Investment Management Industry News Summary - December 2011

Investment Management Industry News Summary - December 2011

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 approves expansion of soft dollar safe harbor to include principal transactions

December 27, 2001 12:39 PM

The SEC recently published interpretive guidance on the application of section 28(e) of the Securities Exchange Act of 1934 (the "Exchange Act"). Section 28(e) provides a safe harbor for money managers who use commission dollars to obtain research and brokerage services. Under the section 28(e) safe harbor, money managers may use commission dollars to obtain research and brokerage services without being deemed to have breached a fiduciary duty, provided the conditions of the section are met. The SEC clarified that, for purposes of the section 28(e) safe harbor, the term "commission" encompasses, among other things, certain transaction costs, even if not explicitly called a "commission."

Previously, the SEC interpreted section 28(e) to apply only to research and brokerage services obtained through commissions paid to a broker-dealer for agency transactions. In an agency transaction, a broker-dealer acts for the accounts of others by buying or selling securities on behalf of customers. The broker-dealer charges a commission for providing the transaction service which is required to be disclosed.

The previous SEC interpretation prevented money managers from relying on the safe harbor for research and brokerage services obtained through fees charged by market makers when they executed principal transactions. In a principal transaction, a broker-dealer either buys securities for customers and takes them into its own inventory or sells securities to customers from its own inventory. In a principal transaction, the difference between the amount which the broker-dealer paid for a security and the amount for which it sold it to a retail customer is commonly referred to as a mark-up or mark-down. A mark-up or mark-down is not required to be disclosed.

The Nasdaq Stock Market, Inc. ("Nasdaq") requested that the SEC reconsider its interpretation of section 28(e). In particular, Nasdaq urged the SEC to interpret the safe harbor to apply not just to commissions on agency transactions, but also to fully and separately disclosed fees on certain riskless principal transactions effected by National Association of Securities Dealers, Inc. ("NASD") members and reported under certain recently amended NASD trade reporting rules.

The SEC noted that section 28(e) requires a money manager relying on the safe harbor to determine in good faith that the amount of "commission" is reasonable in relation to the value of research and brokerage services received. The SEC commented that this requirement presupposes that a "commission" paid by a managed account is quantifiable in a verifiable way and is fully disclosed to the money manager. The SEC further commented that when it issued guidance in 1995 on soft dollars, an agency transaction had more cost transparency than a principal transaction because the cost of a principal transaction frequently included undisclosed compensation to the dealer.

The SEC noted that since 1995, the NASD has modified its trade reporting rules to require that certain riskless principal transactions be reported in the same manner as agency transactions, exclusive of any markup, markdown, commission equivalent, or other fee ("Eligible Riskless Principal Transactions"). The SEC further noted that in an Eligible Riskless Principal Transaction the price is disclosed on a confirmation that also fully discloses the remuneration to the NASD member for effecting this transaction. Thus, a money manager opting for an Eligible Riskless Principal Transaction would now be informed of the entire amount of a market maker's charge for effecting the trade.

The SEC commented that because of the transparency achieved in the Nasdaq market for Eligible Riskless Principal Transactions, which allows a money manager to make the necessary determination under section 28(e), it is modifying its interpretation of section 28(e). Specifically, it has revised its interpretation of the term "commission" in section 28(e) of the Exchange Act to include a markup, markdown, commission equivalent or other fee paid by a managed account to a dealer for executing a transaction where the fee and transaction price are fully and separately disclosed on the confirmation and the transaction is reported under conditions that provide independent and objective verification of the transaction price subject to self-regulatory organization oversight.

The SEC stressed that fees paid to a NASD member for effecting an Eligible Riskless Principal Transaction are distinguishable from fees paid on traditional riskless principal transactions as well as traditional principal transactions involving a dealer's inventory. Fees on other riskless principal transactions can include an undisclosed fee. Fees on traditional principal transactions also can include an undisclosed fee based on some portion of the spread. In contrast, the SEC noted that fees on Eligible Riskless Principal Transactions must be fully and separately disclosed.

The SEC commented that this relief should not be limited to those Eligible Riskless Principal Transactions executed on Nasdaq. It stated that as other markets develop equivalent regulations to ensure equivalent transparency, transaction charges in those markets that meet the requirements of this interpretation will be considered within the interpretation. SEC Release No. 34-45194, December 27, 2001.

 
 



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 Investment Council Association of America (“ICAA”), urges the SEC not to exempt savings associations and thrifts from investment adviser registration

December 27, 2001 10:56 AM

Pursuant to the Act, banks are now included within the definition of “investment adviser” to the extent that they act as investment advisers to investment companies. Banks that do not advise investment companies continue to be excluded from the definition of “investment adviser.” Because the term “bank” does not encompass savings associations and other thrift institutions, thrift institutions have always been subject to SEC regulation under the Advisers Act when they provide advice regarding securities for compensation. While the Gramm-Leach-Bliley Act did not change the application of the Advisers Act to thrifts, the Act did amend the 1940 Act to allow thrift institutions to sponsor common and collective trust funds. These types of funds are exempt from registration under the 1940 Act. The thrifts have argued that in order to be placed on a level playing field with banks regarding offering common and collective trust funds, the SEC should use its rule making authority to exempt thrifts from the Advisers Act to the extent that they engage in bona fide fiduciary activity. The ICAA notes that the SEC is currently working on an exemptive rule for thrifts in this area.

If an exemption is to be granted, the ICAA urges the SEC to craft the exemption narrowly to encompass only those traditional trust activities that have been long considered to be outside the core functions of an investment adviser. The ICAA cites the following reasons for its position:

  • contemplated exemption for thrifts is not consistent with the provisions of the Gramm-Leach-Bliley Act- The Gramm-Leach-Bliley Act involved more than three decades of deliberation in Congress. The Act explicitly amended the definition of investment adviser with respect to banks but was silent with respect to thrifts. The ICAA reasoned that if Congress had intended to grant similar treatment of thrifts as with banks, it could have done so but did not.
  • exemption may be inconsistent with functional regulation and create an unwise loophole – Congress added banking entities to the SEC’s jurisdiction in enacting the Gramm-Leach-Bliley Act in order to facilitate functional regulation. The ICAA noted that granting an exemption for thrifts from Advisers Act registration may create an unnecessary and potentially troublesome gap in regulatory coverage. If the SEC approves a broad exemption for thrift institutions, the ICAA argues that any entity that wishes to avoid registration and regulation under the Advisers Act could do so simply by organizing itself as a thrift.
  • exemption may create an unlevel playing field for investment advisers and thrift institutions – By exempting thrifts from registration, the SEC would allow thrifts to engage in the same activities as investment advisers while avoiding regulatory oversight under the Advisers Act. The ICAA argued that creating an exemption for thrifts may unfairly disadvantage investment advisers that are subject to registration and regulation under the Advisers Act.
  • SEC should evaluate whether there is a compelling public or investor protection benefit that justifies exempting thrifts from Advisers Act registration and regulation – The ICAA argued that the rationale that has been advanced to support the thrift exemption – that banks and thrifts should be treated the same – may not amount to a compelling public or investor protection benefit that justifies the SEC’s use of its exemptive authority under the Advisers Act.
 
 



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 definition for "qualified purchaser" under the Securities Act of 1933 (the "Securities Act")

December 20, 2001 12:44 PM

On December 20, 2001, the SEC proposed a definition of "qualified purchaser" under the Securities Act to implement a provision of the National Securities Markets Improvement Act of 1996 ("NSMIA"). The proposed definition mirrors the current definition of accredited investor under Regulation D of the Securities Act. The SEC noted that the proposal should facilitate capital formation, implement the Congressional intent of NSMIA, impose uniformity in the regulation of transactions with financially sophisticated persons and reduce burdens on capital formation. The SEC also noted that this new qualified purchaser definition identifies well-established categories of persons who are financially sophisticated and therefore not in need of the protection of state registration when they are offered or sold securities.

With NSMIA, Congress realigned the federal and state regulatory partnership governing registration of securities offerings. Under NSMIA, the SEC retains authority to require registration of securities offerings while states are preempted from requiring registration of offerings involving "covered securities" including, among other securities, any security offered or sold to a "qualified purchaser." Congress authorized the SEC to define the term "qualified purchaser" under the Securities Act to include "sophisticated investors, capable of protecting themselves in a manner that renders regulation by State authorities unnecessary," thus preempting securities transactions with these persons from state "blue sky" law.

The SEC noted that it believed it "appropriate" to equate qualified purchasers with accredited investors because the regulatory and legislative history of both terms is based upon similar notions of the financial sophistication of investors. The SEC additionally noted that, in its regulatory experience, use of the term "accredited investor" strikes the appropriate balance between the necessity for investor protection and meaningful relief for issuers offering securities, especially small businesses.

A person or entity may be an "accredited investor" if certain income, net worth, or asset tests are met. Natural persons qualify as accredited investors if they meet certain income or net worth tests. Accredited investors include natural persons with individual incomes in excess of $200,000 (or joint spousal incomes of $300,000) for the two most recent years, if they reasonably expect to earn at least the same amount in the current year. Natural persons with individual (or joint, with a spouse) net worths over $1 million also are considered to be accredited investors.

Other investors are accredited if they have more than $5 million of assets. These generally include state or ERISA employee benefit plans, charitable organizations or business entities if they were not formed for the specific purpose of investing in the securities offered, and trusts if they were not formed for the specific purpose of acquiring the securities offered and their purchase is directed by a sophisticated person.

The definition of accredited investor also includes investors that are financially sophisticated by their nature. These include various institutional investors and employee benefit plans where sophisticated fiduciaries make investment decisions. Directors, executive officers, and general partners of securities issuers also are accredited, due to their relationship with the issuer. In addition, an accredited investor includes any entity whose equity owners are accredited investors.

The SEC commented that NSMIA's legislative history indicates that qualified purchasers for purposes of the Securities Act preemption of state regulation should include investors that, by virtue of their financial sophistication and ability to fend for themselves, do not require the protections of registration under the state securities laws. The SEC acknowledged that there are a number of existing definitions in the federal securities regulatory framework, other than accredited investor, concerning financially sophisticated investors that could be used to implement the qualified purchaser concept under the Securities Act. These definitions include, among others:

  • "qualified institutional buyers" as defined for purposes of Rule 144A under the Securities Act;
  • "qualified purchasers" under section 3(c)(7) of the Investment Company Act of 1940; and
  • qualified clients who may be charged performance fees under the Investment Advisers Act of 1940.

However, the SEC determined that the legislative intent of NSMIA makes using "accredited investor" more appropriate than any of these alternatives. All comments on the proposed definition must be received on or before February 25, 2002. SEC Release No. 33-8041, December 20, 2001.

 
 



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.

Association for Investment Management and Research ("AIMR") proposes guidelines for investment managers on trade execution

December 12, 2001 1:19 PM

AIMR has released for comment a set of trade management guidelines it has compiled for investment management firms to assist them in executing investment trades and managing the trading function. AIMR noted that it intends the guidelines to be a compilation of best practices and that it encourages firms to adopt as many of the recommended guidelines as possible. AIMR stated that the guidelines identify industry best practices and are meant to assist firms in meeting their fiduciary responsibility to act in the best interest of clients.

The guidelines define best execution as "the trading process most likely to maximize the value of client portfolios." AIMR notes that this definition recognizes that best execution is intrinsically tied to the decisions regarding portfolio value and cannot be evaluated independently and recognizes that while best execution may have aspects that can be measured and analyzed over time, accurate measurement on a trade-by-trade basis may not be feasible. The guidelines recommend firms consider actions in the following three areas:

Processes. AIMR recommends that firms establish formal policies and procedures that have the ultimate goal of maximizing the asset value of client portfolios through best execution. AIMR recommends that firms accomplish this by:

  • establishing a trade management oversight committee responsible for developing,
  • evaluating and changing a firm's order-routing practices;
  • implementing firm-wide trade management policies which are communicated to all applicable employees;
  • developing trade management procedures that adequately describe how a firm will implement its trade management policies;
  • implementing a trade measurement process which is structured to reflect a firm's unique circumstances and client needs;
  • establishing clear firm-wide guidelines on broker selection and developing an approved brokers list;
  • exploring realistic and achievable alternative trading options that may help a firm achieve higher quality execution;
  • developing an approved brokers list which includes those brokers that can execute trades at the lowest possible total cost while still meeting client portfolio needs;
  • establishing a brokerage target allocation plan which projects annual trading activity and respective compensation for each approved broker and which periodically compares the actual quantity of trades executed to the projected amount;
  • establishing controls to monitor and evaluate broker performance and execution quality; and
  • ensuring that all clients are treated fairly in the execution of orders and allocation of trades.

Disclosures. AIMR recommends that an investment management firm disclose its trade management practices and any actual and potential trading related conflicts of interest to all current and prospective clients. AIMR recommends that a firm:

  • disclose its order routing practices and any changes thereto, to clients and prospects;
  • ensure that brokerage arrangements and order-routing practices are consistent with the information disclosed on its Form ADV; and
  • disclose actual and potential conflicts of interest, including:
  • research obtained through soft dollar arrangements,
  • client-directed brokerage arrangements,
  • payments for order flow arrangements,
  • allocation of shares received in an initial public offering,
  • equity interest in market makers,
  • step-out transactions,
  • principal trades,
  • use of affiliated brokers to execute trades, and
  • use of client brokerage to pay for client referrals.

Recordkeeping. AIMR recommends that an investment management firm maintain meaningful and complete trading records. AIMR notes firms should strive to:

  • document the process used to select brokers and to oversee broker performance;
    document the reasons for choosing a particular trading system;
  • document actual and potential conflicts of interest and the controls in place to prevent or mitigate any adverse effects these conflicts may cause;
  • maintain documentation of the materials prepared for any trade management oversight committee; and
  • maintain records that support negotiated broker commissions.
 
 



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 Commissioner releases report recommending improvements to Regulation Fair Disclosure

December 12, 2001 1:16 PM

SEC Commissioner Laura Unger recently released a report on Reg FD with recommended improvements to the rule to increase marketplace information. In her report, Ms. Unger recommended that the SEC:

  1. Provide additional guidance on what constitutes "material" information that has to be made public under the rule. In particular the report encourages the SEC to issue an interpretive release that clarifies the meaning of "earnings information" as used in the adopting release for Reg FD. Ms. Unger recommends that the SEC address whether certain income statement items are more likely to be deemed material than others. The report also pointed out that the SEC should clarify whether a company's stock price movement subsequent to an event or announcement is or is not relevant to the event's or announcement's materiality.
  2. Make it easier for companies to use technology, particularly the Internet, to satisfy the public information dissemination requirements of Reg FD. Ms. Unger noted that certain self-regulatory organization rules limit Reg FD's flexibility. For instance, rules of the New York Stock Exchange require listed companies to disclose material news only through a press release. Ms. Unger recommended that the SEC reconsider its position that web site publication alone is insufficient to be deemed a public distribution. Ms. Unger also recommended that the SEC work with the self-regulatory organizations to consider whether options such as adequately noticed website posting, fully accessible webcasts (without an accompanying press release which repeats the substantive information) and electronic email alerts could satisfy Reg FD and amend the self-regulatory organization rules accordingly.
  3. Further determine Reg FD's impact on the depth and quality of company information in the marketplace by closely examining post-Reg FD market information and filings. Ms. Unger noted that the regulation's impact on the amount and quality of information investors receive has not been quantified and urged the SEC to analyze the amount of information being disclosed and the type of information disclosed pursuant to Reg FD. She encouraged the SEC to consider in its analysis:
  • whether information disclosed pursuant to Reg FD is general or specific;
  • whether companies disclose earnings forecasts or discuss future business plans; and
  • how the specificity and depth of information disclosed compare with pre-Reg FD disclosures.

Ms. Unger noted that some corporate issuers may be making fewer future projections to avoid inadvertently triggering Reg FD. In these cases, the report urges the SEC to consider expanding the safe harbor for forward-looking information in the Private Securities

 
 



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 warns public companies to disclose critical accounting policies

December 12, 2001 1:02 PM

On December 12, 2001, the SEC issued cautionary advice to public companies urging them to disclose their "critical accounting policies." In its release, the SEC reminded management, auditors, audit committees and their advisors that the selection and application of the company's accounting policies "must be appropriately reasoned." The SEC reminded registrants that even a technically accurate application of generally accepted accounting principles ("GAAP") may still fail to communicate important information if it is not accompanied by appropriate and clear analytic disclosures regarding the company's financial status and the possibility, likelihood and implication of changes in the company's financial and operating status.

The SEC noted that it intends to consider new rules during 2002 to elicit more precise disclosures about the accounting policies that company management believes are most important to the portrayal of the company's financial condition and results. The SEC also noted, however, that prior to new rulemaking, it felt it necessary to encourage public companies to include in the Management's Discussion and Analysis ("MD&A"), full explanations in plain English of:

  • their critical accounting policies,
  • the judgments and uncertainties affecting the application of those policies, and
  • the likelihood that materially different amounts would be reported under different conditions or using different assumptions.

The SEC noted that investors may lose confidence in a company's management and financial statements if sudden changes in its financial conditions and results occur and if these changes were not preceded by disclosures about the susceptibility of the reported amounts to change. To minimize this loss of confidence, the SEC advised public companies about the importance of employing a disclosure regimen which includes the following:

  1. Company management and the company’s auditor should particularly focus on evaluating critical accounting policies used in financial statements. The SEC advised auditors to obtain an understanding of management's judgments in selecting and applying accounting principles and methods as part of the normal audit process. The SEC also advised management to be prepared to defend the quality and reasonableness of the most critical policies and advised auditors to satisfy themselves thoroughly regarding management's selection, application and disclosure of these policies.
  2. Management should ensure that disclosure in MD&A is balanced and fully responsive. The SEC encouraged management to explain in MD&A the effect of the critical accounting policies applied, the judgments made in their application and the likelihood of reporting materially different results under different assumptions or conditions.
  3. Audit committees should review the selection, application and disclosure of critical accounting policies before finalizing and filing annual reports. The SEC advised management to apprise audit committees of the evaluative criteria used in management's selection of the accounting principles and methods. The SEC also encouraged proactive discussions between the audit committee and senior management about critical accounting policies.
  4. If companies, management, audit committees or auditors are uncertain about the application of specific GAAP principles, they should consult with SEC accounting staff. 
 
 



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.

IARD annual shutdown: December 22 through January 1

December 10, 2001 1:33 PM

The Investment Adviser Registration Depository will be shut down from December 22, 2001 through January 1, 2002 to process state notice filing and registration renewals. The SEC noted that this shutdown is an annual, routine procedure that corresponds to the annual shutdown of the Central Registration Depository, the broker-dealer electronic filing system. During the shutdown, advisers can work on filings and save them as “pending” filings. Advisers, however, will not be able to submit filings.

  • Advisers with a September 30, 2001 fiscal year end must submit their Annual Updating Amendments by December 30, 2001.
  • Advisers that have filings due between December 22 and January 1 must submit their filings by December 21, 2001.

 

 
 



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 issues guidance on fund names rule

December 4, 2001 2:13 PM

On December 4, 2001, the SEC's Division of Investment Management released a set of answers to frequently asked questions (the "FAQ") on new rule 35d-1 under the Investment Company Act of 1940 (the "1940 Act"). Rule 35d-1 addresses the categories of investment company names that are likely to mislead investors about an investment company's investments and risks. The FAQ generally addresses the following:

Fund names which invoke the rule. The SEC noted that the following terms would normally invoke application of rule 35d-1:

  • Municipal or municipal bond
  • Small–, mid- or large-capitalization
  • High-yield (except when referring to municipal bonds)
  • Fixed income
  • Fund names which do not invoke the rule. The SEC also noted that the following terms would normally not invoke application of rule 35d-1:

  • Tax-sensitive
  • Income (except where a type of investment is suggested)
  • Growth and income
  • International
  • Global
  • Short-term, intermediate-term or long-term
  • Money market (however, rule 2a-7 applies to funds that hold themselves out as money market funds)

The FAQ also addresses questions regarding whether shareholder approval is required for adoptions of or changes to investment policies to comply with rule 35d-1 and the form of notice to shareholders of a change in the 80% investment policy. Funds must be in compliance with rule 35d-1 by July 31, 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.

SEC issues cautionary advice regarding use of pro forma financial information

December 4, 2001 1:49 PM

On December 4, 2001, the SEC warned companies about its view of the use of certain financial statements which are calculated on the basis of methodologies other than Generally Accepted Accounting Principles ("GAAP") (i.e., pro forma financial statements). The SEC noted that it believes that, with appropriate disclosures about their limitations, pro forma financial statements can be useful to investors. However, the SEC noted that it is concerned that pro forma financial information, under certain circumstances, can mislead investors if it obscures GAAP results. The SEC also noted that because pro forma financial information departs from traditional accounting conventions, it may be difficult for investors to compare an issuer's financial information with other reporting periods and with other companies. The SEC issued the advisory to alert public companies and their advisors of the following concepts:

  1. The antifraud provisions of the federal securities laws apply to a company issuing pro forma financial information. The SEC warned that because pro forma information is derived by selective editing of financial information compiled in accordance with GAAP, companies should be particularly mindful of their obligation not to mislead investors when using this information.

  2. The SEC is particularly concerned by presentations of financial results that are addressed to a limited feature of a company's overall financial results (e.g., earnings before interest, taxes, depreciation, and amortization), or that set forth calculations of financial results on a basis other than GAAP. The SEC commented that such a statement misleads investors when the company does not clearly disclose the basis of its presentation. The SEC recommended that companies describe accurately the “controlling principles” that underlie the presentation. The SEC cited as an example when a company purports to announce earnings before "unusual or nonrecurring transactions." The SEC recommended that the company describe the particular transactions and the kind of transactions that are omitted and apply the methodology described when presenting purportedly comparable information about other periods.

    The SEC recommended that companies pay attention to the materiality of the information that is omitted from a pro forma presentation. The SEC noted that statements about a company's financial results that are literally true may be misleading if they omit material information.

  3. The SEC recommended the earnings press release guidelines jointly developed by the Financial Executives International and the National Investors Relations Institute. The SEC also encouraged public companies to consider and follow those recommendations before determining whether to issue pro forma results, and before deciding how to structure a proposed pro forma statement. The SEC noted that a presentation of financial results that is addressed to a limited feature of financial results or that sets forth calculations of financial results on a basis other than GAAP generally will not be deemed to be misleading merely due to its deviation from GAAP if the company in the same public statement discloses in plain English how it has deviated from GAAP and the amounts of each of those deviations.

  4. The SEC encouraged investors to compare any summary or pro forma financial presentation with the results reported on GAAP-based financials by the same company.

  5. The SEC also issued an “Investor Alert” that describes how pro forma financials should be analyzed, including a reminder to investors that they should review pro forma financials with “appropriate and healthy skepticism.” SEC Release Nos. 33-8039, 34-45124, December 4, 2001. 
 
 



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’s Director of Division of Enforcement comments on recent actions regarding investment company and investment adviser supervisory procedures

December 4, 2001 1:40 PM

At a recent conference, Stephen M. Cutler, the SEC’s Director of the Division of Enforcement, commented on various enforcement actions involving failure of supervisory procedures of investment companies and investment advisers. He warned attendees to consider the following concepts regarding when evaluating their own supervisory procedures:

A firm may outgrow its supervisory procedures. Mr. Cutler commented on an enforcement action regarding an investment advisory firm’s soft dollar practices. He noted that the firm grew substantially from 1990 through 1996. He further noted that the firm had disclosed to its clients certain categories of products and services it might obtain using soft dollar credit, but that it failed to disclose that it would use soft dollars for personal and non-research business travel, marketing expenses and other administrative expenses. Mr. Cutler commented that the firm gave the firm’s treasurer the sole responsibility for the firm’s soft dollar program without giving the treasurer any training and without creating a system of follow-up or review to ensure that soft dollar payments were properly monitored.

The SEC found, among other things, that the firm had failed - and the treasurer had aided and abetted the failure - to disclose material information about the firm’s use of soft dollars. The SEC also charged the firm with failure to supervise. Mr. Cutler noted that the treasurer’s on-the-job training and the firm’s lack of follow-up procedures may have been sufficient when the firm had only a few soft dollar relationships but that these became more problematic as the firm’s size and use of soft dollars increased.

Mr. Cutler noted that supervisory and compliance procedures, training and resources should grow with an investment advisory firm. He also noted that if a firm’s investment strategy or type of business changes, the firm should re-consider whether it should amend its supervisory procedures.

As a corollary to a firm outgrowing supervisory procedures, Mr. Cutler also noted another enforcement action where an investment advisory firm had failed to extend its supervisory policies to a senior portfolio manager who was also a member of the firm’s executive committee. The senior portfolio manager engaged in a portfolio pumping scheme despite the presence of firm procedures designed to detect such trading activity. Mr. Cutler warned that regardless of title or seniority, an investment advisory employee never outgrows the need for supervision.

A firm should be mindful of market conditions and the market environment when evaluating supervisory procedures. Mr. Cutler warned audience members that appreciating markets necessitate specific supervisory procedures. He cited two recent enforcement actions involving the failure of investment companies to disclose the degree to which their performance success depended on difficult to replicate investment strategies involving hot initial public offerings. Mr. Cutler noted that in each case, the fund advertised high performance without referring to the fund’s reliance on hot IPOs to generate the return advertised. Mr. Cutler further noted that funds should craft supervisory procedures to address risks associated with prevailing market conditions. He also recommended that in a down market scenario, a fund should review its supervisory and internal controls regarding pricing of portfolio securities.

Supervisory procedures require checks and balances. Mr. Cutler noted that a recent settled action involving an investment adviser’s failure to supervise the actions of a subadviser and its portfolio manager illustrated the need for functional separation. Mr. Cutler also noted that the subadviser’s supervisory procedures would have been stronger if a supervisor without a direct interest in the performance of the funds subadvised had the responsibility of monitoring the portfolio manager.

A firm should recognize that supervisory responsibility does not end with organizational boundaries. Mr. Cutler warned that in the above-mentioned failure to supervise case, the investment adviser was also charged with failure to supervise even though the portfolio manager was an employee of the subadviser, not the adviser. He commented that the investment subadvisory agreement specifically stated that the subadviser’s provision of investment advisory services was subject to the supervision of the adviser. He noted that the adviser clearly assumed supervisory responsibility for the portfolio manager even though she was an employee of the subadviser. He also noted that even if the subadvisory agreement did not specify the adviser’s assumption of supervision, the nature of the relationship between the adviser and the portfolio manager established that the adviser was a supervisor. In particular, the SEC noted that the adviser was involved in the portfolio manager’s appointment and that when the portfolio manager was dissatisfied with resources at the subadviser, she complained to the adviser. Mr. Cutler noted that these “indicia of a mutually recognized supervisory relationship” can establish liability even absent a written reservation of supervisory authority.

Mr. Cutler then made the following recommendations to advisers when supervising a subadviser: 

  • Obtain from employees of the subadviser an annual certification of compliance with the substantive policies and procedures governing the subadviser’s responsibilities and with the federal securities laws.

  • Conduct periodic meetings with compliance personnel at the subadviser.

  • Require the subadviser to provide notice of regulatory examinations and provide copies of any exam reports.

  • Implement procedures for follow-up on any troubling findings contained in the reports.

  • Periodically reassess supervisory procedures applicable to the subadviser in light of:
  1. changes in a fund’s investment strategy or portfolio manager,

  2. significant changes in the subadviser’s business,

  3. dramatic changes in market conditions, or

  4. any other event likely to have a significant impact on the subadviser’s operations.

Mr. Cutler also commented on the SEC’s real-time enforcement program and the agency’s framework for evaluating a company’s cooperation in determining whether and how to charge the company with violations of the federal securities laws.

 
 



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.

Compliance alert regarding after-tax disclosure

December 3, 2001 2:01 PM

The SEC has also contacted funds regarding their web sites and the requirement to comply with the new rules regarding after-tax disclosure. As of December 1, 2001, all advertising containing after-tax returns or for funds which purport to have tax management advantages must comply with the new rules.

If you have questions regarding these issues, please contact either Pamela Wilson at (617) 526-6371 or David Phelan at (617) 526-6372.

 
 



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.

Compliance alert for money market funds

December 3, 2001 1:55 PM

The SEC has reportedly contacted some money market funds regarding the continuing decrease in money market fund yields. Specifically, money market funds have been contacted regarding their contingency plans should the fund produce a negative return ( i.e., fund expenses exceed fund yields). Investment advisers to money market funds are reportedly considering whether to waive or lower fees on at least a temporary basis.

 
 



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.