This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
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FINRA Issues Regulatory Notices Regarding Sales Practices for Cash Alternatives and High Yield Securities
December 31, 2008 3:24 PM
On December 16, 2008, FINRA issued two regulatory notices reminding members of their sales practice obligations with regard to cash alternatives and high yield securities. With regard to cash alternatives, including ARS, FINRA reminded members of the requirements to:
With regard to high yield securities, FINRA reminded members that they are obligated to balance any discussion of yield with an appropriate discussion of the features and risks of high yield securities. FINRA reiterated the need for both firm-level reasonable-basis and customer-specific suitability determinations, and the need to present a balanced picture regarding the risks and rewards of the investments. Risks FINRA enumerated for discussion include issuer credit risk, interest rate risk, and liquidity risk.
For more information, please see:
FINRA Announces Special Arbitration Procedure for ARS Consequential Damages
December 31, 2008 3:12 PM
On December 16, 2008, FINRA announced details of a special arbitration procedure for investors seeking recovery of consequential damages related to their investments in Auction Rate Securities (“ARS”). Customers entitled to file for consequential damages under ARS-related settlements that firms have concluded with FINRA or the SEC may use this special procedure. Under the special procedure, firms will pay all arbitration-related fees, including filing fees, hearing session fees and all the fees and expenses of arbitrators. If investors do not opt for this special arbitration procedure, they retain the choice of other remedies, including initiating a regular FINRA arbitration claim. Also under the special procedure, firms cannot contest liability related to the illiquidity of the ARS holdings, or to the ARS sales, including any claims of misrepresentations or omissions by a firm’s sales agents. Further, a firm cannot use in its defense an investor’s decision not to sell ARS holdings before the relevant ARS settlement date or the investor’s decision not to borrow money from the firm if it made a loan option available to ARS holders.
The special arbitration procedure gives investors the option to sell their ARS holdings back to the firms under the regulatory settlements and to pursue consequential damages at the same time. Investors who wish to seek punitive damages or attorneys’ fees may do so under FINRA’s standard arbitration procedures.
Cases claiming consequential damages under $1 million will be decided by a single, chair-qualified public arbitrator. In cases with consequential damage claims of $1 million or more, the parties can, by mutual agreement, expand the panel to include three public arbitrators.
For more information regarding this special procedure, please see:
SEC Approves Exemptions to Allow Central Counterparty for Credit Default Swaps
December 31, 2008 3:06 PM
On December 23, 2008, the SEC approved temporary exemptions from Sections 5, 6 and 17A of the Exchange Act to allow LCH.Clearnet Ltd. to operate as a central counterparty for credit default swaps. The temporary exemptions are intended to allow central counterparties such as LCH.Clearnet and certain of their participants to implement centralized clearing quickly, while providing the SEC time to review their operations and evaluate whether registrations or permanent exemptions should be granted in the future. The conditions that apply to the exemptions are designed to provide that key investor protections and important elements of SEC oversight apply, while taking into account that applying all the particulars of the securities laws could have the unintended consequence of deterring the prompt establishment and use of a central counterparty.
SEC Chairman Christopher Cox described the temporary exemptions as “an important step in our efforts to add transparency and structure to the opaque and unregulated multi-trillion dollar credit default swaps market.” He further stated, “These conditional exemptions will allow a central counterparty to be quickly up and running, while protecting investors through regulatory oversight. Although more needs to be done in this area legislatively, these actions will shine much-needed light on credit default swaps trading.”
For more information, please see:
SEC Charges Wall Street Professionals and Others With Insider Trading
December 31, 2008 2:54 PM
On December 18, 2008, the SEC charged seven individuals and two companies involved in an insider trading ring, alleging that a former registered representative at a major investment bank traded on and tipped his clients and friends with confidential, nonpublic information about 13 impending corporate transactions. Some of the representative’s clients and friends, three of whom worked in the securities or legal professions, tipped others who also traded in the securities of the companies involved in the transactions. The SEC alleges that the illicit trading occurred from at least March 2004 through July 2008, and yielded more than $4.8 million in profits. Related criminal charges by the U.S. Attorney’s Office for the Southern District of New York were unsealed against some of the defendants named in the SEC’s complaint.
According to the SEC’s complaint, the representative received inside information from his wife, a partner in the New York City office of an international public relations firm working on the deals. The SEC’s complaint further alleges that the representative was rewarded with cash and luxury items for providing inside information, including a widescreen TV, a leather jacket, and Porsche driving lessons.
Seven individuals and two companies are charged with violating Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Exchange Act Rules 10b-5 and 14e-3. The SEC seeks injunctive relief, disgorgement of illicit profits with prejudgment interest, and financial penalties. Two other persons and a company are charged as relief defendants and the SEC seeks their trading profits.
For more information, please see:
SEC Approves Interactive Data for Financial Reporting by Mutual Funds
December 31, 2008 2:37 PM
On December 18, 2008, the SEC voted to require mutual funds, as well as public operating companies, to use tagged interactive data for financial information, which has the potential to increase the speed, accuracy and usability of financial disclosure and eventually reduce costs for investors. The information will be filed with the new Interactive Data Electronic Applications (“IDEA”) system, which currently supplements, and ultimately will replace, the SEC’s EDGAR database.
Starting in 2011, mutual funds will be required to include data tags in their public filings that supply investors with such information as objectives and strategies, risks, performance, and costs. A mutual fund also would be required to post the interactive data on its Web site, if it maintains one.
For public operating companies, interactive data financial reporting will occur on a phased-in schedule beginning in 2009. Companies will be able to adopt interactive data earlier than their required start date. All U.S. public companies will have filed interactive data financial information by December 2011 for use by investors.
For more information, please see:
SEC Approves Final Rule for Equity-Indexed Annuities
December 31, 2008 2:23 PM
On December 17, 2008, the SEC approved Final Rule 151A (the “Rule”) under the Securities Act of 1933 (the “Securities Act”) to help protect investors from fraudulent and abusive practices that can occur in the sale of equity-indexed annuities.
The Rule defines the terms “annuity contract” and “optional annuity contract” under the Securities Act. Section 3(a)(8) of the Securities Act provides an exemption under the Securities Act for certain insurance and annuity contracts. The Rule provides that an indexed annuity is not an “annuity contract” under this exemption if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract.
The Rule addresses the manner in which a determination will be made regarding whether amounts payable by the insurance company under a contract are more likely than not to exceed the amounts guaranteed under the contract. The Rule provides that a determination made by the insurer at or prior to issuance of a contract is conclusive if, among other things, both the insurer’s methodology and the insurer’s economic, actuarial, and other assumptions are reasonable.
The new definition applies only to equity-indexed annuities issued on or after January 12, 2011.
For more information, please see:
SEC Settles Breakpoint Action Against Broker-Dealer and Registered Representative
December 31, 2008 8:56 AM
On December 17, 2008, the SEC settled an administrative enforcement action against a registered broker-dealer and one of its registered representatives (together, “Respondents”). The SEC alleged that the registered representative offered and sold mutual fund class A shares to retail customers without adequate disclosure about the availability of breakpoint discounts for which customers could have qualified. The SEC found that the registered representative’s conduct constituted a willful violation of Sections 17(a)(2) and (3) of the Securities Act by failing to adequately disclose, before customers made investment decisions, all breakpoint discounts for which the customers could qualify in the recommended fund families, and by failing to adequately disclose the breakpoint discounts customers could have received by investing larger amounts in fewer fund families. The SEC further found that the representative failed to adequately disclose the financial impact of additional breakpoint discounts, and that purchases below the additional breakpoints would result in a greater profit to the representative.
The SEC found that the firm violated Section 15(b)(4)(E) of the Exchange Act by failing to reasonably supervise the registered representative. In particular, the SEC found that the firm had inadequate systems in place to implement its procedures to insure that customers received breakpoint discount information before they made an investment decision.
As a result of the settlement, the SEC ordered the registered representative to cease and desist from violations of Sections 17(a)(2) and (3) of the Securities Act, censured the firm, and imposed fines of $25,000 on both the registered representative and the firm. Respondents consented to the order without admitting or denying the SEC’s findings.
For more information, please see:
In the Matter of Milkie/Ferguson Investments, Inc., and Daniel Edward Levin, SEC Release Nos. 33-8990 and 34-59115, Admin. Proc. File No. 3-13312 (Dec. 17, 2008), available at http://www.sec.gov/litigation/admin/2008/33-8990.pdf.
First Circuit Reverses Dismissal of SEC Market Timing Action Against Fund Distributor Executives
December 31, 2008 8:53 AM
On December 3, 2008, the U.S. Court of Appeals for the First Circuit reversed a district court’s dismissal of an SEC action against two former executives of the principal underwriter and distributor of a mutual fund complex. The action alleges that the former executives committed fraud and aided and abetted the distributor’s fraud by entering into, approving, and permitting arrangements allowing preferred customers to engage in short-term trading in mutual funds, while at the same time offering those funds using prospectuses that represented that such short-term trading was prohibited. The district court dismissed the action in December 2006, holding, among other things, that the executives could not be primarily liable for false statements contained in the prospectuses because they did not make the statements themselves.
The First Circuit reversed, holding that the scope of conduct prohibited by Section 17(a)(2) of the Securities Act is broader than the antifraud provisions of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The First Circuit held that under Section 17(a)(2), a defendant may be held liable for “using” a false or misleading statement as a means “to obtain money or property,” regardless of the source of the statement. The SEC’s allegations thus fell within the prohibitions of Section 17(a)(2), and should not have been dismissed. The First Circuit further held that the SEC adequately alleged a primary violation under Rule 10b-5, which “renders it unlawful ‘to make any untrue statement of a material fact … in connection with the purchase or sale of any security.” The court stated that underwriters have a statutory duty to review and confirm the accuracy of the prospectus, such that an underwriter “impliedly makes a statement” to investors that the information contained in the prospectus is accurate. Judge Selya dissented with regard to Rule 10b-5, characterizing the court’s opinion as “nothing less than a rewriting of that rule.” Insofar as the majority consisted of Judge Lipez and a district judge sitting by designation, there may be a heightened possibility of rehearing en banc by the First Circuit.
For more information, please see:
SEC v. Tambone, 2008 U.S. App. LEXIS 24457 (Dec. 3, 2008) and
IASB Seeks Comments on Changes to Debt Instrument Disclosure Standards
December 31, 2008 8:50 AM
On December 23, 2008, the IASB published a further round of amendments to its financial instruments disclosure standard, International Financial Reporting Standard 7. The preamble to the exposure draft explains that the changes “would require disclosures about investments in debt instruments that facilitate a comparison between such investments that are classified in different categories.” In a press notice accompanying the exposure draft, IASB Chairman David Tweedie said that the U.S. Financial Accounting Standards Board “will also be issuing similar proposals.” The changes, which affect debt instruments other than those held at fair value through profit or loss, if confirmed by the board, will require entities to:
Interested parties have until January 15, 2009 to comment on the proposals.
For more information on the proposed amendments, please see:
CFTC Announces Certification of CME Proposal to Clear Credit Default Swaps
December 31, 2008 8:43 AM
On December 23, 2008, the CFTC announced that the Chicago Mercantile Exchange Inc. (“CME”) has certified plans to provide clearing services for certain credit default swap contracts (“CDS”) through CME’s clearinghouse, a registered derivatives clearing organization (“DCO”). CME has certified that this initiative will comply with the DCO Core Principles enumerated in Section 5b(c)(2) of the Commodity Exchange Act and Part 39 of the CFTC’s regulations.
Prior to CME’s certification, CFTC staff reviewed CME’s plans to clear credit default swaps, including CME’s planned risk management procedures, and notified CME that the CFTC staff would not object to the certification. Given the unique regulatory posture of credit default swaps, the CFTC, the Board of Governors of the Federal Reserve, and the SEC entered into a Memorandum of Understanding (“MOU”) on November 13, 2008, to establish a framework for consultation and information sharing on issues related to CDS central counterparties, facilitate the regulatory approval process, and promote more consistent regulatory oversight. Pursuant to the MOU, the CFTC coordinated and consulted with the staffs of the Federal Reserve and the SEC in reviewing the CME’s plans to clear credit default swap contracts. Based upon this review, the Federal Reserve staff expressed its support for the CFTC staff’s decision not to object to the CME’s certification.
CFTC Acting Chairman Walter Lukken said: “The advent of clearing solutions for the credit default swap market will benefit the financial system significantly by enhancing transparency, reducing counterparty credit risk, and improving the quantity and quality of information provided to federal regulators.”
For more information, please see:
Second Circuit Limits an Investment Adviser’s Ability to File Suit on Behalf of Its Clients
December 16, 2008 10:17 AM
On December 3, 2008, the U.S. Court of Appeals for the Second Circuit ruled that an investment adviser that has (i) the discretionary authority to make investment decisions on its clients’ behalf; and (ii) the power of attorney to sue on its clients behalf, but does not have ownership in or title to the claim itself, does not have constitutional standing to bring an action under the securities laws in a representative capacity. The appellate court reversed an earlier ruling from the U.S. District Court, which had declined to dismiss the case for lack of standing.
The investment adviser had filed suit on behalf of its clients, including public pension funds, that had invested in a communications company before its abrupt bankruptcy. Rather than suing the company directly, the investment adviser brought suit against the firms that provided underwriting, auditing or legal services to the company, and alleged that these firms prepared, facilitated, or certified inaccurate and misleading disclosures in the company’s financial statements, in violation of the federal securities laws.
The appellate court found that the investment adviser, which acknowledged that it did not suffer financial losses itself, could not demonstrate the requisite “injury-in-fact.” Specifically, the court held that “the minimum requirement for injury-in-fact is that the plaintiff have legal title to, or a property interest in, a claim.” The court determined that investment discretion and power of attorney alone were not sufficient to meet this standard.
The appellate court also rejected the investment adviser’s argument that it should qualify for a “prudential exception” to the third-party standing rules. The court said that the investment advisory relationship has not been recognized as one of the prudential exceptions and there was no indication that denying standing to the adviser would hinder the beneficial owners’ ability to protect their own interests.
The Second Circuit has remanded the case for further proceedings.
For more information, please see: W.R.Huff Asset Management Co. v. Deloitte & Touche, et al. Nos. 06-1664-cv and 06-1749-con (2d Cir. Dec. 3, 2008).
CFTC Creates New Web Page to Facilitate the Filing of Public Comments
December 16, 2008 10:13 AM
On December 4, 2008, the CFTC announced that it has created a new web page on its web site (CFTC.gov) to facilitate the filing of public comments. The new web page is called “Public Comments” and provides detailed instructions on how to file a public comment in response to a proposed CFTC rule or an industry submission pending CFTC action.
For more information, please see:
Treasury Official Testifies Before Congress About the Troubled Assets Relief Program (“TARP”)
December 16, 2008 10:04 AM
On December 10, 2008, Neel Kashkari, Interim Assistant Secretary for Financial Stability, testified before the House Committee on Financial Services at a hearing on “Oversight Concerns Regarding Treasury Department Conduct of the Troubled Assets Relief Program.” Mr. Kashkari’s remarks focused on oversight, transparency, and measuring the results of the TARP.
While discussing oversight of the TARP, Mr. Kashkari described the many actions that have been taken by TARP’s four oversight entities in addition to the Congressional committees of jurisdiction, which are the: (1) Financial Stability Oversight Board, (2) Special Inspector General, (3) Government Accountability Office (“GAO”), and (4) the Congressional Oversight Panel. He talked at length about the GAO’s first report on the TARP, which was delivered to Congress on December 2, 2008. He added that the “report was quite helpful because it provided [Treasury] with thoughtful, independent verification that Treasury is, indeed, focused on the right topics and Treasury agrees with the GAO on the importance of these issues.”
Mr. Kashkari also addressed the reporting and transparency of the TARP. He stated that the “law defined numerous reporting requirements for the TARP” and that “Treasury has met all of [its] requirements on time.” These reporting requirements include: (1) Transaction Reports within two business days of completing each transaction, (2) a Tranche Report to Congress within 7 days of each $50 billion commitment that is made, and (3) a detailed report on the overall program within 60 days of the first exercise of the TARP purchase authority.
Finally, while speaking about measuring the results of the TARP, Mr. Kashkari stated that “we did not allow the financial system to collapse.” He added, “[t]hat is the most direct, important information.” He then highlighted his belief that the TARP had made “remarkable progress since the President signed the law only 68 days ago.”
Federal Reserve Board Extends Three Liquidity Facilities Through April 30, 2009
December 16, 2008 9:59 AM
On December 2, 2008, the Federal Reserve Board announced the extension of the Primary Dealer Credit Facility (“PDCF”), the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (“AMLF”), and the Term Securities Lending Facility (“TSLF”). The PDCF provides discount window loans to primary dealers. The AMLF provides loans to depository institutions to purchase asset-backed commercial paper from money market mutual funds. Under the TSLF, the Federal Reserve Bank of New York auctions term loans of Treasury securities to primary dealers. Each of these facilities had previously been authorized through January 30, 2009.
For more information, please see:
SEC Approves Final Rule Changes and Proposes Additional Rules for Nationally Recognized Statistical Rating Organizations (“NRSROs”)
December 16, 2008 9:47 AM
On December 3, 2008, the SEC approved final rule amendments relating to NRSROs’ credit rating procedures and methodologies. These rules were originally proposed in June 2008. (See the June 19, 2008 edition of the WilmerHale Investment Management News Summary for further details on the proposed rules). The rule amendments are intended to increase transparency and accountability at NRSROs, and are a response, in part, to the findings of the SEC’s examination of three major credit rating agencies. According to SEC Chairman Christopher Cox, “[t]he SEC’s examinations of credit rating agencies uncovered serious deficiencies that these rules will address, so that investors and markets will have better information to guide investment decisions.” The new NRSRO rule amendments impose additional requirements on NRSROs that are intended to ensure that NRSROs provide more meaningful ratings and greater disclosure to investors. Chairman Cox added, “[t]hese comprehensive rules touch every aspect of the credit rating process – from conflicts of interest, to publication of ratings methodologies, to disclosure of ratings track records.”
The SEC also proposed additional rules related to transparency and competition concerning credit rating agencies. Public comments on the new proposed amendments must be received by the SEC within 45 days after their publication in the Federal Register. According to the SEC press release, the full text of the final rule amendments and proposed rule amendments will be posted to the SEC Web site as soon as possible.
For more information, please see: http://www.sec.gov/news/press/2008/2008-284.htm
SEC and N.Y. Federal Prosecutor Charge N.Y. Attorney in $113 Million Securities Fraud
December 16, 2008 9:43 AM
On December 8, 2008, the SEC charged a New York attorney with orchestrating a fraudulent scheme to sell at least $113 million in false promissory notes and other fake securities. On the same day, the U.S. Attorney for the Southern District of New York filed corresponding criminal charges.
The SEC’s complaint alleges that the attorney marketed false promissory notes to at least 3 hedge funds, and that two of the funds paid over $113 million for the notes. According to the SEC, in approaching the hedge funds, the attorney purported to represent both the issuer and the original holders of the notes. He then allegedly claimed that the original note holders needed to raise cash quickly to meet high redemption requests and as a result, were offering the notes at a substantial discount. In order to facilitate the scheme, the attorney allegedly fabricated audited financial statements and audit opinions, created false email accounts and phone numbers, forged signatures, and enlisted others to impersonate officers of the issuer. According to the complaint, the purported issuer of the notes had never issued the promissory notes, had not authorized the attorney to market any notes, and had no knowledge of the attorney’s scheme.
The targets of the alleged scheme were sophisticated institutional investors. At least one purchaser who discovered the fraud demanded and received the return of the purchaser’s investment. The SEC asserted that over $100 million remains unaccounted for.
The SEC is seeking a permanent injunction, civil penalties and disgorgement with pre-judgment interest. The federal criminal charges carry a maximum prison sentence of 20 years per count, as well as a fine of up to $5 million for the securities fraud and the greater of $250,000 or twice the gross gain or loss for the wire fraud. The attorney also faces related criminal charges in Canada.
For more information, please see: http://www.sec.gov/news/press/2008/2008-285.htm, http://www.sec.gov/litigation/litreleases/2008/lr20823.htm, and http://www.sec.gov/litigation/complaints/2008/comp20823.pdf
Office of Compliance Inspections and Examinations (“OCIE”) Director Warns CEOs of Registered Firms Not to Cut Compliance
December 16, 2008 9:40 AM
On December 2, 2008, OCIE director Lori Richards published an open letter to CEOs of SEC-registered firms, including broker-dealers, investment advisers, investment companies and transfer agents. In the letter, Ms. Richards emphasized the critical role each firm’s compliance program plays in helping to meet the obligations each firm faces under the securities laws. Ms. Richards encouraged CEOs to remain committed to their compliance efforts. This includes providing adequate resources to compliance programs and functions even as firms impose other reductions and cost-cutting measures, and ensuring that CCOs and compliance personnel are integrated into the activities of the firm. Ms. Richards also indicated that firms should make certain that their interactions with investors meet high standards, that sales and trading practices are appropriate, that financial, valuation and risk controls are followed, and that all disclosure obligations are met – as well as meeting all other obligations in conformity with the securities laws. Finally, Ms. Richards asserted that “by fulfilling their obligations, regulated firms in the financial services industry can help to restore and bolster public confidence in the fairness and integrity of our markets and market participants.”
For more information, please see: http://www.sec.gov/about/offices/ocie/ceoletter.htm
State Securities Regulators Offer Reform Plan
December 16, 2008 9:35 AM
Members of the North American Securities Administrators Association offered the incoming Obama Administration and the U.S. Congress a series of principles and recommendations to reform the financial services regulatory structure. The reform aims to provide investors with a system that is strong, comprehensive, collaborative, and efficient. These reforms include preserving the longstanding system of state/federal regulatory cooperation; an imposition of a fiduciary duty on all securities professionals who dispense investment advise, including broker-dealers; reforms to make the financial markets more comprehensive and transparent; managing risk through better interagency communication; and tougher punishments and greater support for private remedies for harmed investors.
For more information, please see: http://www.nasaa.org/NASAA_Newsroom/Current_NASAA_Headlines/10002.cfm
New Tool Developed to Help Funds Review Fund Intermediaries
December 16, 2008 9:33 AM
The Investment Company Institute (“ICI”) has developed a new tool to help funds review the internal controls of broker-dealers, fund supermarkets, and other financial intermediaries. A working group of ICI members and representatives of the four national accounting firms have developed a framework, the Financial Intermediary Controls and Compliance Assessment, to support an industry standard compliance review for fund intermediaries. Under this framework, an omnibus account record keeper would hire an independent accounting firm to access its internal controls relating to specified activities that it performs, such as account creation and maintenance, transaction processing, and privacy protection. The independent accounting firm would issue a report on the design and operating effectiveness of the intermediary’s compliance controls. The record keeper could then provide this report to all of the funds its represents. Such engagement would be performed under attestation standards issued by the AICPA.
For more information, please see: http://www.ici.org/home/08_news_comp_review.html#TopOfPage and http://www.ici.org/pdf/08_inter_assessment_matrix.pdf
CFTC Proposes Rules to Expand Regulatory Authority over Exempt Commercial Markets (“ECM”)
December 16, 2008 9:27 AM
The CFTC has proposed rules and rule amendments that increase the oversight of ECMs as directed by the CFTC Reauthorization Act of 2008 and has requested public comment on this proposed rulemaking. The CFTC Reauthorization Act of 2008 created a new regulatory category called ECMs with significant price discovery contracts (“SPDCs”) and subjects electronic futures trading facilities to additional regulatory and reporting requirements. The proposed rules seek to do the following:
Comments must be received by the CFTC on or before February 10, 2009.
Division Director Reviews Accomplishments in 2008 and Looks to 2009
December 16, 2008 9:20 AM
On December 15, 2008, Mr. Andrew J. Donohue, Director of the Division, addressed the ICI 2008 Securities Law Developments Conference. In his address, Donohue reviewed important accomplishments and meaningful lessons learned in the past year. Donohue briefly discussed the recent adoption of the summary prospectus and reviewed the recent events in the money market fund and auction rate preferred securities industries. He applauded the money market fund industry’s willingness to voluntarily come to the support of funds when that support was structured to benefit all fund shareholders. Donohue also discussed some of the Division’s accomplishments in 2008, including recent proposed and adopted rulemakings, a review of the exemptive application process, the issuance of a bibliography of SEC materials related to funds’ use of senior securities, and the ongoing financial statement review.
Donohue said he is hopeful that the Division will address reforms to rule 12b-1 under the Investment Company Act and investment adviser recordkeeping in 2009. He stated that the Division has made great progress in its thinking on possible approaches to resolving the fundamental concern that rule 12b-1 provides for an alternative means of paying a sales load without those fees being treated, regulated, or disclosed as a sale load. In addition, Donohue stated that adviser recordkeeping rules are out of date and need reform. He stated that the Division’s plan is to recommend revisions to the adviser recordkeeping regime and then translate that approach to investment company books and records.
For more information, please see: http://www.sec.gov/news/speech/2008/spch121508ajd.htm
Executives of Fund Distributor Held Liable for Market Timing of Preferred Fund Customers
December 16, 2008 9:15 AM
The SEC announced that the US. Court of Appeals for the First Circuit issued a ruling that allowed the SEC to proceed with its fraud action against two executives of the principal underwriter and distributor of a group mutual funds. The SEC alleged in a civil injunction action that the two executives had participated in a fraudulent scheme with the funds’ distributor and adviser by secretly entering into or approving arrangements with preferred customers allowing them to engage in frequent market timing or other short-term or excessive trading prohibited by the funds’ prospectuses. The First Circuit ruling reversed a decision by the District Court that dismissed the case on the grounds that the two executives did not make the statements themselves.
The First Circuit held that the two executives could be held liable because they had a legal duty to confirm the accuracy and completeness of the prospectuses and other fund material distributed. The First Circuit emphasized the unique role that underwriters play in the sale and distribution of mutual funds and the reliance the investing public places on them as a result. The First Circuit reasoned that the two executives were liable for distributing misleading prospectuses because they made implied statements to potential investors that they had a reasonable basis for believing that the key statements in the prospectuses regarding market timing were accurate and complete.
For more information, please see: http://www.sec.gov/litigation/litreleases/2008/lr20822.htm
SEC No-Action Letter Applies Only to the Money Market Fund Seeking Relief
December 16, 2008 9:12 AM
On December 8, 2008, the Division of Investment Management (“Division”) of the SEC stated it would not recommend that the SEC take an enforcement action under Section 17(a), 17(d), and 12(d)(3) of the Investment Company Act of 1940 (“Investment Company Act”) if a money market fund enters into a capital support agreement with the fund’s investment adviser to provide support for notes that have been ceased to be Eligible Securities (as defined in rule 2a-7 under the Investment Company Act). Previous to the issuance of this no-action letter, the Division had issued another no-action letter to the same money market fund permitting it to receive a standby letter of credit to support the same notes. It should be noted that the Division stated in a footnote that in light of the very fact-specific nature of the money market fund’s request, the position expressed in this letter applies only to the entities seeking relief, and no other entities may rely it. The no-action letter advises other funds facing similar legal issues to contact the Division about the availability of no-action relief.
For more information, please see: http://www.sec.gov/divisions/investment/noaction/2008/liquidres120808.pdf
President-Elect Selects New SEC Chairwoman
December 16, 2008 9:06 AM
On December 18, 2008, President-Elect Barack Obama announced that Mary L. Shapiro will be his selection as chairwoman of the SEC when Obama is sworn into office in 2009. Shapiro, a former SEC commission and CFTC chairwoman, is currently the chief executive officer of the Financial Industry Regulatory Authority.
For more information, please see: http://change.gov/newsroom/entry/president-elect_obama_names_key_regulatory_appointments/
EU to Study Oversight of Hedge Funds
December 5, 2008 10:41 AM
In a speech to the European Parliament on December 1, 2008, Charlie McCreevy, the European Commissioner for the Internal Market and Services and long-time opponent to increased hedge fund regulation, announced the commencement of a study regarding the oversight and systemic risks of hedge funds. The study will review the adequacy of the existing hedge fund rules, how hedge funds should be defined, who should oversee hedge fund activities, the proper manner with which to measure hedge fund risk, and whether to ban short selling. Prior to this announcement, Mr. McCreevy had rejected calls to increase hedge fund regulation made by many EU governments and lawmakers. According to a press report, Mr. McCreevy stated that he is now open to new rules for hedge funds, but he warned that any new rules must be carefully considered to ensure that they do not contribute to the current financial crisis. The results of the study are scheduled to be released in February 2009.
For more information, please see:
Federal Reserve Board Initiates a Program to Purchase the Direct Obligations of Housing-Related Government-Sponsored Enterprises
December 5, 2008 10:37 AM
On November 25, 2008, the Federal Reserve announced that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (“GSEs”), such as Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, and mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae. Purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the Federal Reserve's primary dealers through a series of competitive auctions. Purchases of up to $500 billion in mortgage-backed securities will be conducted by asset managers selected through a competitive process with a goal of beginning purchases before the end of the year. Purchases of both direct obligations and mortgage-backed securities are expected to take place over several quarters.
For more information, please see:
Federal Reserve Board Creates the Term Asset-Backed Securities Loan Facility
December 5, 2008 10:35 AM
On November 25, 2008, the Federal Reserve Board announced the creation of the Term Asset-Backed Securities Loan Facility (“TALF”), a facility that is intended to help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. Under the TALF, the Federal Reserve Bank of New York (“FRBNY”) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated asset backed securities backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount equal to the market value of the asset-backed securities less a haircut, and will be secured at all times by the asset-backed securities. The U.S. Department of the Treasury, under the Troubled Assets Relief Program, will provide $20 billion of credit protection to the FRBNY in connection with the TALF.
For more information, please see:
FINRA Provides Guidance Regarding Credit for Extraordinary Cooperation
December 5, 2008 10:33 AM
In a November 2008 Regulatory Notice, FINRA issued guidance on the circumstances in which extraordinary cooperation by a firm or an individual may influence the outcome of an investigation. The Notice categorizes the types of extraordinary cooperation that could result in a firm or individual receiving credit as follows: “(1) self-reporting before regulators are aware of the issue; (2) extraordinary steps to correct deficient procedures and systems; (3) extraordinary remediation to customers; and (4) providing substantial assistance to FINRA’s investigation.” According to the Notice, “[c]redit for extraordinary cooperation in FINRA matters may be reflected in a variety of ways, including a reduction in the fine imposed, eliminating the need for or otherwise limiting an undertaking, and including language in the settlement document and press release that notes the cooperation and its positive effect on the final settlement by FINRA Enforcement.” The Notice was careful to mention that while “[c]rediting extraordinary cooperation by firms and individuals in appropriate situations advance important regulatory goals,” a firm or individual’s “cooperation is just one factor to be considered in determining the appropriate disciplinary action and sanctions.”
For more information regarding this notice, please see:
Temporary Exemption for Liquidation of Certain Money Market Funds
December 5, 2008 10:28 AM
On November 20, 2008, the SEC adopted an interim final temporary rule under the Investment Company Act to provide relief from certain provisions of the Investment Company Act for money market funds that have elected to participate in the temporary guaranty program (“Guaranty Program”) established by the U.S. Department of the Treasury (“Treasury”). (See the September 26, 2008 and November 26, 2008 editions of the WilmerHale Investment Management News Summary for further details on the Guaranty Program). The Guaranty Program includes a procedure for the orderly liquidation of money market fund assets in certain circumstances, and the interim final temporary rule will permit money market funds that commence liquidation under the Guaranty Program to temporarily suspend redemptions of their outstanding shares and postpone the payment of redemption proceeds.
Section 22 of the Investment Company Act generally prohibits registered investment companies, including money market funds, from suspending the right of redemption, or postponing the date of payment or satisfaction upon redemption of any redeemable security for more than seven days. This temporary exemption allows a money market fund liquidating under the Guaranty Program to suspend redemptions and postpone the payment of proceeds beyond the seven-day limit. The interim final temporary rule will remain in effect until October 18, 2009 unless the SEC announces an earlier termination date in connection with the termination of the Guaranty Program.
For more information regarding this release, please see:
No-Action Relief Granted for the Use of Past Specific Recommendations in Investment Adviser Advertisements
December 5, 2008 10:25 AM
On November 7, 2008, the Staff said it would not recommend enforcement action under Section 206(4) of the Investment Advisers Act of 1940 (the “Advisers Act”) or Rule 206(4)-1(a)(2) if an investment adviser provides prospective clients with marketing materials that contain a list of best and worst performing account holdings. Specifically, the relief permits an investment adviser to provide “Best Performers/Worst Performers Charts” (“Charts”) with “no fewer than five holdings that contributed most positively to a representative account’s performance and an equal number of holdings that contributed most negatively to the representative account’s performance” in its marketing materials to prospective clients.
According to the Staff, the primary concern underlying the prohibition against advertisements containing past specific recommendations is that an adviser might “cherry pick” profitable recommendations and omit the unprofitable ones. Therefore, under prior Staff guidance, investment advisers only were permitted to distribute past specific recommendations, such as the Charts, to current clients (with respect to the investment strategy in which such clients currently invest) and to prospective clients or consultants who specifically made unsolicited requests for such information. This no-action letter provides relief for providing the Charts to prospective clients, consultants, or current clients not currently invested in the investment strategy represented in a particular Chart who do not specifically make unsolicited requests for them.
The Staff based its response in particular on the following representations made by the investment adviser: (1) the method used to calculate the best and worst performing holdings will take into account the weighting of every holding in the account that contributed to the account’s performance during the applicable measurement period; (2) the Chart’s presentation of information and number of holdings will be consistent from measurement period to measurement period; (3) the Charts will disclose how to obtain more information on the method used to calculate the best and worst performing holdings and a list showing every holding’s contribution to the overall account’s performance during the applicable measurement period; (4) each Chart will include all information necessary to make the Chart not misleading, including presenting the best and worst performing holdings on the same page with equal prominence in close proximity to the performance information; and (5) the adviser and its employees will maintain, and make available to the Staff upon request, certain records that support the information and demonstrate the appropriateness of the information contained in the Chart.
For more information regarding this no-action letter, please see:
No-Action Relief Granted for the Inclusion of Foreign Funds in a Committed Line of Credit
December 5, 2008 10:21 AM
On November 21, 2008, the SEC’s Division of Investment Management (the “Staff”) said it would not recommend enforcement action under Section 17(d) of the Investment Company Act of 1940 (the “Investment Company Act”) or Rule 17d-1 if a fund group includes certain foreign open-end investment funds (“Foreign Funds”) along with U.S. open-end registered investment companies (“U.S. Funds,” and together with the U.S. Funds, “Funds”) in a senior committed line of credit for which each Fund would pay a portion of the associated fees. The Staff previously granted no-action relief allowing fund groups of U.S. Funds to enter into a committed line of credit in T. Rowe Price Funds (pub. avail. July 31, 1995) and Alliance Capital management L.P. (pub. avail. April 25, 1997).
According to the Staff, without such relief, fund groups entering into committed lines of credit involving multiple funds could run afoul of Section 17(d) of the Investment Company Act and Rule 17d-1 thereunder, which prohibit joint enterprises and other joint arrangements between affiliated persons of registered investment companies, because each fund would pay its proportional share of the associated fees. The no-action relief was subject to certain conditions, including: (1) each U.S. Fund’s board of trustees, including a majority of the independent trustees, will consider any unique issues presented by participating in the line of credit with Foreign Funds when making its initial and annual best interest determinations about the U.S. Fund’s participation in the line of credit; and (2) at a minimum, none of the Foreign Funds would be permitted to borrow more than the amount permitted for a U.S. Fund under Section 18 of the Investment Company Act.
For more information regarding this no-action letter, please see: