Investment Management Industry News Summary - June 2000

Investment Management Industry News Summary - June 2000

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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Supreme Court Allows Civil Action Against ERISA "Party in Interest"

June 26, 2000 12:07 PM

In a unanimous decision authored by Justice Clarence Thomas, the U.S. Supreme Court held that Section 502(a)(3) of the Employee Retirement Income Security Act of 1974 ("ERISA") authorizes an ERISA plan participant, beneficiary or fiduciary to bring civil action for appropriate equitable relief against a nonfiduciary "party in interest" for a prohibited transaction barred by Section 406 of ERISA. The Supreme Court's decision overturned a decision by the U.S. Court of Appeals for the Seventh Circuit, 184 F. 3d 646 (1999), which held that, where ERISA does not expressly impose a duty, there can be no cause of action.

In the case before the court, a party in interest that provided broker-dealer services to an ERISA plan sold interests in several properties to the plan, which the plan purchased at the direction of its investment manager. Upon discovering that the interests were nearly worthless, the plan and its trustee sued the party in interest seeking rescission of the transaction, restitution from the party in interest of the purchase price plus interest, and disgorgement of any profits made from the use of plan assets transferred to the party in interest.

Section 502(a)(3) states in relevant part, "a civil action may be brought by a participant, beneficiary, or fiduciary (A) to enjoin any act or practice which violates any provision of [ERISA Title I] or the terms of the plan, or (B) to obtain other appropriate relief (i) to redress such violations or (ii) to enforce any provisions of this title of the terms of the plan."

The court rejected the interpretation of the Seventh Circuit and other appeals courts, that only parties who are ERISA fiduciaries may be liable under the prohibited transaction provisions of Section 406 of ERISA. Although the court noted that "ERISA's "comprehensive and reticulated" scheme warrants a cautious approach to inferring remedies not specifically authorized in the text," the court ultimately held that Section 502(a)(3) of ERISA, was intended not to limit the possible universe of defendants, and therefore liability under Section 406 does not require the imposition in the statute of a specific duty on the party being sued. The court noted that Section 502(a)(3) makes no mention of which parties may be proper defendants, but rather, focuses on redressing practices that violate ERISA. The court also reasoned that the common law of trusts, which is the foundation of ERISA, clearly would allow for such a cause of action. The court rejected the party in interest's argument that recognizing such a cause of action would chill the desire of nonfiduciary parties in interest to transact with plans or would raise the transaction costs for plans because of the additional risk undertaken by the party. Harris Trust and Savings Bank v. Salomon Smith Barney, Inc., No. 99-579 (2000).

 
 

            

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.

Congress Passes Bill Authorizing Electronic Signatures

June 26, 2000 8:23 AM

After months of political wrangling, Congress overwhelmingly passed a bill earlier this month which will give electronic documents the same legal effect as paper documents. President Clinton has indicated that he will sign that bill into law. Supporters of the "Electronic Signatures in Global and National Commerce Act" believe that electronic signatures will make it easier and faster for companies and consumers to conduct online transactions.

The new law, which takes effect October 1, 2000, establishes a general rule that electronic signatures, contracts, and other records affecting interstate or foreign commerce shall have the same legal effect as traditional written signatures, contracts, and records. An electronic signature can be an electronic sound, symbol, or process which is either attached to or associated with an electronic contract or record and which is executed or adopted by a person intending to "sign" the document. Voice recordings are specifically excluded and cannot be used as electronic signatures. The law does not establish technical standards for conducting electronic transactions or verifying electronic signatures.

Under the new law, electronic documents may be substituted for any document which is legally required to be made available "in writing" to a consumer, provided the consumer affirmatively consents to the use of electronic records after being informed of any right or option to obtain the documents in paper form. Documents which must be notarized or executed under oath may also be created electronically.

If a law or regulation requires that a record be retained, then the record may be retained in an electronic form so long as it is accurate and can be accurately reproduced for future reference. Electronic records may even be substituted for "original" paper documents, including bank checks.

The new law does not establish the legal validity of the following classes of electronic documents:

  • Electronic documents provided or made available to a consumer who consents prior to October 1, 2000. The validity of such documents may still be protected by existing laws authorizing the use of electronic documents for specific purposes.
  • Documents relating to wills.
  • Documents relating to family law, including adoption and divorce. Presumably, marriage documents are also excluded.
  • Court documents.
  • Notices concerning the cancellation of utility services or life or health insurance benefits.
  • Default, acceleration, repossession, foreclosure, eviction, or cure notices under residential leases or under home equity loans.
  • Notices concerning product recalls or hazardous product failures.
  • Documents relating to the handling of hazardous materials.

The law does not force businesses or consumers to use electronic signatures or to accept electronic records, but companies are allowed to encourage the use of electronic documents by charging extra fees for providing paper copies. In addition, consumers may be subjected to fees or potentially significant penalties for withdrawing their consent to use electronic documents, including "termination of the parties' relationship."

The pro-business flavor of the new law worries some consumer advocates, who fear that consumers may be coerced into electronic agreements in order to obtain products or services, while reducing choices for consumers without computer access. Some privacy advocates are concerned that electronic signatures may make consumers more susceptible to electronic fraud, identity theft, and intrusive collection of personal data.

Passed overwhelmingly despite these concerns, the electronic signature law may be the strongest indication yet that Congress supports the continued rapid development of e-commerce. The next challenge will be for the online business community to make suspicious consumers feel more comfortable with electronic transactions, and with the collection of their personal data in particular. Excerpted from Hale and Dorr's Internet law Web site. The Web site also contains extensive information about our Internet attorneys, legal services, clients, transactions and publications, as well as links to numerous Internet resources.

 
 

            

This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.

IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Adopts Amendments to Transfer Agent Reporting Rules

June 26, 2000 8:19 AM

The SEC recently adopted amendments to the rules under the Securities Exchange Act of 1934 governing annual reporting requirements of registered transfer agents, as well as amendments to Form TA-2, the form on which registered transfer agents' annual reports are filed.

Under the amended rule, the reporting period for all filing data will be the calendar year, and each transfer agent registered on any December 31 will be required to file Form TA-2 for that calendar year by March 31 of the following year. The amended rule will allow partial exceptions to the full filing requirement for registered transfer agents that received fewer than 1000 items for transfer during the calendar year and did not maintain master shareholder files for more than 100 individual shareholder accounts as of December 31. Partial exceptions will also be available for named transfer agents that engage service companies to perform some or all of their transfer agent functions.

In addition to numerous technical and conforming changes, the revisions to Form TA-2 include:

  • instructions that transfer agents count securities by CUSIP rather than by prospectus;
  • revised items requesting information regarding issues for which dividend reinvestment plans and/or direct purchase plan accounts are provided;
  • new items requesting information regarding Direct Registration System issues and accounts;
  • designation of the former "investment company securities" category as "open-end investment company securities" and inclusion of closed-end fund securities in the "corporate equity" category; and
  • new sections requesting information regarding buy-ins of overissued shares and turnaround time for routine items.

The SEC also is rescinding the rule under which registered transfer agents were required to report the aggregate number of lost shareholder accounts each year and the percentage of total accounts represented by such lost shareholder accounts for several periods. Under the rules as amended, transfer agents will be required to provide the date of each database search for lost shareholders during the reporting period, the number of lost shareholder accounts submitted for each search and the number of accounts for which a different address was obtained as a result of the search. Transfer agents will continue to be required to report the number of lost shareholder accounts that were remitted to the states during the reporting period, but will no longer be required to report the aging of those accounts. Revised Transfer Agent Form and Related Rule (Sec Rel. 34-42892; File No. S7-11-99).

 
 

            

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 Permits Aggregation With Affiliates of Certain Private Placement Issues

June 26, 2000 8:11 AM

In response to a recent request for no-action relief, the SEC agreed not to take enforcement action against an investment adviser to open-end and closed-end investment companies and private accounts (the "adviser"), if the adviser aggregates orders among one or more of those funds and/or accounts for the purchase and sale of private placement securities for which it negotiates no term other than price. The non-negotiated private placement securities include equity and debt securities, warrants, conversion privileges and other rights that are exempt from registration under the Securities Act of 1933. Although the SMC Capital no-action letter (Sept. 5, 1995) set forth conditions under which funds could aggregate orders for publicly traded securities, it's relief did not extend to orders for private securities.

In its request for no-action relief, the adviser represented to the SEC staff that it will disclose to funds' independent trustees the existence of, and all material facts relating to, any conflicts of interest. If such a conflict exists, the adviser represented that it will allow the independent trustees to approve a fund's participation in the aggregated transaction before or after the transaction and to approve the exercise of ownership rights associated with any non-negotiated private placement securities before or after the exercise of those rights. The fund also represented that it will aggregate purchase and sale orders of non-negotiated private placement securities on behalf of the funds and accounts as follows:

  • the adviser's board or investment committee will approve a trade aggregation policy statement designed to ensure that aggregated transactions are made in a manner that is fair and equitable;
  • the policy statement will establish an aggregation committee of senior officers of the funds and the accounts, which will develop written aggregation procedures designed to result in fair and equitable participation in non-negotiated private placements;
  • the aggregation procedures will be fully disclosed in the adviser's Form ADV and separately to all participating funds and accounts;
  • each portfolio manager initially will review on an individual basis the fund's or account's investment objectives and policies, and determine whether non-negotiated private placements are appropriate for the fund or account;
  • the adviser will not engage in aggregated private placements on behalf of a fund or account unless the transaction is consistent with the adviser's duty to seek best execution (including the duty to seek best price) and with the terms of the applicable advisory agreement;
  • the adviser will produce a written report for each aggregated private placement transaction at the time of or before the transaction describing specifically how the securities or proceeds will be aggregated among participants (any deviation will be documented and approved by the aggregation committee prior to settlement);
  • the adviser will review the aggregation procedures at least annually to ensure fairness;
  • all funds and accounts will participate at the same unit price;
  • the adviser will receive no additional compensation as a result of an aggregated transaction that is not shared pro rata with the other participants in the transaction; and
  • cash and securities of funds and accounts participating in an aggregated transaction may be deposited into, and held in, a single bank or brokerage account only to the extent necessary to settle the trade.

In addition, the adviser agreed to certain record-keeping requirements.

The SEC staff states in its no-action response letter that aggregated transactions involving private placement securities for which terms other than price are negotiated would not be subject to no-action relief and would, in fact, be subject to the application of Rule 17d-1 under the Investment Company Act of 1940 (the "1940 Act"). Massachusetts Mutual Life Insurance Co., SEC No-Action Letter (June 7, 2000).

 
 

            

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 Unveils Online Brochure for Variable Annuities

June 19, 2000 12:02 PM

The SEC unveiled a new online brochure to help investors better understand the benefits, risks, and costs of variable annuities, stressing how they differ from mutual funds. The brochure, "Variable Annuities: What You Should Know," explains that variable annuities can offer attractive benefits to some long-term investors, including periodic payments for life, guaranteed death benefits, and tax deferral. But the brochure also includes several cautions:

  • IRAs. If an investor buys a variable annuity through a tax-advantaged retirement plan, such as an IRA, he or she will get no additional tax advantage from the variable annuity. Under these circumstances, an investor should consider buying a variable annuity only if it makes sense because of the annuity's other features, such as lifetime income payments and death benefit protection.
  • Charges. Investors should make sure they understand the charges associated with a variable annuity before they invest. Charges include sales charges payable on surrender and annual charges, including mortality and expense risk charges, administrative fees, and the expenses of the mutual fund investment options.
  • Exchanges. Investors who already own a variable annuity and are considering exchanging it for another variable annuity should weigh the decision carefully. Although the exchange is tax-free and there may be no charges imposed at the time of the exchange, a new surrender charge period generally begins when a contract is exchanged. This means that an investor who makes an exchange often forfeits the ability to withdraw money without paying substantial surrender charges.
  • Bonuses. Some insurance companies have recently introduced variable annuity contracts with "bonus credit" features. These contracts typically add a bonus credit of 1% or more to an annuity owner's purchase payments. However, variable annuities with bonus credits may carry a downside ¾ higher expenses that can outweigh the benefit of the bonus credit.

According to Paul Roye, Director of the SEC's Division of Investment Management, the variable annuity brochure provides helpful information on this important issue for the first time. It also highlights several issues that require investors to exercise caution and ask hard questions of their financial professional - the use of a variable annuity in an IRA or other tax-deferred vehicle, fees and charges, tax-free exchanges, and bonus payments. SEC Press Release 2000-74.

 
 

            

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 Orders Securities Markets to Phase in Decimalization

June 19, 2000 10:36 AM

The SEC ordered the exchanges and Nasdaq to submit a plan to phase in decimal pricing for listed stocks and certain options starting no later than September 5, 2000, and to phase in decimal pricing for Nasdaq securities beginning no later than March 12, 2001. All securities must be priced in decimals no later than April 9, 2001.

The phase-in plan may fix the minimum quoting increment during the phase-in period, provided that the minimum increment is no greater than five cents and no less than one cent for any equity security. The implementation plan must be submitted to the SEC by July 24, 2000. Individual SRO rule changes necessary to implement the plan must be submitted to the SEC by August 7, 2000.

SEC Chairman Arthur Levitt said, "Under the leadership of Chairman Bliley, Chairman Oxley, Congressman Markey, and other members of Congress, decimalization will become a reality this year and investors will soon reap the benefits of trading in decimal increments." Chairman Levitt continued, "As the securities markets become more global, with many stocks traded in multiple jurisdictions, the U.S. securities markets must adopt the international convention of decimal pricing to remain competitive. The overall benefits of decimal pricing are likely to be significant. Investors may benefit from lower transaction costs due to narrower spreads and prices will be easier to understand. It is time for the U.S. securities markets to make this change." SEC Press Release 2000-79.

 
 

            

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.

Federal District Court Dismisses Callenge to Directors' Independence, but Allows Claim of Excessive Fees

June 19, 2000 10:29 AM

The U.S. District Court for the District of Massachusetts recently issued an order in which it dismissed a shareholder's claim that the directors of certain mutual funds are under the control of the investment adviser to the funds in violation of the Investment Company Act of 1940 (the "1940 Act"). The court did not, however, dismiss claims that the investment adviser charged excessive advisory fees in violation of the fiduciary duties imposed by Section 36(b) of the 1940 Act.

Directors' service on multiple boards. The plaintiff alleged that the directors were not "independent" from the adviser and its affiliates because the same nine independent directors serve on the 12-person boards of all 237 funds in the family of funds and receive annual compensation of about $250,000 per year in consideration of such board service. The court acknowledged that "mutual fund directors can never be truly disinterested when they serve on multiple boards and are paid well," and that the number of boards and amounts of compensation in this case is more than four times the which has been considered in previous cases. Nevertheless, the court was persuaded by the majority view that "the directors' well-compensated multiple board membership is insufficient to rebut the statutory presumption against control without other indicia of control." Moreover, the court dismissed the allegation, ruling that the plaintiff had not overcome the statutory presumption because the plaintiff did not allege that the investment adviser sets director compensation, determines director retention or reelection, or actually controls the directors.

Excessive advisory fees. The plaintiff also alleged that the investment adviser charged excessive advisory fees in violation of Section 36(b) of the 1940 Act, which imposes a fiduciary duty on mutual fund advisers with respect to receipt of compensation. Shareholders have a direct private cause of action under Section 36(b) for breach of this fiduciary duty. The court looked to the standard articulated by the Second Circuit in Gartenberg v. Merrill Lynch Asset Management Inc., which held that a fee is excessive in violation of Section 36(b) if it is so disproportionately large that it bears no reasonable resemblance to the services provided and could not have been the product of arms-length bargaining. The six factors identified in Gartenberg are:

  • the nature and quality of the services provided to shareholders
  • the profitability of the fund to the investment adviser
  • economies of scale in operating the fund as it grows larger
  • comparative fee structure
  • fallout benefits; and
  • the independence and conscientiousness of the directors.

The court found that, although the plaintiff did not provide factual allegations to support all of the Gartenberg factors, it did provide factual allegations to support several of the factors. The allegations included evidence of lack of trustee independence (high compensation for service on multiple boards), relative quality of service provided (poor fund performance compared to peers) and inability to pass on savings due to economies of scale. On this basis, and because the defendant had not produced documents relating to the Gartenberg factors, the court denied the motion to dismiss allegations that the investment adviser charged excessive advisory fees. Krantz v. Fidelity Management & Research Co., et al., Civil Action No. 98-11988-PBS (D. MA. May 31, 2000).

 
 

            

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 Permits Unit Investment Trust Sponsor to Assess Sales Charge as a Fixed Percentage of Net Asset Value

June 19, 2000 10:18 AM

In response to a recent request for no-action relief, the SEC agreed not to take enforcement action against the sponsor of series of several unit investment trusts (the "series") seeking to collect a periodic deferred sales calculated at the time of each deduction as a fixed percentage of net asset value as opposed to a fixed dollar amount, subject to the maximum amount per unit determined at the inception of the series. The sponsor sought to implement this sales load structure under an existing exemptive order (the "1995 order") in order to compete more effectively with the sales load structures offered by mutual funds.

The 1995 order, which exempts the sponsor and certain existing and future series from certain sections of the 1940 Act, permits the sponsor to collect sales charges on a deferred basis by establishing a maximum sales charge per unit at the inception of the series and collecting all or a portion of the sales charge through deductions from the series'distributions. If distribution income is insufficient to pay the deferred sales charge, the trustee has the authority to sell portfolio securities in amounts necessary to provide for the requisite payment. Likewise, if a unitholder sells or redeems units before the full sales charge on those units has been collected, the sponsor may collect the unpaid balance from the sale and redemption proceeds. The total of any up-front sales charge, deductions from distributions, and any deferred sales charge collected at the time of redemption or sale would not exceed the maximum sales charge per unit established at the time of inception.

In issuing a favorable response to the sponsor, the staff required the sponsor to adopt accounting methodologies that track sales charges on units and that assess no further sales charges once those units reaching the maximum sales charge per unit established at the time of inception. The staff also required that the overall maximum sales charge comply with the NASD rules and that the sales charge structure, including the maximum sales charge, periodic percentage change and schedule of payments, be disclosed in the series' prospectus. Prudential Securities Inc., File No. 812-8846 (May 23, 2000).


 
 

            

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.

Investment Adviser Settles Charges with CFTC

June 5, 2000 9:28 AM

The CFTC issued an order finding that a California investment adviser acted as a commodity trading advisory (CTA) by directing trading in numerous commodity futures trading accounts pursuant to powers of attorney, without being registered with the CFTC as a CTA. The investment adviser had filed a notice of exemption, in which he claimed that he was exempt from registration as a CTA under the exemption for investment advisers that are registered with the SEC. The adviser, however, had withdrawn his registration with the SEC in 1997 due to changes in federal securities laws that now require regulation of an investment adviser by the state in which it maintains a place of business (and prohibit SEC registration) unless, among other things, the adviser has assets under management of at least $25 million. In this case, the adviser was registered with the state of California, and not the SEC, because he had assets under management of less than $25 million.

The order also finds that the investment adviser solicited and entered into agreements with prospective clients to direct their commodity interest accounts without first delivering required CTA disclosure documents and obtaining a signed acknowledgment of delivery of disclosure documents. CFTC News Release 4403-00 (CFTC Docket No. 00-20).

 
 

            

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.

NASD Regulation Panel Reverses Failure to Supervise Decision

June 5, 2000 9:24 AM

NASD Regulation (NASDR) recently released a decision of the National Adjudicatory Council (NAC) reversing a 1998 decision in which a branch manager was found to have inadequately supervised a broker. The broker was found to have engaged in unsuitable trading in violation of NASD conduct rules and was censured and suspended by the NASD. The NASD also initially found that the manager had violated NASD conduct rules by failing to supervise adequately the broker. Specifically, the initial decision held that, despite taking corrective action against the broker, the manager violated conduct rules because he failed to directly contact the customer and ascertain precisely what the customer understood about what was occurring in her account.

On appeal, the NAC reversed the initial decision, finding that the manager's conduct was reasonable under the circumstances. The manager:

  • met with the broker on the same day the broker's unsuitable, excessive trading was brought to the manager's attention;
  • instructed the broker to reduce the customer's margin debt and to purchase only "blue chip" stocks for the account;
  • called the director of compliance the following day to discuss and seek approval of his actions; and
  • upon learning of the broker's later purchase of speculative stock for the customer's account, ordered the broker to clear all trades for the account through a supervisor.

The NAC found that the manager's conduct complied with NASD Conduct Rule 3010, which requires the establishment, maintenance and enforcement of a set of written supervisory procedures reasonably designed to achieve compliance with applicable securities laws and regulations and NASD rules. Moreover, the NAC noted that the firm's procedures did not require customer contact, but gave the manager the discretion to contact the customer or take other corrective action, such as prohibiting certain types of transactions in the customer's account. The manager chose the latter approach and thus was not required to contact the customer to determine whether she understood the trading strategy being employed. Nevertheless, before this appeal was decided, the firm did revise its written procedures to require that managers contact customers when suitability issues arise. In the matter of District Business Conduct Committee for District No. 7 v. Lobb, NASDR NAC, Complaint No. C07960105, April 6, 2000 (released May 30, 2000).

 
 

            

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.

Industry Trade Groups Urge Securities and Exchange Commission (SEC) to Modify Proposed Broker-Dealer Exemption Form Adviser Registration

June 5, 2000 9:18 AM

In a recent comment latter to the SEC, several groups representing consumers and investment advisers jointly urged the SEC to modify its proposed changes to the exemption for broker-dealers from registration under the Investment Advisers Act of 1940 (the "Advisers Act"). The proposal (described in Industry News Summary, week of 11/01/99-11/08/99) generally would exclude from the definition of investment adviser a broker-dealer that gives investment advice, as long as:

  • the advice is provided on a non-discretionary basis
  • the advice is solely incidental to the brokerage services; and
  • the broker-dealer discloses to its customers in ads and all customer agreements that their accounts are brokerage accounts

In addition, the proposal would subject to Advisers Act regulation discretionary brokerage accounts for which customers pay an asset-based fee, but not discretionary accounts for which customers pay commission-based transaction fees.

In the comment letter, the industry and consumer groups urged the SEC to:

  • clarify what constitutes "solely incidental" investment advice by a broker-dealer;
  • treat all discretionary accounts as advisory accounts, regardless of the fee structure; and
  • preclude broker-dealers claiming the exclusion from marketing their services as investment advisory services.

Finally, the comment letter suggested that in order to curb broker-dealers from portraying brokerage accounts as advisory accounts, the "SEC and others" should undertake an educational campaign to alert investors as to the difference between brokers and investment advisers. BNA Securities Regulation and Law Report, Volume 32 No. 22, June 5, 2000.

 
 

            

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.