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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SEC Staff Grants No-Action Relief For Investment Adviser’s De-Registration
June 22, 2006 10:49 AM
The SEC staff will not recommend enforcement action to the Commission under Section 203 of the Investment Advisers Act of 1940 (“Advisers Act”) if an SEC-registered investment adviser that is a wholly owned subsidiary of a public company, and provides investment advisory services solely to employee benefit plans serving employees of the parent company and its other affiliates (the “Plans”), withdraws its registration as an investment adviser. The investment adviser argued that in prior no-action letters, the staff had stated that the provision of investment advisory services solely to employee benefit plans does not constitute being “engaged in the business of providing investment advice to others” for purposes of Section 202(a)(11) of the Advisers Act. In response, the staff distinguished this request from prior letters, noting that (1) unlike the prior letters, in this case the adviser provided investment advisory services to foreign plans that are not subject to the Employee Retirement Income Security Act of 1974 (“ERISA”), as well as plans that are subject to ERISA; and (2) the employer is reimbursed by certain of the plans for the direct costs and expenses of the subsidiary’s advisory services. Nonetheless, the staff said it would not recommend enforce action to the Commission against the adviser under Section 203(a) as a result of its withdrawal as an investment adviser, based particularly on the following representations (1) the adviser is a wholly owned subsidiary of the parent company and was established, and has been operated, for the sole purpose of providing investment advisory services to the Plans; (2) the adviser does not hold itself out to the public as an investment adviser, and provides investment advice only to the Plans; (3) the Plans were established solely for the benefit of employees of the parent company and its affiliates, and comprise employee benefit plans governed by ERISA, foreign employee benefit plans, and plans that consist solely of assets of the employer; (4) the only amounts received by the parent company and the adviser in connection with the Plans are reimbursements that are subject to the restrictions imposed by ERISA; and (5) none of the Plans is required to register as an investment company under the 1940 Act.
Lockheed Martin Investment Management Co., SEC No-Action Letter(June 5, 2006).
SEC Staff Grants No-Action Relief Regarding Qualified Purchasers
June 22, 2006 10:46 AM
The SEC staff agreed that a trust would not be deemed to have been formed for the purpose of acquiring interests in certain private investment funds for purposes of Section 2(a)(51)(A)(iii) of the 1940 Act if those interests were transferred by a limited partnership to the trust in order to permit the orderly liquidation and dissolution of the partnership. The interests were issued by private investment funds relying on Section 3(c)(7) of the 1940 Act for exclusion from the definition of investment company. The interests were held by a limited partnership that itself was a qualified purchaser, and whose term of existence expires in 2010, but whose limited partners included one or more persons who were not qualified purchasers. The staff relied on a number of representations in connection with taking its position, including the following: (1) the activities of the trust would be limited to liquidating the interests in an orderly manner and distributing the proceeds to the trust’s beneficial owners; (2) the trust will terminate upon completion of the liquidation process; (3) the trust’s beneficial owners will be persons who were limited partners at the time of its liquidation and will hold an interest in the trust proportionate to their interests in the limited partnership at the time of its liquidation; and (4) the trust will not allow those limited partners to acquire any additional 3(c)(7) interest.
SCP Private Equity Partners II, L.P., SEC No-Action Letter (June 6, 2006).
SEC Staff Grants No-Action Relief Relating to Fund Mergers
June 22, 2006 10:42 AM
The SEC staff will not recommend enforcement action to the Commission under Section 17(a) of the Investment Company Act of 1940 (“1940 Act”) if a registered investment company (the “dissolving fund”) transfers all of its assets and liabilities to two affiliated funds (the “surviving funds”), notwithstanding the fact that the transaction would not fall within the Rule 17a-8 definition of “merger.” Under the proposed reorganization, the dissolving fund would transfer the small cap growth stock in its portfolio (the “small cap growth segment”) to one surviving fund and would transfer the small cap value stocks in its portfolio (the “small cap value segment”) to another surviving fund in exchange for shares of the two surviving funds, which would then be distributed to the dissolving fund’s shareholders prior to that fund’s dissolution.
The dissolving fund conceded that the proposed reorganization does not, on its face, qualify for conditional relief from the prohibitions of Section 17(a) for mergers of affiliated funds that is available under Rule 17a-8 because, having more than one surviving company, the transaction would not fall within the Rule’s definition of “merger.” However, the dissolving fund noted that the transaction is substantially similar to the “mergers” covered by the rule and that it would otherwise comply with all the conditions of Rule 17a-8.
The SEC staff based its decision not to recommend enforcement action to the Commission on the dissolving fund’s representations that (1) the proposed reorganization would fully comply with Rule 17a-8, other than its failure to meet the Rule’s definition of a merger; and (2) that the proposed reorganization would be approved by the surviving funds’ board of directors and the dissolving fund’s shareholders.
Mutual of American Investment Corp., SEC No-Action Letter (avail. June 2, 2006).
SEC Staff Issues No-Action Letter Relating to Cross Trades With Affiliated Accounts
June 22, 2006 10:39 AM
The SEC staff has taken the position that an investment adviser may cause a private fund in which it or its controlling persons have, in the aggregate, a 25% or less ownership interest to engage in cross trades with client accounts without complying with the disclosure and consent requirements of Section 206(3) of the Investment Advisers Act of 1940 (“Advisers Act”). In this case, the adviser represented that its general partner controlled the adviser and held an ownership interest in each of two private funds. The adviser asserted that Section 206(3) should not apply to cross transactions between those private funds and other client accounts, because the general partner’s ownership interest in the two funds was only 6.237% and 1.4405%, respectively.
In response, the staff stated that for purposes of Section 206(3) it would deem the investment adviser to have the same ownership interests in the private funds as its general partner because the general partner controls the adviser. The staff further stated that an investment adviser may be acting as principal for its own account for purposes of Section 206(3) in effecting transactions involving the account, depending on the aggregate ownership by the adviser and its controlling person(s) in the account. The staff then stated that as a general matter it believes that Section 206(3) would not apply to a cross transaction between a client account and account in which the investment adviser and its controlling persons, in the aggregate, hold 25% or less. Notably, however, the staff also stated that such a transaction (where the adviser has a 25% or less interest) still may present conflicts of interest that would implicate Advisers Act Sections 206(1) and 206(2).
Gardner Russo & Gardner, SEC No-Action Letter (June 7, 2006).
NASD Offers Course on the Sales Practice Responsibilities Associated With Hedge Funds
June 16, 2006 11:12 AM
The NASD announced the availability of an online course that will explore the sales practice obligations that a registered representative must follow when recommending hedge funds and/or funds of hedge funds to retail investors. Key topics covered in the course include providing a balanced disclosure in sales efforts, performing a reasonable-basis suitability determination and performing a customer-specific suitability determination.
NYSE Issues Information Memo Regarding Directed Brokerage
June 16, 2006 11:03 AM
NYSE Regulation, Inc. issued an Information Memo providing guidance to New York Stock Exchange (“NYSE”) members regarding their obligation to refrain from participating in directed brokerage arrangements prohibited by Rule 12b-1 under the Investment Company Act of 1940. That rule prohibits a mutual fund from considering the sale and promotion of its shares as a factor in the selection of executing brokers for the fund’s portfolio transactions ("Executing Brokers") or using commissions from its portfolio transactions to provide additional compensation to brokers that promote or sell fund shares ("Selling Brokers"). The Information Memo notes that, while a NYSE member firm may act as both an Executing Broker and Selling Broker for a fund, the member firm must be diligent with respect to its obligation not to accept directed brokerage, pursuant to NYSE Rules 401 and 476(a)(6). The Information Memo then identifies the following steps a member firm acting as both an Executing Broker and a Selling Broker should take in fulfillment of this obligation: (1) perform reasonable due diligence of the fund, including obtaining written representations from the fund that it has policies and procedures to ensure that no directed brokerage arrangements will arise and that it uses reasonable criteria in the selection of its Selling Brokers; (2) establish policies and procedures that strictly prohibit receipt of directed brokerage, designate supervisory personnel to conduct reviews to detect any correlation between fund sales and directed brokerage commissions suggesting an arrangement in violation of Rule 12b-1, and require employees to report any information with respect to proposed or existing directed brokerage arrangements; (3) appropriate training of marketing, sales and trading desk staff; and (4) fully and promptly review any allegations or information suggesting the existence of an improper directed brokerage arrangement, and determine whether such information should be reported to regulators.
Directed Brokerage Arrangements, NYSE Regulation Information Memo 06-38, June 1, 2006.
SEC Sanctions 15 Broker-Dealer Firms
June 16, 2006 11:00 AM
The SEC settled an administrative proceeding against fifteen broker-dealer firms for allegedly engaging in a variety of practices related to auction rate securities without adequately disclosing such practices to investors, in violation of Section 17(a)(2) of the 1933 Act. According to the SEC, each of the firms engaged in one or more of the following activities, in violation of Section 17(a)(2): (1) allowing customers to place open or market orders in auctions, which in certain circumstances advantaged such investors by displacing other investors’ bids and/or affected the clearing rate; (2) intervening in auctions by bidding for its own propriety accounts without adequate disclosure; (3) placing bids in order to either prevent failed auctions, set a “market” rate, or to prevent all-hold auctions without adequate disclosure; (4) allowing customers to submit or change orders after auction deadlines; (5) prioritizing customers’ bids prior to submitting them to the auction agent without accurate disclosure; (6) allowing certain investors to decline to purchase partially-filled orders intended to be irrevocable; (7) tacitly agreeing to provide certain customers with returns higher than the auction clearing rate; and (8) providing certain customers with information that gave them an advantage over other customers in determining what rate to bid. The settling firms neither admitted nor denied the SEC’s findings, and consented to an order providing for a censure, an order to cease and desist form violating Section 17(a)(2), an undertaking to provide disclosures about their material auction practices and procedures to customers, and more than $13 million in penalties, in the aggregate.
In the Matter of Bear, Stearns & Co. Inc.; Citigroup Global Markets, Inc.; Goldman, Sachs & Co.; J.P. Morgan Securities, Inc.; Lehman Brothers Inc.; Merrill Lynch, Pierce, Fenner & Smith Incorporated; Morgan Stanley & Co. Incorporated and Morgan Stanley Dw Inc.; RBC Dain Rauscher Inc.; Banc of America Securities LLC; A.G. Edwards & Sons, Inc.; Morgan Keegan & Company, Inc.; Piper Jaffray & Co.; Suntrust Capital Markets Inc.; and Wachovia Capital Markets, LLC,Securities Act Release No. 8684 (May 31, 2006).
SEC Announces It Will Replace Many Paper Effectiveness Orders with Electronic Notifications of Effectiveness
June 16, 2006 10:58 AM
The SEC announced that the Divisions of Corporation Finance and Investment Management will begin to use the EDGAR system to issue notifications of effectiveness for registration statements filed under the Securities Act of 1933 (“1933 Act”) and post-effective amendments thereto, and will no longer prepare and mail paper effectiveness orders associated with these filings. The SEC said that registrants will continue to be notified promptly by telephone that their registration statements or post-effective amendments are effective. The electronic notifications will be posted to the Edgar system the morning after a filing is determined to be effective. In addition, the SEC has begun, as announced, to post on its website a list of filings declared effective on the previous business day. Orders relating to applications for registration as a transfer agent or as a municipal securities dealer also will be supplemented by electronic notifications through EDGAR.
SEC Press Release No. 2006-61 (April 25, 2006), available at http://www.sec.gov/news/press/2006/2006-61.htm. The list of filings declared effective can be found at http://www.sec.gov/cgi-bin/browse-edgar?action=geteffect.
SEC Staff Congressional Testimony Concerning Hedge Funds
June 16, 2006 10:53 AM
Susan Wyderko, formerly Acting Director of the Division of Investment Management, testified before a Senate subcommittee about hedge funds, their role in the securities markets and the role of the SEC in the oversight of hedge funds. With respect to the SEC's role, Ms. Wyderko focused on fiduciary obligations, market abuse and risks to broker-dealers. She said that, as investment advisers (whether registered or unregistered) under the Investment Advisers Act of 1940, hedge fund managers have a duty "to place the interests of the hedge fund and its investors first, or at least fully disclose any material conflict of interest the manager may have with the fund and its investors." She reported that, as of the end of April, there were approximately 2,500 hedge fund managers registered with the SEC as investment advisers. Ms. Wyderko also discussed the application of the SEC's examination program to hedge fund advisers. She identified the following as areas of focus in hedge fund adviser examinations: (1) side-by-side management of hedge funds and other types of accounts, (2) side letters with certain investors, (3) valuation of fund assets and (4) custody of fund assets. She also discussed SEC enforcement actions against hedge fund advisers and hedge funds' use of prime brokers for clearing and related services and for secured financing, as well as the SEC's focus on the exposure of broker-dealers to hedge fund risks.
Susan Ferris Wyderko, Testimony Concerning Hedge Funds before the Subcommittee on Securities and Investment of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, (May 16, 2006), available at http://www.sec.gov/news/testimony/ts051606sfw.htm
SEC Selects Andrew Vollmer as SEC Deputy General Counsel
June 16, 2006 10:51 AM
On June 5, 2006, the Securities and Exchange Commission (“SEC”) announced that WilmerHale partner Andrew N. Vollmer will become the agency’s Deputy General Counsel. Mr. Vollmer succeeds Meyer Eisenberg, who retired from the Commission in January.
SEC Press Release No. 2006-86 (June 5, 2006), available at: http://www.sec.gov/news/press/2006/2006-86.htm