The U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness issued a report that examined the efficiency and effectiveness of three of the SEC’s core operations, including staff no-action letters, exemptive orders and SRO rule orders. The report made several recommendations, including, among others: 

• Realigning the Division of Trading and Markets and the Division of Investment Management into a Division of Investor Protection and Retail Financial Services Regulation and a Division of Market Oversight and Operations that also would include the examination programs currently conducted by the Office of Compliance, Inspections, and Examinations. 
• Creating a conditional approval process for new investment products or services. 
• Establishing a chief operating officer for the SEC and forming a coordinating council to address coordination and uniform regulation across the SEC’s divisions. 
• Increasing staff experts in financial economics, the capital markets, and business operations for regulated entities. 
• Expediting the process for routine exemptive applications that mirror prior orders, and expanding the use of exemptive rules to reduce the number of routine exemptive applications. 
• Reducing the number of vehicles the SEC and staff use to provide guidance, and publishing guidelines for distinguishing the use of no-action letters and exemptive orders. 
• Requiring the SEC to issue annual interpretive statements that review, adopt and codify significant staff positions contained in no-action letters following an opportunity for public notice and comment.

For more information, please see:
http://www.uschamber.com/assets/ccmc/090211ccmc_sec_speed.pdf  

On February 6th, the MSRB sent a letter to members of Congress recommending several changes to the overall federal financial regulatory structure for municipal securities. The MSRB’s suggestions included, among other things:

• Requiring a comprehensive federal regulatory scheme for unregulated intermediaries in the municipal securities market, including financial advisors and investment brokers. 
• Creating a market stability regulator to address the overall stability of the financial markets, a prudential financial regulator to address market discipline, and a business conduct regulator to address business practice standards. 
• Utilizing market-funded, market-specific self-regulatory organizations (“SROs”) to take actions that embody and expand on basic antifraud standards of the federal securities laws. 
• Creating a municipal securities “czar” or federal-level municipal securities position charged with representing the municipal market’s unique needs or, alternatively, a senior-level, multi-agency group to coordinate municipal finance issues. 
• Creating a more formal process to coordinate federal and state entities’ enforcement activities. 
• Subjecting derivative instruments based on municipal securities to the same comprehensive regulations that may be developed for other derivatives.

For more information, please see:
http://www.msrb.org/msrb1/Press/Release/MSRBRecommendsComprehensiveRulesforIntermediaries.asp
http://www.msrb.org/msrb1/Press/Release/MSRBletteronexpandedregulation_0209.pdf
http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8796  
 

On February 6th, the U.S. Court of Appeals for the First Circuit affirmed the dismissal of aiding and abetting fraud charges against three officers of a firm that served as the administrator for employee-defined contribution plans and mutual funds. The complaint alleged that the administrator invested plan assets in several mutual funds the day after the administrator received the instruction to invest, which caused the plans to miss approximately $4 million in profits. Allegedly, the three officers were aware that other firm officers executed transactions to try to cover the loss and used accounting adjustments to mask the effect of these transactions without compensating the other shareholders for the dilution, as required by the administrator’s policies. These actions offset approximately $3 million of the plan’s loss at the expense of other fund shareholders. In 2002 and 2003, the three officers signed statements in connection with financial audits that represented they were not aware of any uncorrected errors, fraud or illegal acts that had affected the administrator’s clients. The SEC filed a civil complaint alleging that the three officers, along with the other officers, engaged in a scheme to defraud the plan and other mutual fund clients, and violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and aided and abetted the administrator’s uncharged primary violations of Section 10(b) and Rule 10b-5 thereunder, thus violating Section 20(e) of the Exchange Act. The District Court dismissed the actions against the three officers.

On appeal, the SEC argued that the three officers had aided and abetted the administrator’s primary violations by signing the audit statements. The administrator had an ongoing fiduciary duty to disclose the original loss and subsequent partial transfer of loss, the SEC argued, and the officers’ statements in the audit letters “assisted” the administrator in continuing to breach its duty because accurate answers would have revealed the conduct to the auditors and eventually to the plan and funds.

The Court affirmed the District Court’s dismissal, finding that the non-disclosures did not cause the transactions or the losses resulting from them, and that the officers’ mere denials of knowledge a year or more later did not constitute aiding and abetting of ongoing securities fraud.

For more information, please see:
SEC v. Papa, 2009 WL 280358 (1st Cir. 2009).

On February 12th, the Massachusetts Office of Consumer Affairs and Business Regulation (“Massachusetts Office of Consumer Affairs”) issued amended data privacy regulations (201 CMR 17.00). These regulations apply to persons who own, license, store or maintain personal information about a resident of Massachusetts, including mutual funds, transfer agents, broker-dealers, investment advisers and banks. The amended regulations imposed an effective date of January 1, 2010 for all of the provisions, which extended the prior effective date of May 1, 2009 that had applied to certain provisions.

The amended regulations also changed the vendor supervision requirements. Previously, a person subject to the regulations was required to obtain a written certification that the provider maintained a security program that met the Massachusetts standards. The amendments deleted the contractual obligation and only require a person to take “all reasonable steps” to ensure the provider applies protective security measures that are at least as stringent as those the regulations require. A person also continues to be required to verify the provider’s ability to protect personal information in compliance with the regulations. These amendments and the extension of the effective date are expected to decrease the compliance burden that would have occurred under the original regulations.

The Massachusetts Office of Consumer Affairs provided the Investment Company Institute (“ICI”) with a letter dated December 11, 2008 responding to the ICI’s written request for interpretative guidance on the regulation. The Massachusetts Office of Consumer Affairs’ response, among other things, (a) stated that various definitions and phrases were taken directly from the enabling statute and any use of the those terms in the regulation do not alter any definitions or phrases in that statute; (b) indicated the type of discipline for violating the security program would be left to the reasonable determination of the employer; (c) noted the third-party service provider certification proposed by the ICI would be in compliance with the regulations; and (d) interpreted terms and phrases, such as “responsive actions,” “reasonableness,” “reasonable monitoring of systems,” “computer access,” “reasonably consistent with industry standards,” “immediately,” and “portable devices.” The ICI has distributed these letters to its members.

For more information about the amendments, please see:
http://www.mass.gov/?pageID=ocapressrelease&L=3&L0=Home&L1=Consumer&L2=Identity+Theft&sid=Eoca&b=pressrelease&f=20090212_idtheft&csid=Eoca 
http://www.mass.gov/Eoca/docs/idtheft/201CMR17amended.pdf 

For more information about the regulations before the amendments, please see:
http://www.wilmerhale.com/publications/periodicals/investment_management/blog.aspx?entry=104 
http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8529 
 

On February 19th, Chairman Schapiro announced that Robert Khuzami will be the Director of the Division of Enforcement. Mr. Khuzami served as a federal prosecutor for 11 years with the United States Attorney’s Office for the Southern District of New York. Most recently, Mr. Khuzami served as General Counsel for the Americas at Deutsche Bank AG.

For more information, please see:
http://www.sec.gov/news/press/2009/2009-31.htm  

On February 10th, the SEC charged two hedge fund managers and their principal with fraud in connection with two hedge funds they managed by creating the impression of profitable performance they had not achieved in order to attract and retain investors in the hedge funds. The SEC charged the defendants with violations of Section 17(a) under the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. The SEC sought an injunction, the disgorgement of illegal profits, the payment of prejudgment interest, and the payment of civil money penalties.

The complaint alleged that the managers provided investors with monthly account statements, newsletters, and fact sheets that materially overstated the funds’ performance and assets. The SEC further alleged that the principal and one of the managers fabricated and distributed “certified” financial information, confirmations of a fund’s trading operations, and financial statements containing a false audit opinion that overstated the funds’ performance and contained representations that they were created by purportedly “independent” back-office administrator and accounting firm, both of which were sham companies created by the principal. Additionally, the SEC alleged that one of the hedge fund’s offering memorandum was materially misleading because it identified the administrator and accounting firm but did not disclose that they were affiliated with the manager.

For more information, please see:
http://www.sec.gov/litigation/litreleases/2009/lr20893.htm 
http://www.sec.gov/litigation/complaints/2009/comp20893.pdf  

On February 18th, the SEC announced that it had settled an action against a non-U.S. Bank for acting as an unregistered broker-dealer and investment adviser to U.S. persons and offshore entities with U.S. citizens as beneficial owners from at least 1999 through 2008. The SEC alleged that the bank provided brokerage and investment advisory services that facilitated the ability of certain U.S. clients to maintain undisclosed off-shore accounts enabling those clients to avoid paying taxes related to assets in those accounts (“cross-border business”). The bank conducted the cross-border business largely through off-shore client advisers who were not associated with a registered broker-dealer or investment adviser in the U.S., but who traveled to the U.S. several times per year and used other U.S. jurisdictional means (telephones, facsimiles, email, and mail) to solicit, provide investment advice to, and engage in securities transactions for, U.S. clients. The SEC alleged the bank was aware that it was required to be registered with the SEC, and the bank took action to conceal its use of U.S. jurisdictional means to provide these services, such as providing training to client advisers on methods to avoid detection by U.S. authorities of their activities in the U.S.

The SEC alleged that the bank violated Section 15(a) of the Securities Exchange Act of 1934 (“Exchange Act”) and Section 203(a) of the Investment Advisers Act of 1940 (“Advisers Act”). The bank consented to the issuance of a final judgment permanently enjoining the bank from further violations of those provisions, ordering the bank to disgorge $200 million, and ordering the bank to terminate the cross-border business. The bank also entered into a related deferred prosecution agreement with the Department of Justice, and will pay an additional $180 million in disgorgement and $400 million in tax-related payments.

For more information, please see:
http://www.sec.gov/news/press/2009/2009-29.htm 
http://www.sec.gov/litigation/litreleases/2009/lr20905.htm 
http://www.sec.gov/litigation/complaints/2009/comp20905.pdf  

On February 11th, the SEC issued a release adopting rule amendments that will require mutual funds to file their risk/return summaries in the eXtensible Business Reporting Language (“XBRL”) interactive data format. The amendments require funds to provide their risk/return summaries in XBRL format as an exhibit to any registration statement or post-effective amendment that are annual updates to effective registration statements on Form N-1A that includes or amends risk/return summary information, as well as in an exhibit to any form of prospectus filed under Rule 497(c) or (e) under the Securities Act of 1933 (the “Securities Act”) containing risk/return information that varies from the information contained in their most recent registration statement or post-effective amendment. Funds also will be required to make the XBRL data available on their own websites (if funds have a website) when they file with the SEC, and to keep the data posted as long as the registration statement to which it relates remains current. Additionally, the amendments limit liability provisions for interactive data until October 31, 2014, set forth tagging requirements, and provide a non-exclusive safe harbor to determine when a correction is “promptly” made.

XBRL submissions will be required for initial registration statements and annual updates to effective registration statements that become effective after January 1, 2011. A form of prospectus filed under Rule 497(c) or (e) will be required to include an XBRL risk/return summary exhibit only if the relevant fund has already submitted an XBRL exhibit with its registration statement. If a registrant fails to submit the required XBRL data or make the data available on its website by the required date, the registrant’s ability to file post-effective amendments under Rule 485(b) under the Securities Act will be suspended automatically.
Funds may continue to participate in the SEC’s voluntary program for XBRL filings with respect to risk/return summary information until the compliance date of January 1, 2011, and with regard to financial statement information indefinitely. In addition, funds may submit XBRL portfolio holdings information through the voluntary program without having to submit other financial information in interactive data format.

For more information, please see:
http://www.sec.gov/rules/final/2009/33-9006.pdf 
http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8801  

On February 2nd, the SEC adopted rule amendments to address practices the SEC identified during its examination of the three largest nationally recognized statistical rating organizations (“NRSROs”), increase the transparency of NRSROs’ rating methodologies, strengthen disclosures, prohibit certain practices that create conflicts, and enhance recordkeeping obligations. The amended rules require an NRSRO to, among other things:

• provide enhanced disclosures of performance measurements statistics, by, among other things: disclosing separate sets of default and transition statistics for each class of credit ratings; including the credit ratings of any security or money market instrument issued by an asset pool or as part of any asset-backed or mortgage-backed securities transaction; and breaking out class-by-class disclosures over 1, 3 and 10-year periods;
• provide enhanced disclosures of the procedures and methodologies the NRSRO uses to determine credit ratings for structured finance products and other debt securities on Form NRSRO, by disclosing certain information about the NRSRO’s review of its credit ratings and by disclosing whether the NRSRO relies on information about verification performed on underlying or referenced assets or relies on assessments of the quality of underlying or referenced assets’ originators to determine credit ratings;
• make, keep and preserve records of all rating actions, any written third-party complaints about credit analysts, and the rationale when a final credit rating for structured finance products materially deviates from the rating implied by a quantitative model that is a substantial component of the rating process;
• make publicly available on the NRSRO’s website in XBRL format a random sample of 10% of the ratings histories of credit ratings in each class that was paid for by the obligor or the issuer, underwriter, or sponsor of the security (“arranger”) being rated and for which the NRSRO has issued 500 or more ratings; and
• provide the SEC with an additional annual report, showing the number of certain rating actions the NRSRO took during the fiscal year.

The amended rules also prohibit an NRSRO from issuing or maintaining a credit rating if: the NRSRO or its associated person made certain recommendations to the obligor or the arranger; the fee paid for the rating was negotiated, discussed or arranged by a person within the NRSRO who participated in determining or approving credit ratings or the procedures and methodologies to determine credit ratings; or any person who determined, monitored or approved the credit rating received gifts or entertainment of more than $25 from the obligor or the arranger. The amended rules have a compliance date of April 10, 2009, except that the compliance date for the requirement to make publicly available a random sample is August 10, 2009.

In a separate release, the SEC also re-proposed certain rule amendments. The SEC proposed to require an NRSRO to publicly disclose credit rating histories for all credit ratings that were paid for by the obligor or arranger on or after June 26, 2007. The SEC also proposed prohibiting an NRSRO from issuing a rating paid for by the arranger for a structured finance product unless the product information the NRSRO used to determine and monitor the rating is made available to other NRSROs. The arranger would be required to represent to the NRSRO that the arranger would make available to other NRSROs the information given to the hired NRSRO. NRSROs that seek access to this information would be required to annually certify to the SEC that they access the information solely to determine or monitor credit ratings, will keep the information confidential, and will determine a minimum number of ratings using the information. Finally, the SEC proposed amending Regulation FD to, among other things, permit disclosure of material non-public information to an NRSRO regardless of whether it makes its ratings publicly available. Comments are due by March 26, 2009.

In the amendments and re-proposal, the SEC stated that it is seeking to provide additional transparency to investors, other ratings agencies, and other market participants regarding the NRSROs’ procedures, methodologies, ratings actions, and quality, while continuing to preserve the confidentiality of their trade secrets. The amended rules also attempt to reduce the NRSROs’ conflicts of interest and require the maintenance of records and filing of reports that will assist the SEC staff in monitoring and examining the NRSROs. The SEC also stated that the re-proposed intended to promote competition among the NRSROs and to provide additional information for comparing NRSROs.

For more information, please see:
http://www.sec.gov/rules/final/2009/34-59342.pdf  
http://www.sec.gov/rules/proposed/2009/34-59343.pdf  

On February 3rd, the SEC staff granted no-action relief to a real estate investment trust relying on the exclusion from the definition of an investment company in Section 3(c)(5)(C) of the Investment Company Act of 1940 (“1940 Act”). Section 3(c)(5)(C) excludes any issuer primarily engaged in purchasing or acquiring real estate mortgages or other liens and real estate interests (“qualifying interests”). Previous no-action letters under Section 3(c)(5)(C) to companies acquiring mortgage loan participations included a condition that the companies had sole discretion to foreclose on the loans in the event of default. The SEC staff took the position that a junior participation in a commercial mortgage loan, which included many characteristics that would make it a “qualifying interest” but lacked the right to foreclose, was an interest in real estate, and thus a qualifying interest. The SEC staff considered, among other things, that:

• the participation interest was in a mortgage loan fully secured by real property;
• the trust had the right to receive its proportionate share of the interest and principal payments made by the borrower, and its returns on the interest were based on these payments;
• the trust performed the same due diligence and credit underwriting procedures it would perform if it were underwriting the underlying mortgage;
• the trust had approval rights regarding any material decisions about the administration and servicing of the loan and any material modification of the loan agreements; and
• the trust had effective control over the remedies to enforce the mortgage loan in the event the loan became non-performing.

In a footnote, the SEC staff recognized that although the right to foreclose is an important attribute to consider when determining whether an asset should be considered a qualifying interest, other attributes of an asset also need to be considered. The SEC staff, however, did not withdraw the previous no-action positions.

For more information, please see:
http://www.sec.gov/divisions/investment/noaction/2009/capitaltrust020309-3c5c.htm  
http://www.sec.gov/divisions/investment/noaction/2009/capitaltrust012909-3c5c-incoming.pdf  

On February 5th, the SEC announced that it had settled a case against a brokerage firm (formerly two brokerage firms that had consolidated into one firm) for allegedly misleading investors about the nature and increasing liquidity risks of auction rate securities (“ARS”) that the firm underwrote, marketed and sold. The firm allegedly misrepresented to customers that the ARS were safe and highly liquid investments comparable to cash or money market instruments. In addition, the firm routinely purchased ARS from another firm between auctions, without telling customers that the firm’s willingness to do so depending on the continued success of the auctions. In late 2007 and early 2008, the SEC alleged that the firm was aware that the risk of auction failures was increasing materially but continued to market ARS to customers as highly liquid investments without adequately disclosing the increased risk. In early 2008, the firm stopped supporting the auctions, and the auctions failed. Although the firm created documents that disclosed its auction practices and procedures, the SEC alleged that it did not take adequate steps to ensure its registered representatives were aware of the procedures or provided an accurate description of the product to customers.

Without admitting or denying the SEC’s allegations, the firm agreed to be permanently enjoined from violations of Section 15(c) of the Exchange Act and to comply with a number of undertakings, including: buying back ARS from customers affected by the fraud; paying customers who sold their ARS below par the difference between par and the sales price plus interest; compensating customers who received loans from the firm because of liquidity concerns; and lending to customers the full par value of their ARS, pending buyback, with set interest rates. Additionally, customers who incurred consequential damages because of the illiquidity of their ARS may participate in special FINRA arbitrations. After the firm has completed its obligations under the settlement agreement, the SEC will decide whether to seek a financial penalty.

For more information, please see:
http://www.sec.gov/news/press/2009/2009-17.htm  
http://www.sec.gov/litigation/litreleases/2009/lr20885.htm  
http://www.sec.gov/litigation/complaints/2009/comp20885.pdf  

On February 5th, the SEC filed a complaint in the U.S. District Court for the Southern District of New York alleging that seven individuals had engaged in insider trading and generated over $11.6 million in profits and losses avoided. The SEC alleged that from at least November 2005 through December 2006, a former Associate Director for a financial services firm tipped his father and friends, including a former portfolio manager for a hedge fund, with material nonpublic information about two corporate acquisitions that he obtained as a result of his direct work on the deals, communications with other employees advising the acquisitions, and/or access to firm files. The SEC further alleged that the Associate Director also tipped a friend and his father with material nonpublic information about another corporate acquisition that he obtained from a former Managing Director for another financial firm. The Managing Director allegedly obtained that information while advising the corporate acquisition. The SEC alleged that the Associate Director’s friends traded on the basis of that information, and that the Associate Director’s father and his friend’s father either traded on the basis of the information or their sons traded in their accounts to avoid detection.

Seeking injunctive relief, disgorgement of illicit profits and losses avoided, prejudgment interest, and civil monetary penalties, the SEC charged the Associate Director, his father, two friends, and his friend’s father with violating Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5. The SEC also charged the Managing Director and the hedge fund portfolio manager with violating Section 10(b) and Rule 10b 5. The U.S. Attorney’s Office for the Southern District of New York also filed related criminal charges.

For more information, please see:
http://www.sec.gov/news/press/2009/2009-18.htm
http://www.sec.gov/litigation/litreleases/2009/lr20884.htmhttp://www.sec.gov/litigation/complaints/2009/comp20884.pdf  
 

On February 6th, the SEC announced David M. Becker will become the General Counsel and Senior Policy Director of the SEC later this month. He served as the SEC General Counsel previously from 2000-2002, and is currently a partner at a law firm in Washington, D.C.

On February 9th, the SEC announced that the Director of the Division of Enforcement, Linda Chatman Thomsen, will leave the SEC to return to the private sector. Ms. Thomsen has served in this position for four years, and has nearly fourteen years of experience with the SEC.

For more information, please see:
http://www.sec.gov/news/press/2009/2009-22.htm  
http://www.sec.gov/news/press/2009/2009-20.htm  

On February 6th, SEC Commissioners Luis A. Aguilar, Kathleen L. Casey, Troy A. Paredes, and Elisse B. Walter each addressed the “SEC Speaks in 2009” program.

• Commissioner Aguilar suggested that Congress ensure the appropriate regulation of over-the-counter derivatives, hedge funds and municipal securities; ensure the SEC is independently funded and adequately resourced; and determine how to regulate broker-dealers that provide investment advice. He also recommended that the SEC build examination and enforcement staffs to full capacity, establish an advisory committee of retail investors to provide guidance to the SEC, delegate power to issue certain private investigation orders to the Director of Enforcement, study the consequences of the decrease in individual investor ownership of securities and the increase of institutional ownership, and address proxy issues.
• Commissioner Casey focused on the regulation of credit ratings agencies, noting that there is little competition in the industry and that issuing high-quality ratings had not been necessary in the past. Commissioner Casey stated the two most important initiatives in this area are removing the regulatory requirements embedded in numerous SEC rules and requiring rating agencies that are nationally recognized statistical rating organizations to disclose the information they use to issue a structured finance rating.
• Commissioner Paredes discussed the SEC’s actions last fall related to short selling and the lessons learned from those actions. In addition, he discussed the importance of engaging in a rigorous cost-benefit analysis for each regulatory decision made at the SEC.
• Commissioner Walter recommended that the regulatory structure should be reformed, including addressing significant overlap in the securities and futures markets, strengthening the SEC’s jurisdiction over OTC financial derivatives, reforming the regulation of financial intermediaries (broker-dealers, investment advisers and insurance agents), improving the quality and timing of disclosures in the municipal securities market, and increasing the transparency of the ratings used by credit rating agencies.

For more information, please see:
http://www.sec.gov/news/speech/2009/spch020609laa.htm  
http://www.sec.gov/news/speech/2009/spch020609klc.htm  
http://www.sec.gov/news/speech/2009/spch020609tap.htm  
http://www.sec.gov/news/speech/2009/spch020609ebw.htm  

On February 6th, SEC Chairman Mary L. Schapiro addressed the “SEC Speaks in 2009” program, emphasizing the need for a modernization of the financial regulatory system, greater market transparency and accountability, and vigorous prosecution of those who have broken the law and cheated investors. Chairman Schapiro described the following enforcement and regulatory priorities she hopes to undertake as SEC Chairman:

• End the SEC’s two-year “penalty pilot” that requires Enforcement staff to obtain special approvals from the SEC to seek civil monetary penalties against public companies as punishment for securities fraud.
• Approve more quickly formal orders of investigation by permitting seriatim written approval of the SEC or approval by a single Commissioner acting as duty officer on behalf of the entire SEC.
• Improve the handling of tips and whistleblower complaints, focusing on areas where investors are most at risk.
• Form an Investor Advisory Committee to ensure that the SEC is aware of the issues that concern investors.
• Improve the quality of credit ratings by addressing the conflicts of interest their compensation creates and limiting the impact of ratings on regulated financial institutions’ capital requirements.
• Reduce systemic risk by promoting and regulating centralized clearinghouses for credit default swaps, and strengthening risk-based oversight of broker-dealers and investment advisers.
• Promote the safe custody of customer assets by any broker-dealer or investment adviser, and improve the quality of audits for nonpublic broker-dealers.
• Work with Congress to ensure that any legislative restructuring of the financial regulatory system will preserve and strengthen the SEC’s commitment to investor protection, transparency, accountability, and disclosure.

For more information, please see: http://www.sec.gov/news/speech/2009/spch020609mls.htm  

The Board of Governors of FINRA has established a search committee to identify CEO candidates after former CEO Mary Shapiro was approved as SEC Chairman. Stephen Luparello, FINRA’s Senior Executive Vice President for Regulatory Operations, is serving as Interim CEO while the Board committee conducts its search for a permanent CEO.

For more information, please see:
http://www.finra.org/Newsroom/NewsReleases/2009/P117753
 

On January 20th, it was announced that a foreign businessman wanted in the United States on charges of bribing government officials in Azerbaijan settled a fraud lawsuit filed against him by a hedge fund, which had sought more than $100 million in damages.

The lawsuit stems from the businessman’s 1998 bid to seize control of Azerbaijan’s state oil company. The bid was backed by individual and institutional investors. The Azeri government required foreigners who wanted to bid on state property to first buy options from the government. The suit claimed the businessman had defrauded the hedge fund and other investors by charging $25 each for options in the proposed privatization that had cost the businessman 40 cents.

The hedge fund had agreed in 2007 to pay $500,000 to resolve OFAC’s bribery investigation into its investment in the venture. While the fund reportedly “acknowledged responsibility” for conduct, it neither admitted nor denied wrongdoing. Prosecutors had agreed not to charge the fund.

For more information, please see:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aRqgI_j8seBQ  
 

On January 16th, a group of insurance companies providing indexed annuity products filed a lawsuit against the SEC seeking to vacate Rule 151A adopted by the SEC on January 8, 2009, which classifies indexed annuities issued on or after January 12, 2011, as securities subject to regulation under the federal securities laws and allows the SEC to regulate indexed annuities. The insurance companies claim the rule is costly and argue that indexed annuities should be regulated by the states as insurance. The suit was filed in the U.S. Court of Appeals for the District of Columbia Circuit.

The plaintiffs are also requesting the SEC to stay the effectiveness of the rule until the court has rendered a decision on the case.

For more information, please see:
Am. Equity Inv. Life Ins. Co. v. SEC, No. 09-1021 (D.C. Cir., filed Jan. 16, 2009)
 

On January 29th, the Hedge Fund Transparency Act (the “Act”) was introduced in the U.S. Senate by Senators Levin and Grassley. The bill is a revised version of legislation previously introduced by Senator Grassley. The Act would amend the 1940 Act by replacing the exceptions to the definition of investment company under Sections 3(c)(1) and 3(c)(7) with exemptions from such definition under new Sections 6(a)(6) and 6(a)(7). Under the Act, any fund that relies on the exemptions under either Section 6(a)(6) or (a)(7) and has assets under management of $50 million or more will be required to, among other things:

• Register with the SEC;
• Maintain books and records that the SEC may require;
• Be subject to SEC examinations and requests for examination; and
• File an annual “information form” with the SEC electronically, which will be freely available to the public in an electronic, searchable format and will include:

a. The name and current address of each individual who is a beneficial owner of the fund.

b. The name and current address of any company with an ownership interest in the fund.

c. An explanation of the structure of ownership interests in the fund.

d. Information on any affiliation with another financial institution.

e. The name and current address of the fund’s primary accountant and primary broker.

f. A statement of any minimum investment commitment required of investors.

g. The total number of investors.

h. The current value of the assets and the assets under management of the Fund.

If enacted, the Act would cover any private fund, such as hedge funds, private equity funds, venture capital funds, and certain asset-backed securities, that is currently relying on Sections 3(c)(1) and 3 (c)(7) and meets the requirements discussed above. Although the Act would not expressly remove the Section 203(b)(3) private adviser registration exemption, the Act would, in effect, remove this exemption because the private funds would be registered investments companies and Section 203(b)(3) is not available to advisers as such companies.

If enacted, the Act would require that the SEC issue forms and guidance to carry out the provisions of the Act within 180 days after its enactment. The Act also provides the SEC with rulemaking authority to carry out the Act.

In addition, under the Act, any fund relying on the exemptions under Section 6(a)(6) or 6(a)(7) (regardless of asset size) must establish an anti-money laundering program and report suspicious transactions. The specific requirements of such program are to be established by the Treasury Secretary within 180 days of the enactment of the Act.

On January 27th, the Hedge Fund Adviser Registration Act of 2009 (“Registration Act”), sponsored by Representative Capuano and co-sponsored by Representative Castle, was introduced in the U.S. House of Representatives and referred to the House Committee on Financial Services. The Registration Act would amend the Advisers Act by removing the exemption from registration for investments advisers with fewer than 15 clients under Section 203(b)(3).

The bills can be found at:
http://grassley.senate.gov/private/upload/01292009-2.pdf and http://thomas.loc.gov/cgi-bin/query/z?c111:H.R.711:

On January 21st, the SEC announced the appointment of Andrew N. Vollmer as SEC’s Acting General Counsel. Mr. Vollmer succeeds Brian Cartwright, who left the agency to return to the private sector. As Acting General Counsel, Mr. Vollmer will be the chief legal officer of the SEC and head the Office of the General Counsel, which advises the SEC on various matters including enforcement actions, rulemakings, appellate briefs and adjudications, and provides a variety of legal services to SEC staff.

The press release can be found at:
http://www.sec.gov/news/press/2009/2009-9.htm
 

On January 26th, SEC Commissioner Luis Aguilar urged Congress to give the SEC express authority to regulate hedge fund advisers and derivatives and provide for municipal securities disclosure. Speaking at the Investment Company Institute’s Board of Governors’ Winter Meeting, Commissioner Aguilar also advocated a study examining the ramifications of the growth of institutional investing, and the consequences of this growth for regulation and the capital markets.

The speech can be found at:
http://www.sec.gov/news/speech/2009/spch012609laa.htm
 

On January 27th, the Division of Investment Management provided assurances that it would not recommend enforcement action to the SEC under sections 15(a) and 15(c) of the Investment Company Act of 1940 to an indirect, wholly-owned subsidiary of the global asset management firm that underwent a nationalization resulting in a change of control. In Fall 2008, as a result of the global financial turmoil, a foreign government had acquired the ownership of the global asset management firm. The firm represented that the nationalization may have resulted in a change of control of the subsidiary and an assignment of the subsidiary’s investment advisory agreements with certain registered investment companies. The relief was based on the facts and circumstances described in the request letter, and in particular the emergency nature of the foreign government's action.

The no-action letter can be found at:
http://www.sec.gov/divisions/investment/noaction/2009/fortisgroup012709.htm
 

On January 30th, the SEC charged a registered investment advisory firm and two of its former representatives alleging that the firm and its representatives mislead pension consulting clients about is money manager identification process and failed to disclose conflicts when recommending two of the firm’s affiliated services. The SEC alleged that:

• The firm and the representatives made misleading statements by emphasizing the firm’s resources and centralized process to choose new money managers for clients when the representatives did not use the firm’s centralized process;
• The firm and the representatives failed to disclose that the firm and its representatives could and did receive substantially higher revenue from “directed brokerage” commissions for executing trades through the firm than they would have received if clients had paid brokerage commissions from trades executed elsewhere and paid the firm its hard dollar fee;
• Clients that used the firm’s transition management services were not informed that representatives received production credits for their recommendation; and
• One of the representatives did not disclose his relationships with other recommended money managers and misstated the compensation he received for transition management services provided to a client.

As a result of this conduct, the SEC alleged that the firm violated Section 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”), failed to reasonably supervise certain representatives, and failed to maintain records of the offer or delivery of the firm’s disclosure statements that were provided to clients in lieu of Form ADV Part II. The firm settled its charges and agreed to a censure, to cease and desist from committing or causing any future violations, and to pay a civil money penalty of $1 million. The SEC alleged that the representatives aided, abetted and caused the firm’s violations. One of the representatives settled his charges and agreed to a censure and to cease and desist from committing or causing any future violations. A hearing will be scheduled before an Administrative Law Judge for the other representative.

For more information, please see:
http://www.sec.gov/news/press/2009/2009-13.htm

On January 5th, the CFA Institute publicly commented on the International Organization of Securities Commissions’ (“IOSCO”) Proposed Elements of International Regulatory Standards on Funds of Hedge Funds Related Issues Based on Best Market Practices. The CFA Institute supported IOSCO’s proposals. Regarding managers’ handling of liquidity risk, the CFA Institute emphasized the importance of a depositary’s determination that the limited redemption arrangements are acceptable under the prospectus. The CFA Institute urged disclosure of agreements between hedge funds and specific classes of investors and their impact on the fund. Other points discussed in the comment were provision of information on strategy, performance, manager’s experience, portfolio holdings, valuation and auditors; and risk management through performance of stress tests, scenario tests and back-tests. The CFA Institute also touched on having a documented and traceable procedure for hedge fund selection, adequate resources for due diligence and conditions for authorizing the outsourcing of due diligence.
For more information, please see:
http://cfainstitute.org/centre/topics/comment/2009/pdf/090106.pdf
 

On January 15, 2009, a steering committee of the Group of Thirty issued Financial Reform: A Framework for Financial Stability. The committee is headed by Paul Volcker, former chairman of the Federal Reserve Board and chairman-designate of the Economic Recovery Advisory Board under President-elect Barack Obama.

The committee proposed that all systemically significant financial institutions should be subject to oversight, including managers of private pools of capital that borrow significant amounts. The recommendation would apply to hedge funds and arguably also to private equity funds, but the recommendation expressly makes an exception for venture capital funds. The committee suggests, among other things, a registration requirement for funds determined to be potentially systematically significant and of a minimum size; and periodic regulatory reports and public disclosures of information regarding the size, investment style, borrowing, and performance of the funds under management.

The committee also made recommendations concerning money market funds. According to the committee, money market mutual funds wishing to continue to offer bank-like services should be required to reorganize as special-purpose banks, with appropriate prudential regulation and supervision, government insurance, and access to central bank lender-of-last-resort facilities. Those institutions remaining as money market funds should only offer a conservative investment option with modest upside potential at relatively low risk. The committee suggested that money market funds should not be permitted to use amortized cost pricing, with the implication that they carry a fluctuating net asset value rather than one that is pegged at $1 per share.

For more information, please see: http://www.group30.org  or
http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8745  

On December 30, 2008, the U.S. District Court of Maryland threw out fraud allegations against two investment management firms while allowing the excessive-fee claims to go forward, albeit in a limited manner. The investor lawsuits had been filed following the market timing scandal in 2003. The judge found that “because plaintiffs fail to offer credible proof (or, indeed, any argument at all) that they suffered greater damages from arranged timers than the $50 million they are to receive under the regulatory settlements, defendants are entitled to summary judgment as to the arranged timers.” The judge agreed that the firms have made full restitution in regulatory settlements for firm employees’ market timed trading. The court found that plaintiffs may recover that portion of advisory fees that were “disproportionate, excessive, or unearned” because they were based on market timing trades.

For more information, please see: In re Mutual Funds Inv. Litigation, 2008 WL 5412407 (D.Md.)

On January 13th, Massachusetts Secretary of State William Galvin accused an adviser and its president with making false statements to investors about plans to support a money market fund’s net asset value when it fell below $1. The administrative complaint alleges that the sales staff made statements to investors that were intended to calm those investors and dissuade them from making redemption requests but contained information which the company principals knew at the time was not true. The complaint also alleges that the adviser satisfied redemption requests from large clients before the redemption requests of smaller clients.

For more information, please see: Administrative Complaint, In re Reserve Mgmt. Co., (No. 2008-0079) (Mass. Sec. Div. Jan. 13, 2009)
 

On January 13th, Division of Investment Management Director Andrew “Buddy” Donahue addressed the Mutual Fund Directors Forum. Donahue noted that the market turmoil in 2008 is expected to have an impact on adviser profitability and emphasized the importance of conducting a thorough review of investment adviser contracts in 2009. Mr. Donahue drew attention to modifications or eliminations of expense caps, and the use of peer group benchmarks when analyzing expense ratios and fees.

Mr. Donahue also stated that the Division of Investment Management is continuing to evaluate permitting independent fund directors to delegate certain responsibilities to other persons.

The speech can be found at: http://www.sec.gov/news/speech/2009/spch011309ajd.htm

On January 10th, SEC Commissioner Luis Aguilar stated that broker-dealers providing investment advice to their clients should be subject to “higher standards and fiduciary duties” of investment advisers. Speaking at a North American Securities Administration Association conference, Commissioner Aguilar also stated that the Congress should provide the SEC with authority over hedge fund advisers. Commissioner Aguilar noted that because of the lack of mandate, the SEC staff does not have the opportunity to identify misconduct on the part of hedge fund advisers.

The speech can be found at: http://www.sec.gov/news/speech/2009/spch011009laa.htm

On January 15th, at her confirmation hearing, Mary Schapiro, the nominee for SEC Chairman, stated that she intends to overhaul the SEC’s inspection programs for investment banks, broker-dealers, investment advisers, and rating agencies and strengthen SEC’s oversight of investment companies. Ms. Shapiro expressed her belief that all systematically important financial products should be regulated, and said she strongly favors hedge fund and credit-default swap regulation. Ms. Shapiro also indicated that she would be pursuing registration of hedge fund managers. Ms. Shapiro also indicated she favors the establishment of a risk-assessment office and reintroduction of the uptick rule. On January 27th, Ms. Schapiro was sworn in as the 29th Chairman of the SEC.

The press release can be found at: http://www.sec.gov/news/press/2009/2009-11.htm  

On January 6th, the Division of Investment Management provided assurances that it would not recommend enforcement action to the SEC under provisions of the Investment Company Act and the rules thereunder, to firms that previously have requested and received from the Divisions of Corporation Finance, Investment Management, and Trading and Markets no-action and exemptive relief addressing certain purchases of auction rate securities, certain registered closed-end investment companies and their affiliates (“Participating Firms”). The Division also provided assurances that it would not recommend enforcement action under Section 206(3) of the Investment Advisers Act of 1940 against a Participating Firm if the Participating Firm tenders or causes the sale of subject securities to the Participating Firm on behalf of a discretionary client without first obtaining the discretionary client’s affirmative consent, provided that the Participating Firm follows the protocol for discretionary clients, detailed in the no-action request letter. The Division based the no-action relief on the circumstances underlying the participating firms’ purchases of the subject securities and the public interest underlying the settlements.

The no-action letter can be found at: http://www.sec.gov/divisions/investment/noaction/2009/globalrelief010609.htm  

For more information, please see: http://www.sec.gov/divisions/corpfin/cf-noaction/2008/arsger092208.htm  and http://www.sec.gov/divisions/corpfin/cf-noaction/2008/arsger092208-incoming.pdf  

On January 8th, the Division of Investment Management (“Staff”) provided assurances that it would not recommend enforcement action to the SEC under Section 17(a) of the Investment Company Act of 1940 if a money market fund extends for an additional 60 days the relief previously granted by the Staff. The money market fund and an affiliate had previously received no-action relief allowing an arrangement whereby the affiliate purchases from the fund any securities in the fund’s portfolio that are Eligible Securities, as defined in Rule 2a-7 under the Investment Company Act, at the amortized cost of each purchased security to the extent necessary to allow the fund to pay redemption proceeds.

The no-action letter can be found at: http://www.sec.gov/divisions/investment/noaction/2009/mountvernon010809.pdf  

On January 8th, the SEC adopted a new rule under the Securities Act to clarify the status of indexed annuities under securities laws. The new rule prospectively defines certain indexed annuities as not being “annuity contracts” or “optional annuity contracts” if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract. Annuity contracts, optional annuity contracts and some other insurance contracts are exempted from the Securities Act under Section 3(a)(8) of the Securities Act.

The adopting release stated that the SEC’s stance on indexed annuities is based on fundamental concepts of risk and insurance. According to the release, if more often than not the purchaser of an indexed annuity will receive a guaranteed return similar to a traditional fixed annuity, then the instrument will be treated as insurance; on the other hand, if more often than not the purchaser will receive a return based on the value of a security, then the instrument will be treated as a security. For those indexed annuities that are treated as securities, investors will be entitled to all the protections of the federal securities laws, including full and fair disclosure and antifraud and sales practice protections.

The SEC noted that past offers and sales of indexed annuities are not subject to any legal risk, and that the new definition applies prospectively. The effective date of the new rule is January 12, 2011.

The adopting release can be found at: http://www.sec.gov/rules/final/2009/33-8996.pdf  

On January 16th, the same day that the SEC's release was published in the Federal Register, a group of insurance companies filed a petition in the U.S. Court of Appeals for the District of Columbia Circuit challenging the agency's action.

On January 8th, the SEC adopted a new rule under the Securities Act to clarify the status of indexed annuities under securities laws. The new rule prospectively defines certain indexed annuities as not being “annuity contracts” or “optional annuity contracts” if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract. Annuity contracts, optional annuity contracts and some other insurance contracts are exempted from the Securities Act under Section 3(a)(8) of the Securities Act.

The adopting release stated that the SEC’s stance on indexed annuities is based on fundamental concepts of risk and insurance. According to the release, if more often than not the purchaser of an indexed annuity will receive a guaranteed return similar to a traditional fixed annuity, then the instrument will be treated as insurance; on the other hand, if more often than not the purchaser will receive a return based on the value of a security, then the instrument will be treated as a security. For those indexed annuities that are treated as securities, investors will be entitled to all the protections of the federal securities laws, including full and fair disclosure and antifraud and sales practice protections.

The SEC noted that past offers and sales of indexed annuities are not subject to any legal risk, and that the new definition applies prospectively. The effective date of the new rule is January 12, 2011.

The adopting release can be found at: http://www.sec.gov/rules/final/2009/33-8996.pdf  

On January 16th, the same day that the SEC's release was published in the Federal Register, a group of insurance companies filed a petition in the U.S. Court of Appeals for the District of Columbia Circuit challenging the agency's action.

On January 13, 2009, the SEC issued a release adopting rule changes to allow mutual funds to use summary prospectuses. The release also makes substantial revisions to Form N-1A, which prescribes the content of mutual fund prospectuses. Mutual funds will have to provide a revised summary section at the beginning of each statutory prospectus and can use the information in this summary section as a summary prospectus to satisfy their delivery obligations under Section 5(b)(2) of the Securities Act of 1933. The new summary section of the statutory prospectus must be succinct, generally three to four pages long. It must be in plain English, as defined by the SEC (including, among other things, active voice, short sentences, and an avoidance of jargon and multiple negatives), but it should be noted that this was already a requirement for the risk/return summary of current prospectuses.

The SEC also adopted amendments intended to provide more useful information to investors purchasing exchange-traded funds.

The effective date of the amendments is March 31, 2009. All initial registration statements on Form N-1A, and all post-effective amendments that are annual updates filed on or after January 1, 2010 must comply with the amendments. All post-effective amendments that add a new series, filed on or after January 1, 2010, must comply with the amendments with respect to the new series. The SEC, as it did when it last comprehensively amended Form N-1A, stated that, in almost all cases, filings using the new format must be made using Rule 485(a), which requires 60 days before a filing is effective.

The adopting release can be found at: http://www.sec.gov/rules/final/2009/33-8998.pdf.