Investment Management Industry News Summary - March 2005

Investment Management Industry News Summary - March 2005

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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MSRB Proposes Rule Prohibiting Payment of Solicitors

March 25, 2005 2:19 PM
The MSRB has proposed amendments to Rule G-38, which would prohibit brokers, dealers, and municipal securities dealers from paying persons who are not affiliated with the dealers for soliciting municipal securities business on their behalf. Thus, payments for solicitations would only be permitted to be paid to affiliated persons of the brokers and dealers, including partners, directors, officers and employees.

The MSRB Rule proposal, which has been filed with the SEC, will replace existing Rule G-38 in its entirety. Currently, the rule regulates, but does not prohibit, the use and payment of consultants in connection with obtaining municipal securities business, including business related to Section 529 college savings plans. However, the MSRB has grown concerned about certain practices that it believes could affect the integrity of the municipal securities market, including significant recent increases in the number of consultants being used, the amount of compensation paid to consultants, and political contributions by consultants. The MSRB also noted the limits on its jurisdiction and the need for voluntary action by unregulated entities (such as financial advisers, lawyers, and swap participants) to address concerns about political contributions and other payments benefiting public officials and the contract award process.

MSRB Notices 2005-17 (March 17, 2005) and 2005-16 (March 15, 2005).
 
 



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.

House Committee Approves Legislation Regarding Fund and Insurance Sales to Members of the Military

March 25, 2005 2:15 PM
The House Financial Services Committee approved the Military Personnel Financial Services Protection Act (H.R. 458), which would prohibit the sale of contractual mutual funds to military personnel and clarify that state insurance commissioners have the authority to regulate the sale of insurance products on military bases within their borders and overseas. The Act also would require that sellers of private life insurance inform members of the military about life insurance options available from the federal government prior to selling them any life insurance contracts. Similar legislation passed the House last year, but the Senate did not act on it.

House Panel Clears Bill Aimed at Ending Abusive Fund Sales to Military, BNA Securities Law Daily, March 17, 2005.
 
 



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 Fines Broker-Dealer For Market Timing Violations

March 25, 2005 2:12 PM
The NASD fined a broker-dealer $325,000 for allegedly failing to have an adequate supervisory system in place to prevent market timing in subaccounts of certain variable universal life insurance policies. The broker-dealer is the exclusive distributor of these policies, which are issued by an affiliated insurance company. The broker-dealer also was required to pay approximately $238,000 in restitution to the affected funds.

This apparently was the NASD’s first enforcement action relating to market timing in variable universal life insurance policy sub-accounts. Although the broker-dealer had an electronic system designed to recognize and block excessive trading, the NASD asserted that it had never determined whether the system was functional. The NASD said that the broker-dealer relied on this system exclusively to monitor sub-account transfers, and therefore had a duty to follow-up and review its functionality. The NASD said that because the system was not functional, certain policyholders were permitted to exceed the 20-transfers-per-policy-year limit set by the policies’ prospectus.

Separately, an affiliate of this broker-dealer was fined $125,000 for allegedly failing to maintain and preserve all internal e-mail communications of certain of its registered persons for the required three-year period. The broker’s e-mail system allegedly purged these e-mails automatically after 60 days.

Jefferson Pilot to Pay Over $500,000 in First VUL Market Timing Action; NASD Also Fines Affiliate $125,000 for E-Mail Retention Violations, NASD News Release, March 16, 2005.
 
 



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.

No-Action Letter Regarding Status of a Deferred Compensation Plan

March 25, 2005 2:10 PM
The SEC Staff said that it would not recommend enforcement action under Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 if a company did not register a deferred compensation plan for certain of its and its subsidiaries’ employees as an investment company. The plan is a “top hat” plan under which eligible employees may defer a portion of their annual bonuses or commissions. The amounts deferred would become general assets of the company. The company would, for recordkeeping purposes, establish a notational deferred compensation account for each participant in the plan reflecting all amounts owed to the participant, and these accounts would be adjusted to reflect contributions and investment returns.

Participants may designate certain performance benchmarks against which the company will measure its obligations to each participant. The benchmarks would be selected by the company, and could include investment funds excluded from the definition of investment company by Sections 3(c)(1) or 3(c)(7). The company could choose to invest in the underlying performance benchmarks with its own assets, but any such investments would not belong to any particular participant.

The company said that it may establish a “rabbi trust” to hold the investments, but that the amounts held in the rabbi trust would remain subject to the claims of the company’s general creditors. Participants would be treated as general unsecured creditors of the company.

Based on these facts, the Staff concluded that the company, and not the plan or the rabbi trust, was the issuer of the interests in the plan, because neither the plan nor the rabbi trust would be a pool of assets legally segregated from the company’s assets. The Staff also agreed with the company that the interests in the plan would not be face-amount certificates, because the amount of the payment obligations of the Company would be undeterminable and would fluctuate depending on the performance of the investment benchmarks.

More significantly, the Staff agreed that unregistered investment funds would not lose their status under Section 3(c)(1) of Section 3(c)(7) merely because they are used as benchmarks under the plan. The Staff concluded that participants in the plan should not be deemed to be “beneficial owners” of the 3(c)(1) or 3(c)(7) funds, because the interests in the funds would be purchased only by the company in its discretion, and not as a result of the exercise of investment authority or direction by the participants. The Staff also noted that neither the company, the plan, nor the rabbi trust was or would be formed for the purpose of investing in a particular Section 3(c)(1) or 3(c)(7) fund. Other conditions to the relief were that the company would select and retain benchmarks in accordance with ERISA’s prudence requirements (even though the Plan is intended to be exempt from ERISA), and that the company would not condition the inclusion of a particular Section 3(c)(1) or 3(c)(7) fund as a benchmark on the fund’s use of the company as a prime broker.

The Goldman Sachs Group Inc., SEC No-Action Letter (avail. Mar. 8, 2005).
 
 



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 Publishes Adopting Release for New Redemption Fee Rule

March 25, 2005 2:08 PM
As discussed in the March 4, 2005 edition of the Investment Management Industry News Summary, the SEC has adopted final Rule 22c-2 under to the Investment Company Act of 1940. Rule 22c-2 makes it unlawful for any fund that issues redeemable securities, or any principal underwriter or dealer in such securities, to redeem such securities within seven calendar days after they were purchased unless the board of directors, including the independent directors, has either (i) approved a redemption fee of up to 2% of the value of the shares redeemed during any period of at least seven days, or (ii) determined that imposing such a redemption fee is not necessary or appropriate. The adopting release says that decisions regarding whether and how to impose a redemption fee should be based on the judgment of the fund’s directors, “rather than on a strict assessment of administrative and processing costs, which can be difficult to estimate and may vary from period to period.” Funds must comply with this and other requirements of the rule by October 16, 2006.

SEC staff no-action letters regarding redemption fees have been terminated. The release did not specify whether the termination of those no-action positions is effectively immediately, or whether those positions would remain effective until the compliance date.

Another significant requirement of Rule 22c-2 is that a fund or its principal underwriter must enter into a written agreement with each financial intermediary of the fund. The financial intermediaries must agree to (i) provide promptly upon request by the fund certain information about all customers of the intermediary who purchase, redeem, exchange or transfer fund shares, including taxpayer identification numbers and transaction information, and (ii) execute any instructions from the fund to restrict or prohibit further purchases or exchanges of fund shares by a shareholder identified as violating the fund’s policies intended to combat dilution. In other words, intermediaries will be forced to share information with the funds to help the funds identify shareholders who violate their market timing policies and oversee the intermediaries’ assessment of any redemption fees. The adopting release noted that the definition of “financial intermediary” was changed from the proposal. As adopted, the term financial intermediary encompasses all brokers, dealers, banks, or other entities that hold securities in nominee name; unit investment trusts or funds that are part of variable insurance product structures and other fund of funds arrangements under Section 12(d)(1)(E); and administrators and recordkeepers of a participant-directed employee benefit plan.

Money market funds, funds whose shares are listed on a national securities exchange, and funds that expressly permit short-term trading are not required to comply with Rule 22c-2.

Finally, the SEC requested further comment as to whether it should adopt a uniform redemption fee for funds that decide to implement such a fee, and if so what the terms of such a uniform fee should be. The comment deadline is May 9, 2005.

Mutual Fund Redemption Fees, Investment Company Act Release No. 26782 (March 11, 2005).
 
 



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.

NYSE and NASD Rule Proposals Regarding Research Analysts

March 25, 2005 1:53 PM
The SEC has published for public comment proposed amendments to NYSE Rule 472 and NASD Rule 2711, which prohibit research analysts from participating in certain activities aimed at securing investment banking business. The proposed amendments would further limit research analysts’ participation in investment banking activities by prohibiting them from participating in road shows related to an investment banking services transaction, and from communicating with current or prospective clients about an investment banking transaction while in the presence of investment banking personnel or company management. The proposals also will require that any communication that a research analyst does have with a current or prospective client about such transactions be fair, balanced, and not misleading.

Additionally, the proposed amendments would prohibit investment banking personnel from directing a research analyst to engage in sales or marketing efforts or other communications with a current or prospective client about an investment banking services transaction.

Notice of Filing of Proposed Rule Changes by the New York Stock Exchange, Inc. and the National Association of Securities Dealers, Inc. to Prohibit Participation by a Research Analyst in a Road Show Related to an Investment Banking Services Transaction and to Require Certain Communications About an Investment Banking Services Transaction to be Fair, Balanced and Not Misleading, Securities Exchange Act Release No. 51358 (March 10, 2005).
 
 



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

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

Federal District Court Dismisses State Law Class Action Suit As Preempted By Federal Statute

March 18, 2005 2:45 PM
The U.S. District Court for the Southern District of New York has held that the Securities Litigation Uniform Standards Act (“SLUSA”) preempted a class action complaint brought under New York law. The underlying complaint alleged that a brokerage firm accepted payments from mutual fund families in exchange for recommending those funds.

SLUSA provides that the federal courts are the exclusive venue for class actions alleging fraud in the sale of certain covered securities and requires that such class actions be governed by federal law. A state court action can be removed and dismissed if four requirements are met: (1) the underlying suit must be a “covered class action;” (2) the action must be based on state or local law; (3) the action must concern a “covered security; and (4) the defendant must have misrepresented or omitted a material fact or employed a manipulative or deceptive device or contrivance “in connection with the purchase or sale of” that security.

The plaintiff contended that the payments in question were not in connection with the purchase or sale of a security, and that therefore the complaint was properly brought in state court. Federal courts generally have concluded that such a “holders suit” is impermissible under SLUSA unless the plaintiff's complaint specifically excludes all claims related to the purchase or sale of securities during the period alleged. The court found that the claims set forth in the complaint were “inextricably intertwined” with purchases and sales of securities, and dismissed the action as preempted under SLUSA. The court, however, permitted the plaintiff to replead his complaint by excluding from it all class members who purchased shares of the named mutual funds during the period of time covered by the complaint.

Atencio v. Smith Barney, 2005 WL 267556 (S.D.N.Y. 2005).
 
 



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.

Plaintiffs May Not Use Statistical Probability to Establish Standing

March 18, 2005 2:43 PM
The Fifth Circuit Court of Appeals has held that investors who purchased securities in the aftermarket may not use statistical probability to prove that the securities they purchased are traceable to securities that were sold based on allegedly misleading offering documents. The Appeals Court stated that using statistical probability to satisfy the tracing requirement and establish standing would contravene Section 11 of the Securities Act of 1933 (“1933 Act”).

The plaintiffs had brought their action against the issuer and other parties under Sections 11 and 15 of the 1933 Act alleging that the issuer’s registration statements, filed in connection with an initial public offering and a secondary offering, were materially misleading. The federal district court, however, had concluded that the plaintiffs lacked standing to bring the action because they could not trace the securities they purchased in the aftermarket to the registration statements in question. These plaintiffs purchased stock at a time when less than 100% of the publicly traded stock was from the IPO or the secondary offering, due to insider sales. Although the plaintiffs contended that the stock issued in the IPO and secondary offering constituted over 90% of the shares traded in the market, and therefore there was a very high probability that the stock they purchased was issued in the public offerings, the court ruled that this was insufficient for the plaintiffs to show that all of the securities they held could be traced to the public offering registration statement, and that they therefore lacked standing. The Fifth Circuit Court of Appeals affirmed this position, stating that using statistical probability to prove standing would “impermissibly expand” the 1933 Act’s standing requirements.

Krim v. pcOrder.com, __ F.3d __, 2005 WL 469618 (5th Cir. 2005).
 
 



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.

Market-Timing Case Settled

March 18, 2005 2:40 PM
A broker-dealer agreed to pay a $13.5 million fine to settle a disciplinary proceeding brought by the NYSE alleging that it had failed to supervise representatives who had engaged in market timing of mutual funds. The NYSE censured the firm and imposed the fine, which will be paid to New Jersey, to resolve a related proceeding, and to Connecticut, under a pending settlement.

According to the NYSE’s Exchange Hearing Panel Decision, the firm had notified the NYSE and other regulators that it had discharged three representatives, and reported on Form U-5 filings that the reasons for their discharge related to failure to follow firm policies prohibiting short term trading in mutual fund shares on behalf of clients. After NYSE informed the firm that it was investigating the matter, the firm also told the NYSE that it had fined and disciplined three supervisors of the representatives in question. The NYSE said that although the firm had warned the representatives about their trading activity, the firm failed to recognize or effectively act upon numerous red flags indicating that the representatives were engaged in market timing activity. The NYSE concluded that the firm’s failure to act constituted a failure to supervise the representatives in question in violation of NYSE Rule 342.

Merrill Lynch, Pierce, Fenner & Smith Inc., Exchange Hearing Panel Decision 05-27, March 7, 2005.
 
 



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.

No-Action Relief Regarding Investment Adviser Code of Ethics

March 18, 2005 2:36 PM
The SEC Staff said that it would not object if an insurance company registered as an investment adviser does not comply with Rule 204A-1 or Rule 204-2(a)(12)(iii) under the Investment Advisers Act of 1940 with respect to certain non-advisory personnel. Rule 204A-1 requires each investment adviser to adopt, maintain and enforce a code of ethics that is applicable to its “supervised persons.” Among other things, the rule requires an adviser to require all supervised persons to comply with the code of ethics, provide a copy of the code to each supervised employee, and obtain a written acknowledgement of the person’s receipt of the code. Rule 204-2(a)(12)(iii) requires an adviser to maintain a record of these acknowledgements.

Section 202(a)(25) of the Investment Advisers Act defines “supervised person” to include all of an adviser’s partners, officers, directors and employees, including clerical employees, regardless of their job responsibilities. In this case, however, the insurance company represented that the vast majority of its supervised persons are engaged solely in its insurance businesses, and that these non-advisory personnel have no access to nonpublic information about its investment advisory activities. The company also said it would not count as nonadvisory personnel any supervised person who is involved, directly or indirectly, in its investment advisory activities.

The Staff agreed that non-advisory personnel need not be covered by the adviser’s code of ethics under the facts described in the request. The Staff also said that the term “non-advisory personnel” as used in this letter would exclude persons engaged in solicitation or sales activity related to investment advisory services.

Prudential Insurance Company of America, SEC No-Action Letter (avail. Mar. 1, 2005), available at http://www.sec.gov/divisions/investment/noaction/pru030105.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.

No-Action Relief for Certain Trade Confirmations under Rule 10b-10

March 18, 2005 2:30 PM
In response to a request from the New York Stock Exchange, Inc. (“NYSE”), the Staff said it would not recommend enforcement action under Exchange Act Rule 10b-10 if a broker-dealer sends a single confirmation that reflects the average price and/or multiple capacities in which the broker-dealer acted in multiple executions undertaken to fulfill a single customer order. Although the relief was requested only by the NYSE for its members, the Staff’s response applies to all broker-dealers. The Staff noted that previously it had granted no-action relief to the National Association of Securities Dealers, Inc., the Nasdaq Stock Market, Inc. and NASD members.

The Staff’s position in this letter was subject to the following conditions:

(1) The broker-dealer will average the execution prices of each execution and report the average price per share on the confirmation as the unit price, and note that the confirmed price is an average price and that details of the actual prices are available upon request.

(2) The confirmation must identify each of the capacities in which the broker-dealer acted in executing the order (e.g., “principal” or “agent”), and note that details regarding the capacity in which the broker acted in relation to each execution are available upon request.

(3) The commission, markup, markdown, service fee, and any other remuneration to the broker-dealer will not be detailed separately, but will be stated on the confirmation as a single amount, with a note that more details are available upon request.

(4) The confirmation must include all other information required by Rule 10b-10.

(5) Each individual transaction must be reported separately under applicable trade reporting rules.

(6) The broker must create and maintain all records required under Exchange Act Rules 17a-3 and 17a-4 reflecting the processing and confirmation of these orders and the details of each underlying execution.

Letter from Brian A. Bussey, SEC Division of Market Regulation to Michael Rufino, New York Stock Exchange, Inc., March 3, 2005, available at http://www.sec.gov/divisions/marketreg/mr-noaction/ap030305.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.

No-Action Relief Regarding Financial Statements in Variable Annuity and Variable Life Insurance Registration Statements

March 18, 2005 2:25 PM
The SEC Staff has simultaneously issued four no-action letters stating that it will not object if certain insurance company depositor or sponsor financial statements included in registration statements for variable annuity and variable life insurance contracts are audited in accordance with either the auditing standards of the Public Company Accounting Oversight Board (“PCAOB”) or generally accepted auditing standards issued by the American Institute of Certified Public Accountants Auditing Standards Board (“GAAS”).

The Staff’s position applies only to financial statements of certain mutual insurance companies and other insurance company depositors whose only nexus to the 1934 Act is as depositor of one or more separate accounts that issue variable contracts and are registered as investment companies under the Investment Company Act of 1940 (“Investment Company Act”). Financial statements of insurance company depositors that are, in their own right, Exchange Act filers, must be audited in accordance with PCAOB standards. Financial statements of registered separate accounts that issue variable insurance contracts also must be audited in accordance with PCAOB standards.

The Staff also warned that they are considering a number of recent inquiries as to whether the Sarbanes-Oxley Act requires that the depositors’ financial statements be audited in accordance with PCAOB standards. The Staff stated that the no-action relief granted in these letters should not be read as representing a legal conclusion on this issue.

Staff Letters Regarding Auditing Standards for Financial Statements of Insurance Company Depositors of Variable Insurance Products, March 8, 2005, available at http://www.sec.gov/divisions/investment/letters030805.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.

Banks Have More Time to Comply with Broker Registration Requirements

March 18, 2005 2:21 PM
Banks, savings associations and savings banks falling within the Securities Exchange Act of 1934 (“Exchange Act”) definition of “broker” or “dealer” now have until September 30, 2005 to comply with registration requirements enacted under the Gramm-Leach-Bliley Act (“GBLA”). GLBA repealed the Exchange Act’s blanket exceptions for banks, and added provisions requiring banks that engage in securities activities to either conduct those activities through a registered broker-dealer or ensure that the activities fall within the terms of an exception.

The SEC issued interim rules in 2001 to define certain terms used in, and grant certain exemptions from, the amended definitions of broker and dealer, as well as to give banks more time to comply with the new registration requirements. The SEC also extended the provisions to savings associations and savings banks. The SEC delayed the effective date of the bank “broker” rules until March 31, 2005.

Then, in 2004, the SEC proposed Regulation B to replace the interim rules. Although the comment period on proposed Regulation B expired on September 1, 2004, the SEC said that it is still considering the comments it received, a process that will not be completed by the March 31, 2005 effective date for the bank broker rules. This led the SEC to extend the temporary exemption for banks, savings associations and savings banks from the Exchange Act’s definition of “broker” until September 30, 2005.

Order Extending Temporary Exemption of Banks, Savings Associations, and Savings Banks from the Definition of “Broker” under Section 3(a)(4) of the Securities Exchange Act of 1934, Securities Exchange Act Release No. 51328 ( March 8, 2005).
 
 



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.

IRS Finalizes Diversification Requirements for Variable Contracts

March 11, 2005 3:03 PM
The IRS has issued final regulations that remove a rule that applied specifically to unregistered partnerships for purposes of testing diversification under section 817(h) of the Internal Revenue Code (the “Code”). Under Section 817(h) of the Code, a variable contract based on a segregated asset account does not receive the same favorable tax treatment as an annuity, endowment, or life insurance contract unless the segregated asset account is adequately diversified. For purposes of testing diversification, the regulations permit testing the diversification requirements by looking through certain investment vehicles to their investments, rather than treating the investment vehicle itself as a single investment.
Before the amendment, the Treasury regulations provided disparate treatment of investments in unregistered partnerships and other look-through investments, such as mutual funds. Look-through treatment of an investment company, partnership or trust is available only if: (1) all beneficial interests in the investment vehicle are held by one or more segregated asset accounts of one or more insurance companies; and (2) public access to the investment vehicle is available exclusively through the purchase of a variable contract. Separate rules, however, applied to investments in unregistered partnerships. The prior Treasury regulations stated that the look-through rule was applicable to partnership interests that are not registered under federal or state law regulating the offering or sale of securities but did not require that the ownership of partnership interests be limited to certain holders. In order to put unregistered partnerships on parity with other types of investment funds, the final regulations clarify that look-through treatment is available for interests in unregistered partnerships only if all beneficial interests in the partnerships are held by one or more segregated accounts of one or more insurance companies and public access to the partnership is available exclusively through the purchase of a variable contract. The final regulations also remove an example that illustrated the prior rule as it applied to unregistered partnerships. The regulations were designed to prevent taxpayers from turning otherwise taxable investments in hedge funds and other unregistered investment vehicles into tax-deferred or tax-free investments through purchases of life insurance or annuity contracts.

The final regulations are effective March 1, 2005. Arrangements existing on March 1, 2005 will be considered diversified if: (1) those arrangements were adequately diversified within the meaning of Section 817(h) prior to March 1, 2005; and (2) the arrangements are in compliance with the final regulations by December 31, 2005.

Treasury Decision 9185 (Feb. 28, 2005).
 
 



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.

ICI Objects to Proposed Prohibition Against Penalty Bids for Closed-End Funds

March 11, 2005 2:57 PM
The ICI recently submitted a comment letter to the SEC insisting that the proposed prohibition against penalty bids not be applied to initial public offerings (“IPOs”) of closed-end funds. In December 2004, the SEC proposed to amend Regulation M under the Securities Exchange Act of 1934, which governs the activities of underwriters, issuers, selling security holders and others in connection with offerings of securities and is designed to prohibit activities that have the potential to artificially influence the market for the offered security. The proposed amendments would prohibit certain market activities believed to undermine the integrity and fairness of the offering process, particularly with regard to IPOs, and would enhance the transparency of aftermarket activities engaged in by underwriters. Since shares of closed-end funds are sold through an IPO, they are subject to Regulation M.
Although the ICI generally supports the goals of the SEC’s proposals, the ICI objects to the prohibition on so-called “penalty bids” as it applies to closed-end funds. Penalty bids allow a lead underwriter to reclaim a selling concession paid to a syndicate member if that member’s customers sell their allocated shares in the immediate aftermarket, a practice known as “flipping.” The SEC’s proposal to prohibit penalty bids was based on its belief that penalty bids raise three concerns:

  • since penalty bids do not currently have to be disclosed, they can serve as an “undisclosed form of stabilization” by deterring immediate sales of IPO shares that would otherwise lower the shares’ market price;
  • a sales representative’s fear of losing sales commissions may result in an improper interference with a customer’s right to sell its shares at its discretion; and
  • penalty bids have the effect of discriminating against retail customers of syndicate members as evidence suggests that institutional salespersons are often not penalized when institutional customers flip their shares.

Contrary to the SEC’s understanding that “penalty bids are rarely assessed,” the ICI asserted in its comment letter that the practice of imposing penalty bids is widely used by closed-end funds in order to stabilize the market price of fund shares by curbing the practice of flipping closed-end fund shares. The ICI explained that closed-end funds have unique attributes that do not raise the same concerns as operating companies, and warrant disparate treatment. Some of these unique attributes include the following:

  • Closed-end fund shares often trade at a discount to the net asset value of the fund shortly after the IPO. Penalty bids protect long-term shareholders by discouraging the practice of flipping and thereby reducing the chance that shares would be traded at a market discount.
  • Closed-end funds offer an unlimited amount of shares and do not have any operating histories prior to their IPOs. Therefore, shares of closed-end funds do not significantly appreciate in value in the aftermarket, and thus do not involve the same risks as are associated with “hot IPOs” of operating companies.
  • Closed-end fund shares are primarily issued to retail investors, thereby reducing the concern that retail investors would be unfairly discriminated against in favor of institutional investors.

Ari Burnstein, Associate Counsel, ICI Comment Letter to Proposed Rule: Amendments to Regulation M: Anti-Manipulation Rules Concerning Securities Offerings (Feb. 15, 2005); SEC Release Nos.33-8511; 34-50831; IC-26691; File No. S7-41-04 (Dec. 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 Implements Exam Hotline

March 11, 2005 2:50 PM
Lori Richards, the Director of the SEC Office of Compliance Inspections and Examinations, recently announced that the SEC has implemented an SEC “Exam Hotline” dedicated to receiving calls from personnel of regulated entities who have a complaint or concern about an SEC examination. The Exam Hotline will be answered by senior attorneys in the examination program’s Office of Chief Counsel. The hotline is accessible by phone at (202) 551-EXAM (3926) or via email at ExamHotLine@sec.gov.


Lori A. Richards, “Compliance Programs: Our Shared Mission,” Remarks before the Investment Adviser Compliance Best Practices Summit (Feb. 28, 2005).
 
 



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 Reopens Comment Period on Point of Sale and Confirmation Disclosure Requirements

March 4, 2005 3:11 PM

On March 1, 2005, the SEC reopened the comment period on a new rule and rule amendments originally proposed on January 29, 2004. The proposed rule and amendments would require broker-dealers to provide customers with mandated disclosure at the point of sale and in transaction confirmations for sales of mutual fund shares as well as unit investment trust interests (including insurance securities), and interests in 529 plans (collectively, “covered securities”). The required disclosure is intended to provide investors with information regarding the costs and conflicts of interest that arise from the distribution of covered securities. The supplemental request for comments is being made in response to comments received on the proposed rules and from feedback received from investors about the revised forms containing disclosures at the point of sale.

Point of Sale Proposal

Point of Sale Forms. Among other things, the SEC revised the proposed point of sale disclosure forms that would be required by proposed rule 15c2-3 under the Securities Exchange Act of 1934 (the “Exchange Act”). Under the proposed rule, these point of sale disclosure forms would have to be delivered at the point of sale before the purchase of a covered security. As re-proposed, broker-dealers would still have to disclose certain specified categories of information in a particular format to the extent applicable, but broker-dealers would be permitted to omit categories of information that are not applicable to a particular purchase (e.g., deferred sales fees for a purchase of Class A shares). In the release reopening the comment period (the “Release”), the SEC expressed hope that broker-dealers would embrace this targeted approach and provide different forms tailored to each share class where applicable.

In the Release, the SEC proposed new model point of sale disclosure forms for a hypothetical mutual fund with differences among the forms to reflect differences in share classes and other pricing attributes, and model forms for a hypothetical 529 savings plan that reflect differences in pricing. The proposed forms would have to be delivered in the same format (i.e., font and layout) as prescribed by the SEC, but would not use a “one size fits all” format. Instead broker-dealers would be required to include only those categories of required disclosure that are applicable and could omit those categories that are not. Some of the key aspects of the new forms include:

  • increased clarity due to the use of plain English rather than industry jargon;
  • specific identification of the security subject to disclosure (e.g., a mutual fund’s ticker symbol if applicable);
  • disclosure of costs associated with an investment in covered securities using standardized payment or investment amounts (i.e., $1,000, $50,000 and $100,000) and, if requested by a customer, the transaction-specific cost disclosure of the customer’s anticipated payment amount;
  • presentation of sales fee disclosure;
  • comprehensive annual cost disclosure including investment company costs such as management fees and “other expenses” that are disclosed in the fund’s prospectus in both dollar terms and as a percentage of investment value;
  • disclosures tailored to share class and pricing structure applicable to the contemplated purchase;
  • disclosures of all share classes under consideration, including classes other than typical A, B, and C share classes;
  • conflict of interest disclosure of revenue sharing payments received for promoting covered securities, and the Internet website and toll-free telephone number where customers can find more detailed information about these payments including the amounts and their source;
  • disclosure of special incentives to broker-dealer personnel (e.g., differential compensation depending on the security sold);
  • reference to the fund prospectus as the primary source of information about the fund.

 Oral Disclosure of Point of Sale Information. The original proposal required that point of sale information be disclosed orally when the point of sale occurs through an oral communication rather than an in-person meeting (e.g., telephone conversation). Although the SEC received numerous comments on oral point of sale disclosure, the SEC expressed concern in the Release that written disclosure prior to acceptance of an order or after-the-fact disclosure would be ineffective or cause undue delay. Therefore, the SEC proposed three possible methods of providing oral point of sale disclosure:

  • Under one option, broker-dealers would be required to provide oral point of sale disclosure that is either: (1) quantified to reflect the anticipated amount of the purchase; or (2) quantified to reflect a standardized purchase amount that is appropriate based on the customer’s anticipated payment and fee schedule of the covered security, coupled with transaction-specific quantification upon request.
  • Under a second option, in addition to the quantitative information above, broker-dealers would be required to provide summary qualitative information about whether they receive revenue sharing payments or engage in differential compensation practices.
  • A third option would permit a broker-dealer using an automated telephone system to receive purchase orders to provide the required point of sale disclosures and allow customers to opt out of listening to such information (other than disclosures relating to sales fees) that would otherwise have to be disclosed in a written disclosure document.

The SEC is requesting comments on oral point of sale disclosure and whether one or a combination of the above options would be effective, or whether some combination of oral and supplemental written disclosure should berequired.

Timing of Point of Sale Disclosure. The SEC is requesting comment on the timing of point of sale disclosure. The proposed rule would have required that disclosure be made immediately prior to the acceptance of an order, or upon initial communication with a customer if the broker-dealer could solicit transactions and receive compensation without opening customer accounts or handling customer orders.

Exceptions. The SEC is requesting comments about proposed exceptions for: 

  • purchases by institutional investors
  • transactions in which the broker-dealer exercises investment discretion; and
  • orders received from a customer via mail or delivery service.

Variable Insurance Products. The SEC is soliciting comment on whether it is appropriate or necessary to require written point of sale disclosure for variable annuity and variable life insurance products. The original proposal imposed a single set of disclosure requirements to apply to all covered securities.

Confirmation Proposal

As originally proposed, rule 15c2-2 would have required confirmation disclosure of the amount of dealer concessions earned by the broker-dealer in connection with the transaction, as well as estimates about the amounts of revenue sharing and portfolio brokerage commissions that a broker-dealer or its affiliates would receive from persons within the fund complex. It also would have required disclosure about whether the broker-dealer engaged in certain differential compensation practices. In light of comments received to its proposed rule 15c2-2 confirmation requirements, the SEC is seeking additional comments on the confirmation disclosure proposal. Specifically, the SEC is soliciting comments on:

  • the format of the confirmation disclosure;
  • disclosure of the total ownership costs of the covered securities (e.g., management fees and other expenses); and
  • all aspects of the proposed disclosure of broker-dealer compensation (i.e., concessions earned in connection with the transaction, revenue sharing arrangements, portfolio brokerage arrangements and differential compensation practices).

    Internet-Based Disclosure of Revenue Sharing Payments

    In addition to the proposed requirements to provide point of sale and confirmation disclosure documents, the SEC is considering requiring broker-dealers to make Internet-based disclosures (and maintain toll free numbers to request such disclosures for investors without Internet access) of information about revenue sharing payments, broker compensation, brokers’ differential compensation practices, special compensation-related conditions that broker-dealers place on fund distribution, and certain other payments out of issuer assets that may incentivize broker-dealers to distribute covered securities.


  • rospectus Disclosure of Revenue Sharing Payments

    The SEC originally proposed to amend Form N-1A to require improved disclosure regarding these new requirements concerning sales loads and revenue sharing arrangements. The proposed amendment would have required that a mutual fund’s prospectus disclose, if applicable, the existence of any revenue sharing arrangements and the fact that additional information about the revenue sharing payments is included in the confirmation and point of sale disclosure as originally proposed. The SEC is now considering whether to adopt modified or additional Form N-1A requirements to disclose more extensive information regarding such payments beyond those originally proposed.

    In addition to the supplemental requests for comment, the SEC renewed its request for comments on the original proposals. Comments must be submitted within 30 days following publication of the release in the Federal Register.

    SEC Release Nos. 33-8544; 34-51274; IC-26778.
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    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.

    Securities and Exchange Commission (“SEC”) to Adopt Voluntary Redemption Fee Rule

    March 4, 2005 3:06 PM
    At an open meeting held on March 3, 2005, the SEC voted to adopt new rule 22c-2 under the Investment Company Act of 1940. The new rule will require that fund boards consider imposing a fee not to exceed 2% on shares redeemed within seven calendar days. Fund boards would either have to approve the imposition of a redemption fee or affirmatively determine that a redemption fee is not necessary or appropriate in order to protect the fund’s investors. The adopted rule departs from the original proposal, which would have required funds to impose a 2% redemption fee on shares redeemed within five days of their initial purchase, leaving the ultimate decision to a fund’s board.

    The rule also will require funds that redeem share within seven days to enter into agreements with their intermediaries (such as broker-dealers and retirement plan administrators) obligating them to provide funds with shareholder trading information. This information will permit funds to identify shareholders who violate the funds' market timing policies and oversee the intermediaries’ assessment of any redemption fees. Unlike the rule the SEC proposed last year, the new rule will permit fund managers to determine how frequently the fund asks for this information, and will include a provision requiring that the agreement obligate the intermediary to respond to directions from the fund to enforce the fund’s market timing policies. The rule would not apply to money market funds, exchange traded funds, or funds that explicitly permit short-term trading in their prospectuses and disclose that short-term trading may result in additional costs to the fund.

    The compliance date for the new rule is 18 months after publication in the Federal Register.

    The SEC also will request additional comment on whether it should revise rule 22c-2 to require that any redemption fee conform to certain uniform standards.
     
     



    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.