Investment Management Industry News Summary - December 1999

Investment Management Industry News Summary - December 1999

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.

View previous month...

President Clinton Signs Tax Relief Extension Act of 1999

December 20, 1999 9:29 AM

On December 17, 1999, President Clinton signed the Tax Relief Extension Act of 1999 (the "Act"). The Act extends certain tax credits and other expired or expiring tax provisions. Among the Act's revenue offsets are provisions that:

  • clarify the tax treatment of income and loss on derivatives by excluding from treatment as capital assets (a) commodities derivative financial instruments held by commodities derivatives dealers and (b) certain identified hedging transactions, including those entered into in the normal course of a trade or business primarily to manage risk of price changes or currency fluctuations with respect to ordinary property;
  • recharacterize a portion of long-term capital gain as ordinary income if it arises from a "constructive ownership transaction," which includes certain transactions in derivatives that involve long positions in financial assets and are not marked to market under other tax rules; and
  • modify in a favorable manner the rules for determining how a regulated investment company's distributions are allocated to any of its earnings and profits that are inconsistent with its continued qualification as a regulated investment company because they are attributable to a "C" corporation.

The Act also contains several other revenue offsets that are not of specific interest to the mutual fund industry.

 
 



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 DOL Has Proposed Extending a Prohibited Transaction Exemption to Interest Free Loans to Address Potential Y2K Problems

December 20, 1999 9:24 AM

The DOL has proposed an amendment to Prohibited Transaction Exemption ("PTE") 80-26 to permit parties in interest with respect to employee benefit plans to make interest free loans to the plans to address potential Y2K problems. PTE 80-26 is a class exemption that permits the lending of money or other extension of credit from a party in interest to an employee benefit plan and the repayment of the loan or extension of credit if certain conditions specified in the exemption are met. The extension of PTE 80-26 is intended to enable plans to address any potential liquidity problems that may be created by Y2K disruptions so that the plan will have sufficient liquidity to pay benefits and administer the plan, including transfers among investment options, distributions, hardship withdrawals, health claim payments and loans to participants and beneficiaries. An exemption is already available under paragraph (b)(1) of PTE 80-26 for an interest free loan or extension of credit on an unlimited basis to deal with a Y2K disruption to ordinary plan operations involving the payment of benefits or insurance premiums. A plan may, however, need interest free loans to address potential Y2K problems that are only incidental to the ordinary operation of the plan. Currently, PTE 80-26 imposes a three day limit on loans for purposes incidental to the ordinary operation of the plan, which may not allow enough time to address Y2K contingencies. Accordingly, beginning November 1, 1999 and ending December 31, 2000, the proposed amendment to PTE 80-26 will permit certain interest free loans for an extended period of no more than 14 months. All loans made in reliance on this amendment must be repaid by December 31, 2000. Comments on the proposed exemption are required on or before January 13, 2000. Federal Register, Vol. 64, No. 228 (November 29, 1999).

 
 



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 Proposes New Rules to Address Selective Disclosure and Insider Trading

December 20, 1999 9:12 AM

The SEC is proposing new rules to address three issues: (i) the selective disclosure by issuers of material nonpublic information; (ii) whether insider trading liability depends on a trader's "use" or "knowing possession" of material nonpublic information; and (iii) when the breach of a family or other non-business relationship may give rise to liability under the misappropriation theory of insider trading. The proposals are designed to promote the full and fair disclosure of information by issuers and to clarify and enhance existing prohibitions against insider trading. The following rules were proposed:

Regulation FD (fair disclosure), a new issuer disclosure rule, deals with the problem of issuers making selective disclosure of material nonpublic information to analysts, institutional investors, or others, but not to the public at large. The SEC commented in the proposing release that it does not believe that allowing issuers to disclose material information selectively to analysts is in the best interest of investors or the securities market generally. Instead, to the maximum extent practicable, all investors should have access to an issuer's material disclosures at the same time. Regulation FD is intended to require an issuer, when intentionally disclosing material information, to do so through public disclosure rather than selective disclosure. The regulation would also require an issuer, when learning that it has made a non-intentional material selective disclosure, to make prompt public disclosure of that information. Regulation FD applies to all issuers with securities registered pursuant to Section 12 of the Securities Exchange Act of 1934 (the "1934 Act"), and those issuers required to file reports under Section 15(d) of the Securities Exchange Act of 1934, including closed-end investment companies, but not including other investment companies.

Regulation FD is an issuer disclosure rule and not an antifraud rule. Unlike other Section 13(a) and 15(d) reporting requirements, the SEC noted that it is not intending to create duties under Section 10(b) of the 1934 Act or any other provisions of the federal securities laws. Accordingly, no private liability will arise from an issuer's failure to file or make public disclosure. If an issuer fails to comply with Regulation FD, however, the issuer could be subject to an SEC enforcement action.

Rule 10b5-1 The SEC commented that the proposed rule addresses an important unsettled issue in insider trading law. This issue is whether the SEC must show in its insider trading cases that the defendant "used" the inside information in trading, or merely that the defendant traded while in "knowing possession" of the information. The proposed rule states the general principal that insider trading liability arises when a person trades while "aware" of material nonpublic information but also provides four exceptions to liability. In these four situations, if a trade resulted from a pre-existing plan, contract, or instruction that was made in good faith, the trader will be deemed not to have used the information in his possession.

Rule 10b5-2 The SEC commented that the proposed rule addresses another unsettled issue in current insider trading law. This issue is what types of family or other non-business relationships can give rise to liability under the misappropriation theory of insider trading. The proposed rule sets forth three non-exclusive bases for determining that a duty of trust or confidence was owed by a person receiving information:

  • when the person agreed to keep information confidential;
  • when the persons involved in the communication had a history, pattern, or practice of sharing confidences that resulted in a reasonable expectation of confidentiality; and
  • when the person who provided the information was a spouse, parent, child or sibling of the person who received the information, unless it was shown affirmatively, based on the facts and circumstances of the family relationship, that there was no reasonable expectation of confidentiality.

Comments are due on these proposals within 90 days after the rules are published in the Federal Register. SEC Release No. 33-7787 (December 20, 1999).

 
 



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.

Staff Permits Use of Automated Phone System to Provide Dividend Information to Fund Shareholders

December 20, 1999 9:04 AM

The staff of the SEC stated in a no-action letter that a fund's use of an automated phone system that includes estimated and actual distribution information could, under certain circumstances, comply with Rule 482 under the Securities Act of 1933 (the "1933 Act"). This distribution information does not meet certain other requirements of Rule 482 that apply to the presentation of performance data. In the request letter, counsel representing a number of funds and their investment advisers stated that the funds would like to be able to quote: (1) a fund's estimated distribution per share in dollars; (2) the distribution's income tax character (i.e., long-term or short-term gains or ordinary income); (3) the ex-dividend date; and (4) the payment date, on their automated phone systems. Counsel did not believe that this distribution information would constitute performance data for purposes of Rule 482. Counsel argued that the distribution information would be provided to investors primarily for tax planning purposes and not to convey information about the performance of the funds or to market the funds to prospective investors.

Previously, the staff took the position that a fund's use of an automated phone system that provides the fund's shareholders and other callers with fund performance data must comply with Rule 482 or otherwise satisfy the requirements of Section 10 of the 1933 Act (i.e., be a statutory prospectus). Rule 482 generally permits a fund to include performance data in an advertisement as long as the performance data meets the performance presentation requirements of the rule. In its letter, the staff stated that the proposed distribution information would not constitute performance data within the meaning of Rule 482. The staff further stated that a fund's use of an automated phone system to relay estimated and actual distribution information could comply with Rule 482 even though that distribution information would not meet certain requirements of the rule. The staff noted that its position is based on the following representations:

  • the estimated distribution information will be provided on the fund's automated phone systems no earlier than the date that the fund can calculate a reasonably accurate estimate, and in no event earlier than 90 days before the ex-dividend date;
  • the actual distribution information will be provided on the funds' automated phone systems for a period of no more than 30 days after the payment date; and
  • the distribution information will not be presented in a manner that may mislead callers about the nature and significance of the information.

The staff specifically noted that its position in the letter does not change its position prohibiting the use of distribution rates in Rule 482 advertisements. Vedder, Price, Kaufman & Kammholz, SEC No-Action Letter (December 6, 1999).

 
 



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 Charges New York Pension Fund Manager in $6.9 Million Kickback Scheme

December 20, 1999 8:54 AM

The SEC sued a New York pension fund manager for fraudulently receiving more than $6.9 million in kickbacks from brokerage firms in connection with his management of the pension investment funds of a number of high profile clients. The SEC's complaint, filed in U.S. District Court for the Southern District of New York, alleges that the manager received over $6.9 million in commission kickbacks from three brokerage firms. The complaint further alleges that the kickbacks he received were deducted from the investment returns of his clients in the form of mark-ups on principal trades in the over-the-counter market. According to the complaint, the manager dictated to the brokerage firm the amount of the mark-up on each trade and the firms in turn returned 57-80% of the mark-ups to the manager. In most cases, the kickbacks were funneled through dummy corporations set up by an associate who worked as a broker at these brokerage firms. The manager then instructed the firms not to report the mark-ups on his clients' trade confirmations and account statements.

As part of the lawsuit, the SEC has charged the manager with violating, and his associate with aiding and abetting violations of, the anti-fraud provisions of the federal securities laws. The manager was also charged with filing false documents with the SEC. The SEC is seeking permanent injunctions, disgorgement of all fraudulently received gains plus prejudgment interest and civil penalties against the defendants. SEC Press Release 99-173 (December 16, 1999)

 
 



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 Provides Guidance on Funds' Share Value Pricing Responsibilities

December 13, 1999 11:32 AM

The staff of the SEC, in a letter to the ICI dated December 8, 1999, provided additional guidance as to open-end funds' responsibilities when pricing and redeeming fund shares during emergency or unusual situations. The 1940 Act requires mutual funds to value their portfolio securities by using the market value of the securities when market quotations for the securities are "readily available". When market quotations are not readily available, the 1940 Act requires fund boards to determine, in good faith, the fair value of the securities. In the letter, the staff clarified the following issues relating to a fund's fair value pricing responsibilities:

When market quotations are not readily available: The staff clarified that market quotations for portfolio securities are not readily available when the exchanges and markets on which those securities trade are closed for trading for the entire day. In these instances, funds holding securities traded on the closed exchange or market must fair value those securities. The staff noted that a determination that market quotations are no longer "readily available" does not preclude a fund's board from concluding that the most recent closing market price represents fair value. The staff stated that the most recent closing market prices generally should be considered along with other appropriate factors when determining the fair value of securities for which current market quotations are not readily available.

Fair value pricing: The staff provided further guidance on the factors that fund boards should evaluate when fair valuing a fund's portfolio securities. As a general principle, the fair value of a portfolio security is the price which the fund might reasonably expect to receive upon its current sale. Fair value cannot be based on what a buyer might pay at some later time, such as when the market ultimately recognizes the security's true value as perceived by the portfolio manager. The staff noted that SEC has adopted a flexible standard for determining fair value, which requires fund directors to "satisfy themselves that all appropriate factors relative to the value of securities for which market quotations are not readily available have been considered and to determine the method of arriving at the fair value of each such security." The staff noted that whether a factor is "appropriate," and whether a particular indication of value is available, depends upon the particular facts and circumstances of the situation. The staff continues to believe that fundamental analytical information is among the most important factors for fund boards to evaluate when fair valuing portfolio securities, but that in many situations the fund board may need to incorporate external sources of information in their fair value determination such as:

  • the value of other financial instruments, including derivative securities, traded on other markets or among dealers;
  • trading volumes on markets, exchanges or other dealers;
  • the value of baskets of securities traded on other markets, exchanges or among dealers;
  • changes in interest rates;
  • observations from financial institutions;
  • government (domestic or foreign) action or pronouncements; and
  • other news events.


The factors may also include the value of foreign securities traded on other markets, ADR trading, closed-end fund trading, foreign currency exchange activity and the trading prices of financial products that are tied to baskets of foreign securities, such as WEBS.

The board's good faith responsibilities: The staff commented that "good faith" is a flexible concept that can accommodate many different considerations and incorporate a variety of information sources. The staff stated that the specific actions that a mutual fund board must take in order to satisfy its good faith obligation will vary depending on the nature of the particular fund, the context in which the board must fair value securities and the pricing procedures adopted by the board. The staff recognizes that different fund boards, when fair valuing identical securities, could reasonably arrive at different prices, with both boards satisfying their obligation to fair value securities in good faith. The staff commented that the degree of involvement required of a board during emergencies will depend heavily on the comprehensiveness of the fund's pricing procedures and the degree of discretion invested in fund management. The staff concluded by noting that because a fund's board retains oversight responsibilities for the valuation of the fund's assets, the board should receive periodic reports from fund management that discuss the functioning of the valuation process and that focus on current valuation problems.

 
 



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 Amendments to Rule Governing Interim Advisory Contracts

December 13, 1999 11:27 AM

The SEC has adopted amendments to Rule 15a-4 under the 1940 Act, which permits an investment adviser to advise a fund under a temporary contract that the fund's shareholders have not yet approved. The amendments expand the scope of the Rule to include temporary contracts following a merger or similar business combination involving a fund's adviser. The amendments also lengthen the maximum duration of the temporary contract to 150 days and afford a board of directors more time to approve an interim contract.

Section 15(a) of the 1940 Act prohibits a person from serving as an investment adviser to a fund except under a written advisory contract that the fund's shareholders have approved. Section 15(a) also requires that an advisory contract terminate automatically if it is assigned. Rule 15a-4 under the 1940 Act permits a fund to be advised under a short-term contract until shareholders can vote on a new contract. The rule did not extend to an interim contract entered into after an adviser merger. In light of increasing consolidation in the financial services industry, the SEC has approved the following amendments to Rule 15a-4:

Board approval: Under the amended rule, a fund's board has 10 business days (rather than 7 calendar days) to approve an interim contract. The board may also participate in a meeting to approve an interim contract by any means of communication that allows all participants to hear each other at the same time, such as in a telephone conference. (Boards are usually required to meet in person to approve advisory contracts.)

Adviser mergers: The amended rule permits funds to operate under an interim advisory contract when the previous contract is terminated as a result of an adviser merger (i.e., when the adviser or a controlling person of the adviser has received a benefit in connection with the assignment of the previous contract). The board, including a majority of independent directors, must find that the scope and quality of the advisory services to be provided under the interim contract are at least equivalent to the scope and quality of the services provided under the previous contract. The board must approve the interim contract before the previous contract is terminated. The interim contract must provide that the board may terminate the contract on no more than 10 days written notice. Any fees earned by the adviser during the interim contract must be placed in an interest-bearing escrow account and may be paid to the adviser only if shareholders approve the new advisory contract. If shareholders do not approve the new contract, the adviser may receive the lesser of (i) the fees provided under the interim contract or (ii) the cost of providing services under the interim contract.

Duration of Interim Contract: The amended Rule extends the maximum duration of an interim contract from 120 days to 150 days in order to provide additional time to solicit proxies and obtain a quorum at a meeting of shareholders.

The amendments to Rule 15a-4 became effective December 13, 1999. SEC Release No. IC-24177 (November 30, 1999)

 
 



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 Director Roye Comments on Current SEC Initiatives

December 13, 1999 11:24 AM
Speaking at the Investment Company Institute's ("ICI") Securities Law Developments Conference on December 9, 1999, Paul F. Roye, Director, Division of Investment Management, identified a number of initiatives which the SEC is currently working on. Mr. Roye commented that these initiatives are designed to give the mutual fund industry the flexibility to deal with the increased competition and consolidation expected in the 21 st century while adequately protecting mutual fund shareholders.

Mr. Roye noted that the SEC's Rulemaking Group is considering rule amendments that would permit certain affiliated transactions to proceed without an exemptive order. One specific initiative relates to expanding Rule 17a-8 under the Investment Company Act of 1940 (the "1940 Act") involving mergers between affiliated funds.

Mr. Roye noted that the Office of Chief Counsel is finalizing a no-action letter which may be issued by the end of the month and which sets forth the staff's position on in-kind redemptions of fund shares held by affiliated shareholders. Mr. Roye expects that the letter, when issued, will significantly reduce the need to seek exemptive relief for these redemptions.

Mr. Roye commented that the SEC will continue its efforts to simplify and streamline mutual fund prospectuses.

He expects that the SEC will further amend Form N-1A to address issues identified by the staff during its review of the new prospectuses.

Mr. Roye stated that the SEC is working to amend Rule 482 under the Securities Act of 1933 to eliminate the requirement that the substance of the information contained in the advertisement be derived from the statutory prospectus. He commented that eliminating that requirement would allow funds to provide investors with better and more timely information. He noted that the SEC is coordinating with the NASD on this amendment. Mr. Roye stressed that the SEC will not tolerate the use of misleading performance information, noting that the SEC has initiated several recent enforcement actions for advertising violations.

Mr. Roye noted that the SEC is actively studying ways to improve mutual funds' periodic communications to shareholders. Specifically, he noted that the SEC will recommend revisions to the shareholder report and financial statement requirements.

Mr. Roye commented that the SEC continues to explore ways to reduce costs to mutual fund investors. He noted that the SEC has already proposed rule amendments allowing the householding of prospectuses and shareholder reports. The SEC is also exploring whether to eliminate the need to deliver complete updated prospectuses annually to existing shareholders. Instead, funds could send an "annual prospectus update" document to current shareholders in order to satisfy the prospectus delivery requirements. The document would likely contain updated fee tables and expense examples as well as information on material changes in a fund's operations and management. Mr. Roye noted that the SEC is considering whether this information could be included in the fund's annual report rather than in a separate document. He asked for the industry's reaction to this approach.

Mr. Roye commented that the SEC has been examining how mutual fund disclosure requirements could be revised to provide investors with a better understanding of the tax consequences of holding and disposing of fund shares, the relative tax efficiencies of different funds and how much of a fund's pre-tax return will be lost to taxes. He expects that the SEC will present a proposal on after-tax returns within the coming year.

Mr. Roye commented that the industry is entering the "e-century" in which more funds will use the internet to connect with investors. He noted that Congress is currently considering legislation which would permit the use of electronic signatures. He also commented that the SEC has been working on an interpretive release clarifying and expanding the guidelines contained in releases issued in 1995 and 1996 covering the electronic delivery of information. The release should provide guidance on telephonic and oral consent to receive information electronically and will discuss issues raised by hyperlinks. The release will also address the use of "global consent" by an investor to the electronic delivery of all documents of any issuer whose securities are owned through a broker.

Mr. Roye commented that he believes the fund industry is ready and prepared for the year 2000. He stated that he expects funds to remain open to price and make redemptions at the start of 2000. He noted that the SEC, including its EDGAR system, is also ready for the Year 2000. He stated that the SEC will maintain a "control center" where staff will be available to answer questions over the New Year's weekend.
 
 



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.