Investment Management Industry News Summary-June 2004

Investment Management Industry News Summary-June 2004

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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Fund governance and advisory contract disclosure rules adopted

June 28, 2004 3:25 PM

On June 23, 2004, the Securities and Exchange Commission (“SEC”) voted to adopt final rules regarding fund governance and disclosure regarding approval of advisory contracts. The SEC also adopted Regulation SHO regarding short selling. More detailed summaries will follow.

Fund governance

The amendments relating to fund governance include the following requirements:

  • Independent chairman of the board;
  • Independent directors to constitute at least 75 percent of the fund’s board. An exception to this 75 percent requirement will be allowed for fund boards with three directors to have two independent directors;
  • Annual self-assessment by the board;
  • Separate meetings of independent directors to be held at least once per quarter; and
  • Authority for independent directors to hire their own staff to deal with matters on which they need outside assistance.

Compliance with the fund governance amendments will be required 18 months after their publication in the Federal Register.

Disclosure regarding board approval of advisory contracts

The amendments require the following disclosures in fund proxy statements and shareholder reports:

  • A general discussion of the board’s selection of an adviser and its approval of the advisory fee;
  • The following specific factors: (1) the nature, extent, and quality of the services to be provided by the adviser; (2) the investment performance of the fund and the adviser; (3) the costs of the services to be provided and profits to be realized by the adviser and its affiliates from its relationship with the fund; (4) the extent to which economies of scale would be realized as the fund grows; and (5) whether fee levels reflect these economies of scale for the benefit of fund investors;
  • Whether the board relied on comparisons of the services and fees under the contract with those of other investment advisory contracts, such as contracts with the same adviser and other investment advisers of different funds or other types of clients (e.g. pension funds, institutional investors).

Fund proxy statements filed on or after October 31, 2004 and shareholder reports for periods ending on or after March 31, 2005 will be required to comply with these amendments.

 
 



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.

DOL issues advisory opinion on the applicability of the Employee Retirement Income Security Act of 1974 (“ERISA”) prohibited transaction rules to alternative trading systems

June 28, 2004 8:42 AM

On May 24, 2004, the DOL issued Advisory Opinion 2004-05A in response to a request for guidance on whether the execution of a securities transaction between a plan and a “party in interest” with respect to such plan, through an alternative trading system maintained by Liquidnet, Inc. (“Liquidnet”) would constitute a prohibited transaction under section 406(a)(1)(A) and (D) of ERISA. In addition, the request for guidance asked whether the execution of a securities transactions through Liquidnet between a plan and a counterparty that is an affiliate of the fiduciary directing such trade on behalf of the plan also would also violate section 406(b) of ERISA.

A “party in interest” is defined under ERISA as any fiduciary of an employee benefit plan, and a person providing services to such plan. A “fiduciary” of a plan is defined under ERISA as a person who exercises any discretionary authority or discretionary control with respect to the management of the plan or the disposition of assets, renders investment advice for a fee, or has discretionary authority or responsibility in the administration of such plan. Section 406(a)(1)(A) and (D) of ERISA prohibits a fiduciary with respect to a plan from causing the plan to engage in a transaction if he or she knows or should know that the transaction constitutes a direct or indirect sale, exchange, lease or transfer of any property between the plan and the party in interest. Section 406(b) of ERISA provides that a fiduciary with respect to a plan shall not deal with the assets of the plan in his or her own interest or own account, or act in any transaction in the plan on behalf of a party whose interests are adverse to the interests of the plan and its beneficiaries.

Liquidnet matches purchase and sell orders from its clients and gives purchasers and sellers the opportunity to negotiate a trade based on price and volume. The number of subscribers and the trading procedures assure a party’s anonymity, unless the party wishes to identify itself to the counterparty. The DOL stated that transactions executed through Liquidnet’s trading procedures for the execution of transactions that are designed to permit anonymous negotiations without identifying the parties, function in a manner similar to the operation of an exchange. Accordingly, the “blind” transactions executed pursuant to such procedures would not, in themselves, constitute prohibited transactions under Section 406(a)(1)(A), 406(a)(1)(D), 406(b)(1) or 406(b)(2) of ERISA.

U.S. Department of Labor, Employee Benefits Security Administration , Advisory Opinion 2004-05A, May 24, 2004.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC Commissioner and Director of the Division of Investment Management warn insurance companies of the SEC’s increasing focus on variable annuities

June 28, 2004 8:40 AM

On June 14, 2004, SEC Commissioner Cynthia Glassman warned variable product sponsors and brokers who recommend variable annuities that the SEC will be giving “increased attention” to variable annuities. Ms. Glassman stated that the SEC is reviewing the suitability of exchange, the appropriateness of sales to elderly clients, and the disclosure of conflicts of interest.

Similarly, Director Paul Roye of the Division of Investment Management stated at the National Association of Variable Annuities conference in Washington, D.C. that regulators have brought more than 80 enforcement actions in the variable annuity area in the past year and more will be coming soon as an outgrowth of the recent NASD-SEC joint report released on June 8, 2004, titled “Examination Findings Regarding Broker-Dealer Sales of Variable Insurance Products.” The report included findings of a lack in adequate suitability determinations, written policies and procedures, supervision and training, and disclosure, and deficient books and records.

Ms. Glassman commented that the report provides companies an opportunity for self-examination to determine now whether they have adequately addressed the issues raised in the report, and, if not, “to take action before it is too late.”

BNA Securities Regulation and Law Report, Volume 25 Number 25, June 21, 2004, “Variable Annuities Glassman Warns Insurance Companies Brokers: SEC Focusing on Variable Annuities.”

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC issues guidance on proxy voting by independent third parties

June 28, 2004 8:38 AM

In response to an inquiry from a proxy services firm, the staff of the SEC issued a no-action letter providing guidance on how to determine the “independence” of a third party that votes client proxies. Under the recently adopted Rule 206(4)-6 of the Investment Advisers Act of 1940, advisers are required to adopt and implement written policies and procedures that are reasonably designed to ensure that the adviser’s proxy votes are in the best interests of its clients and are not affected by the adviser’s conflicts of interest. In adopting this new rule, the SEC noted that an adviser could demonstrate that its proxy vote was not a product of a conflict of interest if it voted client securities in accordance with a pre-determined policy based on recommendations of an independent third party.

According to the SEC staff, merely hiring an independent third party to vote its clients’ proxies would not absolve an adviser from potential conflicts of interest, particularly when the adviser knows that the third party’s recommendations are consistent with the adviser’s own interest. The staff recommended that advisers take reasonable steps to verify that the third party is independent of the adviser and its affiliates, and does not have any material business, professional or other relationship with the adviser or its affiliates. In the staff’s view, a third party generally would be independent of the adviser if that person is free from influence or any incentive to recommend that the proxies should be voted in furtherance of any interest other than the adviser’s clients.

The staff stated that an adviser should not conclude that it is appropriate to follow the voting recommendations of an independent proxy voting firm without first ascertaining, among other things, whether the proxy voting firm (a) has the capacity and competency to adequately analyze proxy issues and (b) can make such recommendations in an impartial manner and in the best interests of the adviser’s client. The staff also noted that an investment adviser could breach its fiduciary duty of care to its clients by voting its clients’ proxies based on the proxy voting firm’s recommendations with respect to an issuer in the event that the proxy voting firm makes recommendations to the adviser to promote its own interests and to further its relationship with those issuers, rather than in the interests of the adviser’s clients.

To avoid potential conflicts of interest and determine a third party’s independence, the staff noted that an adviser should establish procedures to identify and address conflicts that can arise on an ongoing basis concerning the third party. The staff’s recommendations included receiving a representation from the third party that there is no conflict of interest with respect to every vote, and obtaining information from the third party regarding relationships with any issuers and amounts of compensation received by the third party from such issuers. In the event of a proxy voting firm’s conflict, the adviser’s procedures could require the adviser to vote the proxies, rather than relying on a proxy voting firm, provided that the adviser is not also conflicted.

SEC No-Action Letter, Egan-Jones Proxy Services, May 27, 2004; Investment Company Institute Memorandum, “SEC Issues Guidance on Adviser’s Use of Independent Third Parties to Vote Client Proxies under Rule 206(4)-6,” dated June 9, 2004.

 
 



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 to publicly release staff comment letters and responses

June 28, 2004 8:26 AM
On June 24, 2004, the SEC announced in a press release its position regarding the release of comment letters and responses relating to disclosure filings reviewed by the staff of the Division of Investment Management and the Division of Corporation Finance.
In its press release, the SEC stated it will begin releasing the staff’s comment letters and response letters relating to disclosure filings under the Securities Act of 1933, the Securities Exchange Act of 1934, the Trust Indenture Act of 1939 and the Investment Company Act of 1940 made after August 1, 2004 that are selected for review. The SEC will announce in the near future a specific date after which these documents will become publicly available through the SEC’s website, www.sec.gov. The staff noted that correspondence will be released no earlier than 45 days after the staff has completed its review of a filing.

The staff stated that it will continue to process requests for confidential treatment of information pursuant to the Freedom of Information Act and Rule 83, but will question a request for confidential treatment that is on its face overly broad. The SEC noted as a reminder to companies and their counsel that there must be an appropriate basis for a request for confidential treatment. Finally, the staff announced that it will request all companies whose filings are reviewed to represent in writing (a “Tandy” letter) that they will not use the SEC’s comment process as a defense in any securities related litigation against them.

SEC press release, “SEC Staff to Publicly Release Comment Letters and Responses,” dated June 24, 2004.
 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC issues no-action relief to a charitable organization

June 18, 2004 8:59 AM

The SEC stated in a recent no-action letter to the American Bible Society (“ABS”), dated June 1, 2004, that it would not recommend enforcement action against ABS if it allows certain foreign bible societies (“FBSs”) to invest in its general fund (the “Fund”) without registering the Fund under the Investment Company Act of 1940 (the “1940 Act”). In addition, the SEC stated it would not recommend enforcement action against ABS or its committee members if they do not register as investment advisers under the Investment Advisers Act of 1940 (the “Advisers Act”), or as broker-dealers or transfer agents under the 1934 Act.

ABS is a charitable organization, as defined in the 1940 Act, which operates exclusively for religious, charitable and educational purposes. Its mission is to make a bible available to every person in a language and format that each can understand and afford. ABS invests in the Fund to assist its operations and it has a committee that oversees the Fund’s investments. ABS partners with various FBSs to distribute bibles worldwide. All the FBSs are nonprofit, nongovernmental organizations that partner with ABS to distribute bibles.

Although the Fund is excluded from the definition of investment company and is not registered under the 1940 Act, ABS requested assurances from the SEC that it would not recommend enforcement action if certain FBSs were allowed to invest in the Fund. Any income received by an FBS from investing in the Fund would be used exclusively for the FBS’s religious, charitable and educational purposes and for bible distribution, translation and related activities. Each FSB that would be eligible to invest in the Fund (an “Eligible FBS”) would be at all times: (1) a member in good standing of the United Bible Societies (“UBS”); (2) in good standing in its own jurisdiction as a nonprofit, nongovernmental organization; (3) operated in a manner that is consistent in all material respects with the requirements of the Internal Revenue Code Section 501(c)(3); (4) organized and operated exclusively for religious, charitable and educational purposes; (5) not organized or operated for the purpose or benefit of any shareholder or natural person; and (6) not engaged in any business in the United States except investing in the Fund. In addition, each Eligible FBS would not assign, encumber, or transfer its interest in the Fund to any other person.

In granting no-action relief, the staff of the SEC noted that its position is based particularly on ABS’s representations that (1) ABS has designed and will implement verification procedures to effectively ensure that only Eligible FBSs are permitted to invest in the Fund; (2) Eligible FBSs are not engaged, and do not intend to engage, in any business in the United States, except for their proposed investment in the Fund; and (3) ABS will redeem an FBS’s interest in the Fund at its net asset value current as of the time of redemption, and promptly transmit the proceeds of the redemption to the FBS as soon as practicable after ABS determines that the FBS does not satisfy ABS’s eligibility requirements or is not a bona fide charitable institution. SEC No-Action Letter to the American Bible Society, June 1, 2004.

 
 



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 Approves Rules for Investment Bank Holding Company Supervision and Consolidated Capital Treatment

June 18, 2004 8:56 AM
On June 8, 2004 the SEC issued two sets of rules relating to the supervision of a broker-dealer’s parent holding company and the broker-dealer’s affiliates.
The first set of rules, described in a release entitled “Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities,” provides a voluntary, alternative method of computing net capital for broker-dealer subsidiaries of Supervised Investment Bank Holding Companies (“SIBHCs”) that utilize group-wide internal risk management control systems and consent to group-wide SEC supervision. Under the rules, broker-dealers that participate in sophisticated internal risk management control systems designed by the SIBHC may apply to the SEC for an exemption from the standard net capital rule. These broker-dealers will be permitted to calculate their net capital requirements for market and derivatives-related credit risk using mathematical models. A broker-dealer using this alternative method of computing net capital will be subject to enhanced net capital, early warning, recordkeeping, reporting, and certain other requirements, and must implement and document an internal risk management system.

The second set of rules, described in a release, entitled “Supervised Investment Bank Holding Companies,” establishes a framework for the SEC to supervise the holding company of a SEC-registered broker-dealer. Under the rules, holding companies can voluntarily apply to become SIBHCs under the supervision of the SEC as long as the holding companies have a broker-dealer subsidiary with a substantial presence in the securities markets. The new rules establish regulatory requirements for an SIBHC, including requirements regarding its group-wide internal risk management control system, recordkeeping and periodic reporting. Under the rules, an SIBHC’s reporting of consolidated computations of allowable capital and risk allowances will be consistent with the standards published by the Basel Committee on Banking Supervision.

Compliance with the approved rules--which is voluntary, not mandatory-- is intended to respond to industry needs and to provide a basis for U.S. securities firms to demonstrate that they are subject to ‘consolidated supervision’ at the holding company level. Without demonstration of such home country supervision, U.S. broker-dealers operating in the European Union (and in other jurisdictions) may face the prospects of additional capital requirements and other duplicative regulatory burdens.

The final rules are effective on or after August 20, 2004. A more detailed newsletter will be available shortly for those interested. SEC Release No. 34-49830 (Jun. 8, 2004) (Final Rule: Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities), available at http://www.sec.gov/rules/final/34-49830.htm; and SEC Release No. 34-49831 (Jun. 8, 2004) (Final Rule: Supervised Investment Bank Holding Companies), available at http://www.sec.gov/rules/final/34-49831.htm.
 
 



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 proposes rule to govern sales practices for deferred variable annuities

June 18, 2004 8:50 AM

The NASD recently proposed a rule to impose specific sales practice standards and supervisory requirements on members for transactions in deferred variable annuities. The proposed rule is the result of a history of disciplinary actions, deficiencies and customer complaints involving a wide array of misconduct involving variable annuities, such as excessive switching, misleading marketing, failure to disclose material facts, unsuitable sales, inadequate training and supervision of salespeople and deficient written supervisory procedures.

Deferred variable annuities are complex investment instruments that have both insurance and securities features that subject investors to various fees. Due to the complexity of these products, NASD has issued a number of Notices, Investor Alerts, and Member Alerts that address deferred variable annuities, including a Notice to Members in May 1999 (NtM 99-35) to assist members in developing appropriate procedures relating to the purchase, sale or exchange of deferred variable annuities. In general, the proposed rule would codify and make mandatory the guidelines issued by NASD in NtM 99-35. These requirements represent the industry’s best practices for transactions in deferred variable annuities. The proposed rule also would create certain written disclosure and principal review requirements. The proposed rule’s key provisions include:

Appropriateness/ Suitability

The proposed rule would require members and persons associated with members to make the following determinations when recommending a deferred variable annuity transaction: (1) the customer has been informed of the unique features of the deferred variable annuity, (2) the customer has a long-term investment objective, and (3) the deferred variable annuity as a whole and the underlying subaccounts are suitable for the particular customer. These determinations would have to be documented and signed by the associated person who makes the recommendation and performs the required analysis.

Disclosure and Prospectus Delivery

The proposed rule would require members and associated persons, regardless of whether the transaction had been recommended, to provide the customer a current prospectus and a separate, brief, and easy-to-read (written in “plain English”) risk disclosure document that highlights the main features of the particular variable annuity transaction, including, but not limited to, (1) liquidity issues, such as potential surrender charges and IRS penalty charges; (2) sales charges; (3) fees, such as mortality and expense charges, administrative fees, charges for riders or special features and investment advisory fees; (4) federal tax treatment of variable annuities; (5) any applicable state and local government premium taxes; and (6) market risk. The risk disclosure document also would have to inform the customer whether a “free look” period applies to the variable annuity contract, during which the customer can terminate the contract without paying any surrender charges and receive a refund of his or her purchase payments. In addition, the risk disclosure document would require the member or associated person to inform the customer that all applications to purchase or exchange a deferred variable annuity contract are accepted subject to review and approval by a designated registered principal.

Principal Review

No later than one business day following the date of execution of the deferred variable annuity application, a registered principal would be required to review and approve the transaction, regardless of whether the transaction had been recommended. In reviewing the transaction, the registered principal would need to take into account whether (1) the customer’s age or liquidity needs make a long-term investment inappropriate, such as a customer over a specific age or with a short-term investment objective; (2) the amount of money invested exceeds a stated percentage of the customer’s net worth or is more than a stated dollar amount; (3) the transaction involves an exchange or replacement of a deferred variable annuity contract; (4) the customer’s account has a particularly high rate of deferred variable annuity exchanges or replacements; (5) the associated person effecting the transaction has a particularly high rate of effecting deferred variable annuity exchanges or replacements; and (6) the purchase of the deferred variable annuity is for a tax-qualified retirement account (e.g., a 401(k) plan, IRA).

In addition, when the member or an associated person has recommended the transaction, a registered principal would be required to review and approve the suitability analysis document (described above) no later than one business day following the date of execution of the deferred variable annuity application.

Finally, when the transaction involves an exchange or replacement of a deferred variable annuity, regardless of whether the transaction has been recommended, a registered principal would need to review and approve a separate exchange or replacement document (which would cover issues specific to exchanges or replacements) no later than one business day following the date of execution of the deferred variable annuity application. The proposed rule would allow a member to use an existing exchange or replacement form authorized by a state insurance commission or other regulatory agency to satisfy the exchange or replacement disclosure provision to the extent that the regulatory agency’s form requires disclosure of the information required by NASD’s proposed rule.

Supervisory Procedures

Members would be required to establish and maintain specific written supervisory procedures reasonably designed to achieve and evidence compliance with the standards set forth in the proposed rule.

Training

Members would need to develop and document specific training policies or programs designed to ensure that associated persons who effect and registered principals who review transactions in deferred variable annuities comply with the requirements of the proposed rule and that they understand the unique features of deferred variable annuities, including liquidity issues, sales charges, fees, tax treatment, and market risks.

Comments on the proposed rule must be submitted to the NASD by August 9, 2004. NASD Notice to Members, June 2004.

 
 



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.

Court dismisses claims of breach of fiduciary obligations with respect to excessive fees

June 7, 2004 9:14 AM

The U.S. District Court for the Southern District of New York dismissed two related fund shareholder cases on May 12, 2004, holding that speculative conclusory allegations were insufficient to support claims that fees paid to the funds’ adviser and distributor were excessive in violation of Section 36(b) of the Investment Company Act of 1940.

The shareholders alleged that the adviser and distributor breached their fiduciary obligations by receiving excessive management and distribution fees in light of the funds’ performance “as compared to a limited sampling of other funds in the market.” One of the complaints relied primarily on claims that the fund underperformed compared to the S&P 500 Index and had an unfavorable expense ratio and that the trustees were “poor watchdogs.” The other complaint similarly alleged unfavorable fund performance as a basis for relief. The court noted that “conspicuously absent from either of the complaints are any factual allegations as to the actual fee negotiations or management and distribution services rendered by these defendants. Instead, the complaints rely on speculation, inference and generalized observations about the security industry from public figures such as Warren Buffet.”

In granting the motion to dismiss, the court stated that the test for a Section 36(b) violation was outlined by the U.S. Court of Appeals for the Second Circuit in Gartenberg v. Merrill Lynch Asset Management Inc., 694 F.2d 923(1982), as follows: “To be guilty of a violation of Section 36(b), the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonably relationship to the services rendered and could not have been the product of arm’s length bargaining.” Securities Regulation & Law Report, Volume 36, Number 22, Mutual Funds – Suits Over Fund Fees Fall To Pleading Specificity Challenge, May 31, 2004, describing Yampolsky v. Morgan Stanley Investment Advisers Inc., S.D.N.Y., 03 Civ. 5710 (RO), May 12, 2004, and Amron v. Morgan Stanley Investment Advisers Inc., S.D.N.Y., 03 Civ. 5896 (RO), May 12, 2004.

 
 



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.

Senate plans to introduce legislation on the “Small Investor Protection Act”

June 7, 2004 9:12 AM

On May 25, 2004, Senator Joseph Lieberman (D-Conn) announced plans to introduce legislation titled the “Small Investor Protection Act” during the week of May 31, 2004. If enacted, the legislation would among other things:

  • create a new Division of Investor Protection at the SEC to address issues of particular concern to small investors;
  • require mutual funds to give investors brief summaries of fund characteristics, clearly outlining relevant characteristics, such as expenses, risks and diversification;
  • require the SEC to use consumer research to guage whether disclosures are likely to be understood by ordinary investors; and
  • institutionalize the SEC’s new office of risk assessment, which is being created to analyze data on new trends and risks and identify areas of concern to the SEC.

Securities Regulation and Law Report, Volume 36, Number 22, Mutual Fund Lieberman Bill Would Add SEC Division of Investor Protection, Seek Fund Reform, May 31, 2004.

 
 



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.

Paul Roye addresses industry at Investment Company Institute (“ICI”) membership meeting

June 7, 2004 9:04 AM
At the ICI’s general membership meeting held on May 20, 2004, Director Paul Roye of the Division of Investment Management addressed ICI members by criticizing what he perceived as the industry’s reluctance to embrace reform. Mr. Roye noted that in the wake of the recent scandals, the industry is currently being scrutinized as never before and the fund industry has a “credibility gap” with regulators, lawmakers, the media, and investors. Highlights of Mr. Roye’s speech include the following:

  • He advised that some within the industry continue to avoid reform measures and questioned whether recent industry criticisms of certain SEC rules suggest that “only lip service is being paid to the primacy of the interests of fund investors.”

  • He mentioned complaints by members of the industry about the lack of guidance with respect to the obligation to fair value fund securities and the “astounding comment letters” in opposition to the proposed requirement that intermediaries provide fund managers with information to identify market timers. Mr. Roye questioned whether fund managers would be willing to accept the responsibility of using data provided by intermediaries to protect fund investors from market timers.

  • He noted that the SEC’s proposal to require an independent chairman was concluded to be a “best practice” by the Mutual Fund Directors Forum. Mr. Roye questioned whether requiring an independent chair would significantly interfere with fund board operations, and he stated that fund organizations that are currently well run would continue to be well run with an independent chair.

  • He stated that the fund industry is at a crossroads. He urged the industry to take action to restore its credibility and explained that, in his view, winning back the trust of mutual fund investors will require a commitment to compliance, ethics and reform. CCH Securities Laws News, May 24, 2004; ICI Memorandum regarding 2004 General Membership Meeting Speeches, May 24, 2004.
 
 
 



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.

WilmerHale

June 7, 2004 9:01 AM
We are pleased to announce that on May 31, 2004, Hale and Dorr LLP and Wilmer Cutler Pickering LLP combined practices to form WilmerHale. We look forward to continuing to provide all of our valued clients and friends with industry news on a weekly basis.
 
 



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