tax consequences of the merger to fund shareholders.

In addition, the amended rule will require an acquired fund to obtain prior shareholder, but (unlike the proposed amendments) such approval will be required only if:

  • any policy of the acquired fund that under Section 13 of the 1940 Act could not be changed without a vote of a majority of its outstanding voting securities is materially different from a policy of the acquiring fund;
  • the acquiring fund’s advisory contract is materially different from that of the acquired fund, except for the identity of the funds as parties to the contract;
  • after the merger, directors of the acquired fund who are not interested persons of the acquired fund and who were elected by its shareholders will not comprise a majority of the directors of the acquiring fund who are not interested persons of the acquiring fund; or
  • after the merger, the acquiring fund will be authorized to pay charges under a Rule 12b-1 plan that are greater than charges authorized to be paid by the acquired fund under such a plan.

The SEC did not adopt its proposal to require certain shareholders to “echo vote” their securities. The amended rule also ncludes extensive recordkeeping requirement for surviving investment companies documenting the merger and its terms.

The amended rule also expands the exemption provided by Rule 17a?8 to permit funds to merge with certain unregistered funds (including bank common trust funds, bank collective trust funds and unregistered insurance company separate accounts). In these transactions, the acquiring fund’s board must approve procedures for the valuation of the securities (or other assets) that the unregistered entity will convey to the fund. These procedures must provide for the preparation of a report by an independent evaluator that sets forth the fair market value of any such assets for which market quotations are not readily available. It is not necessary to obtain an independent evaluator’s report on securities for which market quotations are readily available. Moreover, fund boards are not required to accept the opinion of an independent evaluator, but rather should use the information as a “second opinion” when considering the asset valuations that may have been prepared by a person with an interest in the transaction.

The amendments to Rule 17A-8 become effective July 26, 2002, and the compliance date is October 25, 2002. The release adopting the amendments states that persons entering into mergers that occur between July 26, 2002 and the compliance date may rely on either the rule as it previously existed or the rule as amended.

(SEC Release No. IC-25666 (July 18, 2002); Investment Company Institute Memorandum No. 14961 (July 25, 2002))

 
 
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.

Special Report: Sarbanes-Oxley Act

August 4, 2002 12:48 PM

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, which sets forth significant and wide-ranging accounting and corporate governance reforms for public companies.

 
 
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.

Department of Treasury and SEC issue rule proposal on customer identification programs for mutual funds

August 4, 2002 11:18 AM

The Department of the Treasury and the SEC jointly issued a proposed regulation to implement Section 326 of the USA PATRIOT Act of 2001. Section 326 requires the Secretary of the Treasury to jointly prescribe with the SEC a regulation that requires investment companies to adopt and implement reasonable procedures to verify customer identities, maintain related records and determine whether customers appear on any government agency lists of known or suspected terrorists.

The proposed rule would apply only to investment companies that are mutual funds (and not, for example, hedge funds or other privately offered investment funds).

For purposes of the proposed rule, “customer” includes only shareholders opening new accounts with the mutual fund, and not a shareholder of record before the effective date of the regulation. However, an existing beneficial or record owner of shares becomes a “customer” if the person:

  • becomes a shareholder of record
  • is granted trading authorization in a different account after the effective date; or
  • opens a different type of account with the mutual fund.

Nevertheless, a person does not become a “customer” simply by exchanging shares of one fund for shares of another fund within the same account (or initiating any other transaction that does not involve the opening of a separate account).

Customer Identification Program. Under the proposed rule, mutual funds must develop and operate a customer identification program (“CIP”). A mutual fund’s CIP, which must be a part of its anti-money laundering program, must enable it to form a reasonable belief that it knows the true identity of the customer. A mutual fund’s CIP procedures must be based on the type of information available and an assessment of relevant risk factors.

  • The type of identifying information available. At a minimum, the mutual fund must obtain certain identifying information before an account is opened for the customer (or the customer is granted trading authority over an account):

    • name,
    • date of birth, if applicable,
    • addresses and
    • tax identification number (there is a limited exception under the proposed rule for new businesses).
  • In addition, the release proposing the rule states that mutual funds, in assessing the risk factors listed below, should determine whether obtaining other identifying information is necessary to form a reasonable belief as to the true identity of each customer. The CIP should provide guidelines regarding under what circumstances a mutual fund should obtain additional information and what additional information should be obtained in these circumstances.

  • Assessment of relevant risk factors. Under the proposed rule, these risk factors include:
    • the mutual fund’s size;
    • the manner in which accounts are opened, fund shares are distributed, and purchases, sales and exchanges are effected;
    • the mutual fund’s types of accounts; and
    • the mutual fund’s customer base.

According to the release proposing the rule, the degree to which a CIP is effective will depend on a mutual fund’s assessment of these factors and the nature of its response to them (as manifested in the CIP’s procedures and guidelines). In addition, as Section 326 and the proposed rule provide, the reasonableness of the CIP also will depend on what is practicable for the mutual fund.

Under the proposed rule, it is permissible for a mutual fund to contractually delegate the implementation and operation of its CIP to another affiliated or unaffiliated service provider, such as a transfer agent. However, the mutual fund remains responsible for assuring compliance with this rule. Accordingly, the mutual fund must actively monitor the operation of its CIP program and assess its effectiveness.

A mutual fund’s CIP does not have to include verification of individuals’ identities whose transactions are conducted through an omnibus account (although the omnibus account holder is itself a customer for purposes of the proposed rule).

Verification Procedures. The proposed rule requires a mutual fund’s CIP to have procedures for verifying identifying information provided by the customer. The proposed rule provides for two methods of verifying identifying information: verification through documents and/or verification through non-documentary means. For natural persons, suitable documents for verification include unexpired government-issued identification documents evidencing nationality or residence and bearing a photograph or similar safeguard. For non-natural persons, suitable documents must evidence the existence of the entity, such as registered articles of incorporation, a government-issued business license, a partnership agreement, or a trust instrument.

 
 

The proposed rule requires a mutual fund’s CIP to address both methods of verification. Depending on the type of customer and the method of opening an account, it may be more appropriate to use either documents or non-documentary methods. In some cases, it may be appropriate to use both methods. Under the proposed rule, the CIP should provide guidelines describing when documents, non-documentary methods, or a combination of both will be used. These guidelines should be based on the mutual fund’s assessment of the factors described above. When those assessments suggest a heightened risk, the mutual fund should utilize additional verification measures.

 
 

If a customer whose identification has been verified previously opens a new account, the mutual fund would not need to verify the customer’s identity a second time, provided that the mutual fund continued to have a reasonable belief that it knew the true identity of the customer based on the previousverification.

 

Government Agency Terrorist Lists. The proposed rule would require a mutual fund’s CIP to include reasonable procedures for determining whether a customer’s name appears on any list of known or suspected terrorists or terrorist organizations prepared by any federal government agency and made available to the mutual fund. This requirement applies only with respect to lists circulated, directly provided, or otherwise made available by the federal government. In addition, the proposed rule states that mutual funds must follow all federal directives issued in connection with these lists. A mutual fund must have procedures for responding to circumstances when a customer is named on such a list.

 

Customer Notice. Section 326 provides that financial institutions must give their customers notice of their identity verification procedures. Therefore, a mutual fund’s CIP must include procedures for providing customers with adequate notice that the mutual fund is requesting information to verify their identities. A mutual fund may satisfy the notice requirement by generally notifying its customers about the procedures the fund must comply with to verify their identities. If an account is opened electronically, such as through an Internet website, the mutual fund may provide notice electronically. However, notice must be provided to the customer before the account is opened or trading authority is granted.

 

Lack of Verification. The proposed rule states that a mutual fund’s CIP must include procedures for responding to circumstances in which it cannot form a reasonable belief that it knows the true identity of a customer. A mutual fund’s CIP should specify the actions to be taken when it cannot form a reasonable belief that it knows the customer’s true identity, which could include closing the account or placing limitations on additional purchases. The CIP also should include guidelines for when an account will not be opened (e.g., when the required information is not provided). In addition, the CIP should address the terms under which a customer may conduct transactions while the customer’s identity is being verified. Mutual funds are also encouraged, but not required at this time, to adopt procedures for voluntarily filing Suspicious Activity Reports with the Financial Crimes Enforcement Network (“FinCEN”) and for reporting suspected terrorist activities to FinCEN using its Financial Institutions Hotline.

 

Recordkeeping Requirements. The proposed rule sets forth recordkeeping procedures that must be included in a mutual fund’s CIP. These procedures must provide for the maintenance of all information obtained in accordance with the CIP. Information that must be maintained includes all identifying information and records of the methods and results of measures undertaken to verify the identity of a customer (including, for example, how discrepancies are resolved). The mutual fund must retain all of these records for five years after the date the account is closed. A mutual fund may use electronic records to satisfy the requirements of this regulation in accordance with previously issued SEC guidance.

 

Board Approval. The proposed rule requires that the mutual fund’s CIP be approved by its board of directors or trustees. The board should periodically assess the effectiveness of its CIP and should receive periodic reports regarding the CIP from the person or persons responsible for monitoring the fund’s anti-money laundering program.

 

Exemptions. The proposed rule provides that the SEC, with the concurrence of the Secretary, may exempt any mutual fund or type of account from the requirements of this section. The SEC and the Secretary must consider whether the exemption is consistent with the purposes of the Bank Secrecy Act, and in the public interest, and may consider other necessary and appropriate factors.

 
 
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.