The ICI recently issued a comment letter regarding a proposed rule change filed by the National Association of Securities Dealers, Inc. (“NASD”) relating to Rule 2790, which generally prohibits an NASD member from selling a “new issue” to any account in which a “restricted person” has a beneficial interest. The ICI’s letter addressed the following issues:
Foreign Investment Companies. The letter stated that the current exemption from Rule 2790 for foreign investment companies is ineffectual in permitting these entities to invest in IPOs in the U.S. securities market. In particular, the ICI noted that the condition in the exemption requiring that no person owning more than 5% of the shares of the investment company be a restricted person is impracticable because it is not possible for a foreign investment company to identify all the beneficial owners of the fund and how much of the fund they own. The ICI stated that this is due to the manner in which investors hold shares of foreign investment companies, the broad scope of the definition of “restricted person” under Rule 2790, and because shares of foreign investment companies are typically owned by a large number of individual shareholders. The letter notes that it also is not practical for foreign investment companies to provide a representation, as required under the rule, that all purchases of new issues are in compliance with the rule.

The letter therefore recommends that the NASD change the current exemption for foreign investment companies to eliminate the condition relating to the beneficial ownership of “restricted persons” and, in general, to redefine what constitutes a foreign investment company for purposes of the rule. The letter recommends that the NASD:

• require as a condition of the exemption that the investment adviser for the foreign investment company have investment discretion over the account;
  
• require that the foreign investment company neither be created nor operated for the purpose of circumventing Rule 2790; and
  
• create a definition of a foreign investment company similar to that used by the SEC in its rule requiring the registration under the Investment Company Act of certain hedge fund advisers in order to clarify the scope of the exemption in a more efficient manner than the proposed amendment and promote uniformity between NASD and SEC rules relating to what constitutes a publicly offered foreign investment company.

Foreign Pension Plans and Foreign Charitable Organizations. The letter notes that Rule 2790 contains exemptions for pension plans and charitable organizations organized under applicable U.S. law but does not contain corresponding exemptions for foreign pension plans or foreign charitable organizations. The letter recommends that the NASD amend the rule to provide workable exemptions to permit foreign pension plans and foreign charitable organizations to invest in IPOs in the U.S. securities market. Specifically, the letter recommends creating exemptions for foreign pension funds and foreign charitable organizations that would contain conditions requiring that these entities be created or organized under the law of a foreign jurisdiction, not be created or operated for the purpose of circumventing Rule 2790, and be regulated, as applicable, by the foreign jurisdiction.

July 1, 2005 marks the compliance date for amendments to Regulation S-P adopted by the SEC in December 2004 requiring investment advisers, investment companies, broker-dealers transfer agents to properly dispose of consumer report information maintained or possessed for a business purpose, by taking reasonable measures to protect against unauthorized access to or use of the information in connection with its disposal. “Consumer report information” means any record about an individual, whether in paper, electronic or other form, that is a consumer report or is derived from a consumer report (i.e., any communication of information by a consumer reporting agency). According to the rule, reasonable disposal measures include adopting disposal rule policies and procedures which may be incorporated into existing Regulation S-P safeguard policies and procedures. Advisers and funds should review their existing privacy policies and procedures to ensure compliance with the disposal rule.

On June 21, 2005, the United States Court of Appeals for the District of Columbia published a decision ordering the SEC to address certain “deficiencies” in the adoption of amendments to Rule 0-1 (the “Fund Governance Rules”) under the Investment Company Act of 1940 (the “Investment Company Act”). These amendments require mutual funds to have a board consisting of at least 75% independent directors (versus 50%) and a chairman that is not an “interested” person, in order to engage in certain transactions otherwise prohibited under the Investment Company Act. The Chamber of Commerce had petitioned the court for review of these conditions of the Fund Governance Rules, arguing that the Investment Company Act does not give the SEC the authority to regulate “corporate governance” and that the SEC promulgated the amendments without adhering to the requirements of the Administrative Procedure Act (“APA”). Specifically, the court held that, although the SEC did not exceed its statutory authority in adopting the two conditions, the SEC promulgated the rule without adhering to the requirements of the APA in (a) failing adequately to consider the costs funds would incur in complying with the conditions, and (b) failing adequately to consider a proposed alternative to the independent chairman condition, as argued by the Chamber of Commerce.
SEC’s Authority

The court held that the SEC did not exceed its statutory authority in adopting the two new conditions of the Fund Governance Rules. In its opinion, the court affirmed the SEC’s authority under Section 6(c) of the Investment Company Act, which confers upon the SEC authority to exempt transactions otherwise prohibited by the Investment Company Act, subject to the public interest and the purposes of the Investment Company Act. The court rejected the Chamber of Commerce’s contention “that Section 6(c) should not be read to enable the Commission to leverage the exemptive authority it clearly does have so as to regulate a matter, namely, corporate governance, over which the states, not the [SEC], have authority.”

The court also rejected the Chamber of Commerce’s contention that the two conditions conflict with the intent of the Congress, expressed in Section 10(a) of the Investment Company Act, that 40% of the directors of an investment company be independent. The court stated that “Section 10(a) . . . speaks not at all to authority of the [SEC] to provide an incentive for investment companies to enhance the role of independent directors.” The court also noted that the challenged conditions apply only to funds that engage in exempted transactions.

Violations of the APA

The Chamber of Commerce argued that the SEC violated the APA by:

• Failing to show the connection between the abuses that prompted the rulemaking and the two conditions included in the Fund Governance Rules. The court, however, concluded that the SEC’s stated justification for amending the exemptive rules – strengthening the role of independent directors in relation to exempted transactions to address a general problem with conflicts of interest between a fund and its adviser – satisfied the standards of the APA.
  
• Not complying with its obligation under the Investment Company Act to consider whether those conditions “will promote efficiency, competition, and capital formation.” The court concurred with the Chamber of Commerce, and concluded that the SEC failed adequately to consider the costs imposed on funds by each of the conditions. With regard to the 75% independent director condition, the SEC had claimed it did not have a reliable basis for determining how funds would chose to satisfy the condition, making it difficult to determine the costs associated with electing independent directors. With regard to the independent chairman condition, the SEC had claimed it had no reliable basis for estimating the costs associated with hiring staff for an independent chairman. The court determined that the SEC had a statutory obligation to determine as best it could the economic implications of the rule amendments.
  
• Failing to consider reasonable alternatives to the independent chairman condition. The court concurred with the Chamber of Commerce and concluded that the SEC failed to consider a disclosure alternative proposed by dissenting SEC Commissioners Cynthia Glassman and Paul Atkins, which would require a fund prominently to disclose whether it has an inside or an independent chairman, thereby allowing investors to make an informed choice.

The court granted in part the Chamber’s petition and remanded the matter to the SEC “to address the deficiencies with the 75% independent director condition and the independent chairman condition.”

U.S. Chamber of Commerce v. SEC, D.C. Cir., No. 04:1300, June 21, 2005

The ICI has filed a comment letter with the SEC on a proposed new rule under the Exchange Act that would define the term “nationally recognized statistical rating organization” (“NRSRO”). The letter supports the adoption of a formal definition of “NRSRO.” The letter notes, however, that the proposal does not enhance the SEC’s current regulatory structure and oversight of NRSROs and, in fact, may diminish the SEC’s oversight by eliminating the need for credit rating agencies to seek no-action letters in order to be designated as NRSROs. Absent SEC authority to impose a more stringent regulatory structure over NRSROs, the letter recommended that the SEC continue to require that credit rating agencies obtain NRSRO designation through the no-action process. At the same time, in order to facilitate competition among credit rating agencies, the letter recommended that the SEC institute several changes to the current no-action process.

Specifically, the ICI stated that it:

• supports the establishment of a time period within which SEC staff would act on credit rating agency no-action requests for NRSRO status; and
• supports allowing credit rating agencies that confine their activities to limited sectors of the debt market or to limited geographic areas to be deemed an NRSRO.

 The letter states that these changes would significantly improve the current no-action process and facilitate competition for credit rating agencies, while at the same time ensuring that there is the minimum amount of NRSRO oversight necessary to ensure adequate investor protections and an efficient NRSRO process. The letter also recommends that the SEC consider, as an additional factor for assessing whether a credit rating agency meets the proposed NRSRO definition, the level of disclosure of these procedures to investors.

ICI Memorandum No. 18936 (June 10, 2005)

On June 9, 2005, the SEC issued a release adopting rules under Regulation NMS and amendments to the joint industry plans for disseminating market information.
The new rules redesignate the national market system rules previously adopted under Section 11A of the Securities Exchange Act of 1934 (the “Exchange Act”) and consolidate them into a single regulation, Regulation NMS. In addition, the new regulations address the following substantive areas:

Order Protection. Rule 611, referred to as the “Order Protection Rule” (previously referred to as the “Trade-Through Rule”) requires trading centers to obtain the best price for investors when such price is represented by automated quotations that are immediately accessible. Specifically, the Order Protection Rule:

• requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs, and, if relying on one of the rule’s exceptions, which are reasonably designed to assure compliance with the exception.
  
• protects the best bids and offers of each exchange, Nasdaq, and the NASD’s alternative display facility.
  
• includes a number of exceptions to help ensure that the rule is workable with high-volume stocks and that relate to, among others, intermarket sweep orders, quotations displayed by markets that fail to meet the response requirements for automated quotations, and flickering quotations with multiple prices displayed in a single second.

 The Order Protection Rule does not contain a general “opt-out” exception that would allow market participants to disregard displayed quotations. The SEC release stated that the elimination of any protection for manual quotations is the principal reason that this broad exception is not included in the rule being considered for adoption. Moreover, the Order Protection Rule does not change a broker-dealer’s existing duty to obtain best execution for customer orders.

Intermarket Access. Rule 610, referred to as the “Access Rule” establishes a uniform market access requirement that would promote non-discriminatory access to quotations displayed by self-regulatory organizations’ (“SRO”) trading centers through a private linkage approach. The Access Rule is intended to harmonize the pricing of quotations across different trading centers by limiting the fees that any trading center could charge for accessing protected quotations or manual quotations that are at the best bid or offer, to no more than $0.003 per share (or, if the price of a protected quotation is less than $1.00, to no more than 0.3% of the quotation price per share). The Access Rule requires each SRO to establish and enforce rules that, among other things, prohibit its members from engaging in a pattern or practice of displaying quotations that lock or cross the protected quotations of other trading centers.

Sub-Penny Pricing. Rule 612, referred to as the “Sub-Penny Rule” prohibits market participants from displaying, ranking, or accepting quotations in NMS stocks that are priced in an increment of less than $0.01, unless the price of the quotation is less than $1.00. If the price of the quotation is less than $1.00, the minimum increment would be $0.0001. This rule is intended to prevent sub-penny pricing from being used to “step-ahead” of customer limit orders for an economically insignificant amount which could, over time, discourage investors from placing limit orders, an important source of market liquidity.

Market Data. Regulation NMS updates the “Market Data Rules” formulas for allocating revenues generated by market data fees to the various SROs to correct the flaws of the current formulas, which may contribute to distortive behavior such as wash sales and trade shredding, and to allocate revenues to SROs that contribute to public price discovery by dividing market data revenues equally between trading and quoting activity. The amendments also require the SRO committees governing the market data consolidation systems to create advisory committees composed of non-SRO representatives to the joint industry plans. The advisory committees are intended to improve the transparency and effective operation of the plans by broadening participation in plan governance. Finally, the rule promotes the wide availability of market data by authorizing markets to distribute their own data independently (while still providing their best quotations and trades for consolidated dissemination through the plans) and streamlining requirements for the display of market data to investors.

Compliance Dates

The SEC acknowledged that significant systems and other changes may be necessary to implement certain of the new regulatory requirements and established delayed compliance dates for those regulatory requirements. Accordingly, new rules 610 and 611 will be phased in through September 1, 2006. The compliance date for the remaining new regulations and amendments (i.e., rule 612, the amendment to Rule 301 of Regulation ATS, amendments to the Market Data Rules and certain related plans, and the redesignation of the NMS rules as Regulation NMS) is 60 days after publication in the Federal Register.

Dissent

The release adopting the rules and amendments under Regulation NMS was accompanied by a dissent of Commissioners Cynthia A. Glassman and Paul S. Atkins, who expressed concerns about the potential impact on competition and innovation as a result of Regulation NMS.

Regulation NMS; SEC Rel. No. 34-51808; File No.: S7-10-04 (June 9, 2005)

On June 9, 2005, the SEC issued a release adopting rules under Regulation NMS and amendments to the joint industry plans for disseminating market information.
The new rules redesignate the national market system rules previously adopted under Section 11A of the Securities Exchange Act of 1934 (the “Exchange Act”) and consolidate them into a single regulation, Regulation NMS. In addition, the new regulations address the following substantive areas:

Order Protection. Rule 611, referred to as the “Order Protection Rule” (previously referred to as the “Trade-Through Rule”) requires trading centers to obtain the best price for investors when such price is represented by automated quotations that are immediately accessible. Specifically, the Order Protection Rule:

• requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs, and, if relying on one of the rule’s exceptions, which are reasonably designed to assure compliance with the exception.
  
• protects the best bids and offers of each exchange, Nasdaq, and the NASD’s alternative display facility.
  
• includes a number of exceptions to help ensure that the rule is workable with high-volume stocks and that relate to, among others, intermarket sweep orders, quotations displayed by markets that fail to meet the response requirements for automated quotations, and flickering quotations with multiple prices displayed in a single second.

 The Order Protection Rule does not contain a general “opt-out” exception that would allow market participants to disregard displayed quotations. The SEC release stated that the elimination of any protection for manual quotations is the principal reason that this broad exception is not included in the rule being considered for adoption. Moreover, the Order Protection Rule does not change a broker-dealer’s existing duty to obtain best execution for customer orders.

Intermarket Access. Rule 610, referred to as the “Access Rule” establishes a uniform market access requirement that would promote non-discriminatory access to quotations displayed by self-regulatory organizations’ (“SRO”) trading centers through a private linkage approach. The Access Rule is intended to harmonize the pricing of quotations across different trading centers by limiting the fees that any trading center could charge for accessing protected quotations or manual quotations that are at the best bid or offer, to no more than $0.003 per share (or, if the price of a protected quotation is less than $1.00, to no more than 0.3% of the quotation price per share). The Access Rule requires each SRO to establish and enforce rules that, among other things, prohibit its members from engaging in a pattern or practice of displaying quotations that lock or cross the protected quotations of other trading centers.

Sub-Penny Pricing. Rule 612, referred to as the “Sub-Penny Rule” prohibits market participants from displaying, ranking, or accepting quotations in NMS stocks that are priced in an increment of less than $0.01, unless the price of the quotation is less than $1.00. If the price of the quotation is less than $1.00, the minimum increment would be $0.0001. This rule is intended to prevent sub-penny pricing from being used to “step-ahead” of customer limit orders for an economically insignificant amount which could, over time, discourage investors from placing limit orders, an important source of market liquidity.

Market Data. Regulation NMS updates the “Market Data Rules” formulas for allocating revenues generated by market data fees to the various SROs to correct the flaws of the current formulas, which may contribute to distortive behavior such as wash sales and trade shredding, and to allocate revenues to SROs that contribute to public price discovery by dividing market data revenues equally between trading and quoting activity. The amendments also require the SRO committees governing the market data consolidation systems to create advisory committees composed of non-SRO representatives to the joint industry plans. The advisory committees are intended to improve the transparency and effective operation of the plans by broadening participation in plan governance. Finally, the rule promotes the wide availability of market data by authorizing markets to distribute their own data independently (while still providing their best quotations and trades for consolidated dissemination through the plans) and streamlining requirements for the display of market data to investors.

Compliance Dates

The SEC acknowledged that significant systems and other changes may be necessary to implement certain of the new regulatory requirements and established delayed compliance dates for those regulatory requirements. Accordingly, new rules 610 and 611 will be phased in through September 1, 2006. The compliance date for the remaining new regulations and amendments (i.e., rule 612, the amendment to Rule 301 of Regulation ATS, amendments to the Market Data Rules and certain related plans, and the redesignation of the NMS rules as Regulation NMS) is 60 days after publication in the Federal Register.

Dissent

The release adopting the rules and amendments under Regulation NMS was accompanied by a dissent of Commissioners Cynthia A. Glassman and Paul S. Atkins, who expressed concerns about the potential impact on competition and innovation as a result of Regulation NMS.

Regulation NMS; SEC Rel. No. 34-51808; File No.: S7-10-04 (June 9, 2005)

A subcommittee of the House Judiciary Committee conducted a hearing June 7, 2005 to hear from state and federal regulators, the Government Accountability Office, and a Stanford University business professor about trading abuses in mutual fund shares. The Subcommittee on Commercial and Administrative Law, chaired by Representative Chris Cannon (R-Utah), held the hearing, which included testimony from Eric Zitzewitz, assistant professor of Strategic Management in the Graduate School of Business at Stanford University and author of the paper “Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds” (October 2002); Lori Richards, director of the SEC’s Office of Compliance Inspections and Examinations; William Galvin, secretary of the Commonwealth of Massachusetts; and Richard Hillman, Government Accountability Office’s (“GAO”) Director of Financial Markets.

The hearing focused on the GAO’s two recent investigations into the failure of the SEC to uncover mutual fund trading fraud abuses. The GAO initiated these investigations at the request of House Judiciary Committee Chairman Sensenbrenner and Ranking Member Conyers. The GAO studies found that the SEC failed to uncover “one of the most widespread and serious scandals in the history of the mutual fund industry” because it believed that market timing was not a high risk area for examination. The GAO also found that, prior to September 2003, the SEC did not examine mutual fund companies for trading abuses such as market timing violations because agency staff viewed other activities as representing higher risks and believed that companies had financial incentives to establish effective controls. The GAO concluded as follows:

• First, by conducting independent assessments of controls in areas such as market timing (through interviews, reviews of exception reports, reviews of independent audit reports, or transaction testing as necessary), the SEC could reduce the risk that violations may go undetected.
  
• Second, the SEC could further develop its capacity to identify and evaluate evidence of potential risk (for example, academic studies completed between 2000 and 2002 identified certain market timing concerns as a persistent risk to mutual fund customers).
  
• Third, ensuring the independence of company compliance staff is critical and SEC staff could better assess company risks and controls through routine interactions with such staff.

The GAO determined that while the SEC has taken several steps to strengthen its mutual fund oversight program and the operations of mutual fund companies, it is too soon to assess the effectiveness of several key initiatives. For example, the SEC has instructed its staff to make additional assessments of company controls and established a new office to identify and assess potential risks. The SEC also adopted Rule 38a-1 under the Investment Company Act of 1940, which requires mutual funds to appoint independent compliance officers who must prepare annually written reports on their funds’ policies and violations thereof. However, the SEC has not developed a plan to receive and review these annual reports on an ongoing basis and thereby enhance its capacity to detect potential violations.

In reviewing a sample of enforcement actions brought by the SEC against investment advisers, the GAO found that the SEC followed a consistent process for determining penalties and that it coordinated penalties and other sanctions with interested states. However, the GAO found certain weaknesses in the SEC’s management procedures for making referrals to criminal law enforcement and ensuring staff independence. The GAO noted that the SEC does not require staff to document whether a criminal referral was made or why. The GAO believes that, without such documentation, the SEC cannot readily determine whether the staff made appropriate referrals.

In conclusion, the GAO reports recommend that the SEC develop a plan to review annual compliance reports on an ongoing basis and document criminal referrals and the post- employment plans of departing staff. According to the GAO report, the SEC generally agreed to implement these recommendations.

GAO, “SEC Mutual Fund Oversight Positive Actions Are Being Taken, But Regulatory Challenges Remain,” GAO-05-692T (June 7, 2005); Securities Law Daily, ISSN 1524-7902 (June 7, 2005).

One June 1, 2005, the DOL and the SEC jointly published “tips” to assist fiduciaries of employee benefit plans in reviewing conflicts of interest of pension consultants. According to the Employee Benefits Security Administration (“EBSA”), the tips are designed to “help plan fiduciaries evaluate the objectivity of advice and recommendations furnished by their pension consultants.” An investment adviser registered under pursuant to the Investment Advisers Act of 1940, in providing consulting services, has a fiduciary duty to provide disinterested advice and disclose any material conflicts of interest to its clients.

The tips provide relevant questions the SEC and EBSA believe plan fiduciaries should ask to encourage better disclosure and information relating to potential areas of conflicts of interest by pension consultants. The guidance, entitled “Selecting and Monitoring Pension Consultants – Tips for Plan Fiduciaries,” addresses questions raised by an SEC staff report on potential conflicts of interest disclosures by pension consultants. Topics covered by the suggested questions include the following:

• whether the consultant is registered with the SEC or a state regulator,
  
• whether there are any financial relationships between the consultant and any money manager,
  
• whether the consultant receives payments from a money manager for recommendations,
  
• use of the plan’s brokerage commission to pay consulting fees, and
  
• whether the consultant believes it is in a fiduciary relationship to the plan.

The report by the SEC Office of Compliance Inspections and Examinations indicates that such potential conflicts of interest may affect the objectivity of the advice pension consultants are providing to their pension plan clients. According to Susan F. Wyderko, Director of the SEC Office of Investor Education and Assistance, “these questions should help plan trustees navigate among the many choices in pension consultants and make informed choices that are beneficial to plan participants.”

The tips are available on the websites of the EBSA at http://www.dol.gov/ebsa or the SEC at http://www.sec.gov/investor/pubs/sponsortips.htm. SEC Release No. 2005-81 (June 1, 2005).

The Department of Labor (“DOL”) issued an advisory opinion on May 11 addressing the situation where an adviser counsels retirement plan clients to invest in the adviser’s affiliated mutual funds as well as other funds. The DOL opined that an investment in affiliated funds would be permissible under ERISA if the adviser’s fees from the retirement plan were reduced by the amount of any fees that the adviser received because of the investment in the affiliated funds. The opinion referenced and reaffirmed an earlier DOL opinion discussing fee offsets in the context of 12b-1 fees received from mutual funds in which a retirement plan is advised to invest. The advisory opinion does not change existing interpretations of the law, but received a write-up in the New York Times in light of recent attention being given to conflicts of interest relating to retirement plans.

DOL Advisory Opinion 2005-10A (May 11, 2005) (issued to Country Trust Bank); DOL Advisory Opinion Not All It’s Cracked Up To Be, IM Insight News (May 30, 2005); Gretchen Morgenson, “U.S. Cautions Banks On Fees Intended To Steer Retiree Accounts,” N. Y. Times, May 24, 2005 at C1.

In its first published enforcement action, the Public Company Accounting Oversight Board (“PCAOB”) revoked the registration of a public accounting firm and imposed sanctions on the firm’s managing partner and two former partners after finding that they concealed information and submitted false information in connection with a PCAOB inspection. The PCAOB charged that the accounting firm had both prepared and audited the financial statements for two issuers, which is a violation of auditor independence standards under federal law. When the firm was notified of an impending inspection, the partners named in the action concealed the fact that the accounting firm had prepared the financial statements it later audited. The PCAOB also charged that the partners created and back-dated documents and placed them in the firm’s audit files before the inspection to hide that they had not complied with applicable standards when preparing and releasing audit reports for the two issuers. In addition to revoking the firm’s registration, the PCAOB prohibited the firm’s managing partner from associating with a registered accounting firm. Two former partners of the firm received a lesser sanction of censure because they had voluntarily notified the PCAOB of their actions and cooperated in the investigation.

In the Matter of Goldstein and Morris, CPAs, P.C. and Edward B. Morris, CPA, PCAOB Release No. 2005-010 (May 24, 2005); In the Matter of Alan J. Goldberger, CPA and William A. Postelnik, CPA, PCAOB Release No. 2005-011 (May 24, 2005).

Inaccurate budgeting of costs related to the SEC’s new headquarters in Washington, DC and SEC offices in New York and Boston have resulted in an anticipated budget shortfall of approximately $48 million through fiscal year 2007. The errors were discovered in a mid-fiscal year review in late March, and the estimated shortfall was reportedly determined in early May. An SEC official told BNA that the SEC will not seek more funding from Congress to make up for the shortfall, but instead plans to absorb the costs, partly through a slowdown of hiring and a reduction of non-critical expenses.

SEC Expects $48M Budget Shortfall Through FY 2007 Due to Inaccurate Budgeting, BNA Securities Law Daily (May 25, 2005).

A former vice president of institutional sales for an investment adviser settled SEC charges that he aided and abetted an investment adviser’s violations of Sections 206(1) and (2) of the Investment Advisers Act, and Section 34(b) of the Investment Company Act, by striking a deal on behalf of the investment adviser which allowed Canary Capital Partners, Ltd. to execute frequent exchanges in a mutual fund managed by the adviser in exchange for a long-term investment in another fund managed by the adviser. The prospectus of the fund being timed represented that the fund did not permit short-term trading, market timing, or other abusive trading practices. The SEC charged that the officer was aware of these prohibitions, but nonetheless arranged for Canary to time the fund. The SEC determined that the arrangement resulted in additional advisory fees of approximately $131,000 for the adviser. The officer agreed to a six-month suspension from association with any investment adviser and an $11,000 penalty. The investment adviser no longer manages the mutual funds involved in the arrangement, and has withdrawn its registration as an investment adviser.

In re Larry Adams, Investment Advisers Act Release No. 2388 (May 19, 2005).

SEC Chairman William Donaldson announced on Wednesday that he will resign from the Commission effective June 30, 2005. Chairman Donaldson was confirmed in February 2003 and defied expectations by siding with the Commission’s two Democratic commissioners in some of the Commission’s more controversial rulemaking decisions, such as those involving hedge fund adviser regulation and independent chairs for mutual fund boards. Donaldson has weathered significant criticism from some business groups, such as the United States Chamber of Commerce and the Business Roundtable. His announcement caught many by surprise, as he had earlier expressed his intention to stay on through the end of the year.

President Bush acted quickly to replace Donaldson, and on Thursday nominated California Congressman Christopher Cox to serve as Chairman. Representative Cox was elected to Congress in 1988 after serving in the White House Counsel’s office under President Reagan. He was previously a partner at Latham & Watkins. Cox holds both a J.D. and M.B.A. from Harvard University and currently serves as Chairman of the House Committee on Homeland Security. Cox is expected to be confirmed easily.