Investment Management Industry News Summary - March 2007

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 Proposes Amendments to Broker-Dealer Financial Responsibility Rules
March 23, 2007 1:35 PM

On March 9, 2007, the SEC proposed for comment amendments to its broker-dealer customer protection rule (Rule 15c3-3), net capital rule (Rule 15c3-1), books and records rules (Rules 17a-3 and 17a-4), and notification rule (Rule 17a-11) under the Securities Exchange Act of 1934. Please see the WilmerHale “Securities Alert” dated March 16, 2007, which provides a summary of the proposal and is available at: http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=3624.

The deadline for submitting comments is May 18, 2007. SEC Release No. 34-55431; File No. S7-08-07 (March 9, 2007), available at: http://www.sec.gov/rules/proposed/2007/34-55431.pdf.

ICI Comments on SEC’s Proposed New Rules to Implement the Credit Rating Agency Reform Act
March 23, 2007 1:32 PM

The ICI submitted a comment letter to the SEC regarding the SEC’s proposal to establish new rules to implement the Credit Rating Agency Reform Act of 2006 (“CRARA”). CRARA authorizes the SEC to implement registration, recordkeeping, financial reporting, and oversight rules to govern registered credit rating agencies. CRARA requires the SEC to review, and amend or revise, its existing rules and regulation that use the term “nationally recognized statistical rating organization” (“NRSRO”). The ICI’s comment letter urged the SEC to evaluate the need to make appropriate changes to Rule 2a-7 under the 1940 Act, and to consider whether the proposed rules would have unintended consequences for money market funds. Rule 2a-7 requires money market funds to, among other things, invest in securities that receive the highest credit ratings issued by NRSROs. The ICI letter also recommended that the SEC require NRSROs to employ standardized performance measurement statistics under the new rules, and to make non-confidential information filed with the SEC by NRSROs publicly available as soon as possible after such information is filed.

Investment Company Institute (“ICI”) Submits Comments to the SEC on Voluntary Interactive Data Tagging Proposal and Implementation of Credit Rating Agency Reform Act Proposal
March 23, 2007 1:29 PM

The ICI filed a comment letter with the SEC expressing support for the SEC’s proposal to amend rules to permit funds to use eXtensible Business Reporting Language (“XBRL”) to submit supplemental tagged risk/return summaries in fund prospectuses. The ICI recommended that the SEC permit funds to file risk/return summaries for fewer than all funds, series or classes included in the corresponding official filing. The ICI also recommended that the SEC not require funds to submit separate tagged risk/return exhibits for each series or share class, noting that such requirement would not be necessary given the design of the ICI’s draft taxonomy for risk/return summaries.

In response to a question posed by the SEC in its proposing release regarding what steps the SEC could take to encourage funds to participate in the voluntary data tagging program, the ICI suggested that the SEC offer participants expedited review of exemptive applications, or alternatively, expedited review of initial registration statements or amendments to registration statements for new funds.

SEC Staff Issues No-Action Letter Regarding Investments in 3(c)(7) Funds by Certain Charitable Foundations
March 23, 2007 1:24 PM

On March 13, 2007, the SEC Division staff issued a no-action letter providing assurance that it would not recommend enforcement action against an investment adviser and its affiliates (the “Adviser”), or against private investment funds managed and/or distributed by the Adviser that rely on the exclusion from the definition of “investment company” provided in Section 3(c)(7) of the Investment Company Act of 1940 (“1940 Act”) (the “Private Funds”), if certain charitable foundations are treated as “qualified purchasers” for purposes of Section 3(c)(7), notwithstanding that the foundations do not fall expressly within the definition of “qualified purchaser” in Section 2(a)(51)(A) of the 1940 Act.

Specifically, the staff stated that it would not recommend enforcement action if the Adviser and the Private Funds treated a charitable foundation as a “qualified purchaser” if:

The foundation qualifies for tax-exempt status under Section 501(c)(3) of the Internal Revenue Code of 1986;
The foundation is organized as a non-profit, non-stock corporation;
The foundation was not formed for the specific purpose of acquiring an interest in a Private Fund; and
Either:
- all of the individuals who have contributed assets to the foundation are related in one or more of the ways enumerated in Section 2(a)(51)(A)(ii) of the 1940 Act (e.g., siblings, spouses, parents), and the foundation owns at least $5 million in “investments,” as defined in Rule 2a51-1(b) under 1940 Act, or
- each person authorized to make investment decisions on behalf of the foundation, and each person who has contributed assets to the foundation, is a qualified purchaser within the meaning of subsections (i), (ii), or (iv) of Section 2(a)(51)(A) of the 1940 Act.

SEC Enters into Settlement with Broker-Dealer for Alleged Violations of the Anti-Fraud and Internal Controls Provisions of Federal Securities Laws in connection with the Issuance of Research
March 23, 2007 1:22 PM

The SEC entered into a settlement with a registered broker-dealer (the “Broker-Dealer”) for alleged violations of the anti-fraud and internal controls provisions of the federal securities laws in connection with the issuance of research. The SEC order alleged that (1) the Broker-Dealer failed to establish, maintain and enforce written policies and procedures reasonably designed to detect and prevent the misuse of material nonpublic information concerning the firm’s equity research; and (2) the Broker-Dealer failed to adequately manage conflicts of interest by employing business practices that linked research and investment banking and that fostered an environment in which investment bankers inappropriately influenced research analysts. As a result of these failures, the SEC order stated that (i) the Broker-Dealer’s traders improperly received access to material nonpublic information concerning upcoming research reports and established proprietary positions in those securities prior to the release of the research to the firm’s customers, and (ii) the Broker-Dealer published equity research reports on companies which did not reflect the true view of the research analyst covering the security.

Under the terms of the settlement, the Broker-Dealer agreed, without admitting or denying any wrongdoing, to pay $26 million in disgorgement and penalties, to retain an independent consultant to conduct a comprehensive review of its internal controls, and to certify that it has implemented structural and other reforms of its investment banking and research departments to bolster the integrity of its equity research.

SEC Administrative Proceeding File No. 3-12591(Release No. 34-55466), March 14, 2007, available at http://www.sec.gov/litigation/admin/2007/34-55466.pdf

SEC Division of Investment Management Director Speaks at American Bar Association (“ABA”) Section of Business Law Spring Meeting
March 23, 2007 1:16 PM

At the ABA Section of Business Law Spring Meeting held on March 16, 2007, Andrew J. Donohue, Director of the SEC’s Division of Investment Management (the “Division”), discussed the status of various Division initiatives. He reiterated that mutual fund disclosure reform and interactive data tagging are top priorities for the Division and Chairman Cox. In connection with the disclosure reform initiative, Mr. Donohue explained that the Division is reviewing the current profile prospectus model and examining liability, updating and delivery issues. Mr. Donohue said that the Division intends to work with the Department of Labor to standardize the varying levels of information currently provided to 401(k) plan participants regarding fund investments. Mr. Donohue also noted that the Division is examining the fees that are charged for the administration of 401(k) plans. Mr. Donohue also reiterated his interest in reconsidering the purpose and use of Rule 12b-1 and the factors that fund boards must consider in evaluating rule 12b-1 plans. Mr. Donohue also highlighted his interest in providing fund directors with additional guidance, including fair valuation and the use of soft dollars. Mr. Donohue concluded his speech by stating that the Division’s primary responsibility with respect to the increased globalization of the investment management industry is to focus on issues of investor protection.

Speech by SEC Staff: Remarks Before the American Bar Association Section of the Business Law Spring Meeting, by Andrew J. Donohue, March 16, 2007, available at http://www.sec.gov/news/speech/2007/spch031607ajd.htm

Senator Grassley Proposes Bill Amendment to Require Hedge Fund Adviser Registration; Senate Aides Considering Change in Tax Treatment of Carried Interests
March 16, 2007 2:07 PM

On March 7, 2007, Senator Charles “Chuck” Grassley (R-Iowa) proposed an amendment to a homeland security bill that would require managers of hedge funds and other private investment pools to register with the SEC under the Advisers Act. The proposed amendment, which was ultimately blocked, followed a March 1 letter from Senator Grassley and Senator Max Baucus (D-Mont.) requesting the Government Accountability Office (GAO) to investigate the scope of public and private pension plan investments in hedge funds and the impact of such investments on workers’ retirement savings.

In the same week, the Wall Street Journal reported that Senate tax aides are weighing possible changes to tax rules for hedge funds and other private investment pools, including a possible requirement that managers of such pools treat carried interests as ordinary income, rather than capital gain. The Wall Street Journal quoted a Senate aide as saying that any such changes are “still in the formation stages,” and that no proposals are imminent.

Wall Street Journal, “Senate Aides Weigh Hedge-Fund Tax Changes,” March 9, 2007. See also Press Release: Baucus, Grassley Question Hedge Fund Investments for American Workers’ Pension Plans, available at http://finance.senate.gov/press/Bpress/2007press/prb030107c.pdf; Press Release: Grassley Seeks Hedge Fund Registration, Says Congress Needs to Bring About Transparency, available at http://grassley.senate.gov/index.cfm?FuseAction=PressReleases.Detail&PressRelease_id=5296&Month=3&Year=2007

House Committee Holds Hearing on Hedge Funds; Senator’s Proposal to Add Hedge Fund Adviser Registration Requirement to Homeland Security Bill is Blocked
March 16, 2007 2:04 PM

House Committee on Financial Services Hearing: Hedge Funds and Systemic Risk in the Financial Markets

The House Committee on Financial Services held hearings on March 13, 2007 to consider issues related to the growth of hedge funds and systemic risk in financial markets. Chairman of the Committee Barney Frank (D-Mass.) noted at the hearing that he has not concluded whether further regulation of hedge funds is warranted, but said the Committee would hold additional hearings focusing on insider trading by hedge funds, potential risks to pension funds investing in hedge funds, and the recent recommendations published by the President’s Working Group on Financial Markets. A panel comprising hedge fund industry representatives, institutional investor representatives and academics gave testimony at the hearing. Prepared testimony and member statements are available at http://www.house.gov/apps/list/hearing/financialsvcs_dem/ht031307.shtml.

Wall Street Journal, “No Decision Yet On Hedge Fund Regulation,” March 13, 2007; New York Times, “House Panel Ponders the Growth and Risk of Hedge Funds,” March 14, 2007.

ICI Comments on NASD and NYSE Proposal Regarding Research Analyst Conflicts of Interest Rules
March 16, 2007 1:57 PM

The ICI also submitted comments regarding proposed amendments to NASD and NYSE rules addressing research analyst conflicts of interest. The ICI expressed support for the proposal’s exclusion of sales material for certain registered investment companies (open-end funds that are not listed or traded on an exchange) from the definition of “research report.” The ICI recommended, however, that the definition be expanded to exclude sales material relating to all registered investment companies.

ICI Comment Letter Addressed to SEC, dated March 5, 2007, available at http://www.ici.org/statements/cmltr/07_nasd_rsrch_conflict_com.html.

Investment Company Institute (“ICI”) Submits Comments to the SEC Regarding Recent Rule Proposals
March 16, 2007 1:53 PM

ICI Comments on SEC Proposal to Amend the Definition of “Accredited Investor” and to Adopt New Anti-Fraud Rule under the Advisers Act

The ICI submitted comments to the SEC last week regarding proposed amendments to the definition of “accredited investor” in rules under the Securities Act of 1933 and the new anti-fraud rule proposed under the Advisers Act. The ICI expressed support for the change to the definition of “accredited investor” that would require natural persons to own $2.5 million of investments to invest in certain private investment pools, including hedge funds. However, the ICI disagreed with the SEC’s exclusion of venture capital funds from the proposed requirement, explaining that the ICI believes investors in venture capital funds should have the same level of financial sophistication and ability to bear economic risk as investors in other private pools.

With respect to the proposed anti-fraud rule under the Advisers Act (Rule 206(4)-8), which would prohibit managers of pooled investment vehicles from making false or misleading statements or otherwise defrauding investors, the ICI expressed concerns about the potential application of the proposed rule to managers of registered investment companies. Noting that the SEC already has extensive authority with respect to managers of registered funds, the ICI questioned whether the SEC anticipates addressing any types of conduct under the proposed rule that are not covered under existing federal securities laws and regulations. The ICI also questioned whether the proposed rule falls within the scope of the SEC’s rulemaking authority under Section 206(4) of the Advisers Act, and suggested that the rule could be susceptible to challenge in the courts.

ICI Comment Letter Addressed to SEC, dated March 9, 2007.

The Commonwealth of Massachusetts Proposes New Regulations Relating to Senior Citizens
March 16, 2007 1:48 PM

On March 6, 2007, the Secretary of the Commonwealth of Massachusetts, William F. Galvin, proposed regulatory amendments that would prohibit representatives of broker-dealers and investment advisers doing business in Massachusetts from using any credentials or professional designations that indicate or imply that the representative has special expertise, certification, or training in advising senior citizens, unless the credential has been accredited by an organization recognized by the Secretary of the Commonwealth by rule or order. On the same day, Secretary Galvin also filed regulatory enforcement actions against two individual agents and a broker-dealer for using dishonest and unethical marketing practices in selling annuities to senior citizens.

Secretary Galvin’s full proposal is available at http://www.sec.state.ma.us/sct/sctpropreg/propreg.htm. The enforcement complaints are available at http://www.sec.state.ma.us/sct/sctmktsen/mktsenidx.htm.

NASD Announces Changes in Examinations Procedures
March 16, 2007 1:45 PM

In a recent letter to its members, the NASD announced several developments in its examinations process. The letter stated that, going forward, the NASD will provide notice to firms 30 days in advance of routine examinations. Previously, the NASD provided 14 days’ advance notice of such examinations. The letter also outlines recent regulatory developments that the NASD recommends firms consider when reviewing their supervisory and compliance programs, and directs members to a webcast it produced last year that provides an overview of the examinations process.

The NASD’s announcement follows changes the SEC Office of Compliance Inspections and Examinations announced last summer regarding its examinations process, including improved procedures for updating firms about the status of their examinations (generally 120 days after completion of an on-site examination) and providing notice to firms when examinations have concluded.

Letter from Robert C. Errico, Exec. Vice President, Member Regulation, NASD, February 13, 2007, available at: http://www.nasd.com/web/groups/corp_comm/documents/home_page/nasdw_018635.pdf. NASD Webcast, “What to Expect: Preparing for an NASD Routine Examination,” available at: http://www.nasd.com/webcasts/whattoexpect. SEC Office of Compliance Inspections and Examinations, “Examination Information for Broker-dealers, Transfer Agents, Investment Advisers, and Investment Companies,” available at: http://www.sec.gov/about/offices/ocie/ocie_exambrochure.pdf

SEC Staff Issues No-Action Letter Regarding U.K. Adviser Code of Ethics
March 16, 2007 1:43 PM

The SEC’s staff issued a no-action letter dated March 1, 2007 to an SEC-registered investment adviser based in the U.K. (the “Adviser”) providing assurance that it would not recommend enforcement action if the Adviser amended its code of ethics to permit its access persons to exclude from their personal securities holdings and transaction reports certain types of securities that are analogous to securities excluded from the definition of “reportable securities” in Rule 204A-1 under the U.S. Investment Advisers Act of 1940 (“Advisers Act”). The staff’s letter contemplates that the Adviser’s amended code of ethics will allow all of its access persons to omit from the reports certain securities issued and sold by National Savings and Investments (a U.K. government agency) and certain U.K. unit-linked life and pension products. In addition, the staff’s letter contemplates that certain of the Adviser’s access persons would be permitted to omit interests in certain U.K.-authorized unit trusts and open-ended investment companies. The staff’s letter noted that access persons who may direct, or influence the decision to direct, the execution of the Adviser’s U.S. client’s portfolio transactions to broker-dealers and other intermediaries would be required to continue to include such unit trust and open-ended investment company interests in their reports.

SEC No-Action Letter, M&G Investment Management Ltd. (March 1, 2007), available at: http://www.sec.gov/divisions/investment/noaction/2007/mgim030107-204a-1.pdf.

SEC Director of Division of Investment Management (“Division”) Addresses Mutual Fund Directors Forum
March 16, 2007 1:40 PM

In a keynote address at the Mutual Fund Directors Forum held on March 1, 2007, Division Director Andrew J. Donahue highlighted the CCOutreach program, interactive data tagging and mutual fund disclosure reform as ongoing priorities of the Division. With regard to disclosure reform, Mr. Donahue expressed a personal preference for a streamlined two-page document containing key information, such as fees and expenses, risks, investment objectives and strategies, and historical returns, with more detailed information made available to investors via the Internet or in paper form upon request. Mr. Donohue also noted that fair valuation guidance, standardized disclosure and guidance on soft dollars, review of Rule 12b-1, and the modernization of the books and records rules are other priorities for the Division. Mr. Donahue cited recent failures by fund managers to comply with basic requirement, such as the requirement that payments of dividends and distributions from any source other than net income be accompanied by a written statement identifying the source of payment, and the requirement to make fidelity bond filings with the SEC.

The full text of the speech is available at http://www.sec.gov/news/speech/2007/spch030107ajd.htm.

SEC Staff Opens Registration for 2007 Regional Outreach Seminars
March 16, 2007 1:38 PM

Last week, the SEC staff opened registration and announced the dates and locations for its 2007 regional CCOutreach seminars. Information regarding the seminars is available at http://www.sec.gov/info/cco/ccorsgeninfo2007.htm.

SEC Proposes Amendments to Broker-Dealer Financial Responsibility Rules
March 16, 2007 1:35 PM

The deadline for submitting comments is May 18, 2007. SEC Release No. 34-55431; File No. S7-08-07 (March 9, 2007), available at: http://www.sec.gov/rules/proposed/2007/34-55431.pdf.

ICI Supports and Provides Comments Regarding Proposed Auditing Standard for Audits of Internal Control Over Financial Reporting
March 9, 2007 2:30 PM

The ICI submitted a comment letter regarding the Public Company Accounting Oversight Board’s (“PCAOB”) proposed auditing standard for the audits of an issuer’s internal control over financial reporting. The PCAOB originally adopted Auditing Standard No. 2 (“AS No. 2”) following the adoption of the SEC’s rules to implement Section 404 of the Sarbanes-Oxley Act of 2002, which require issuers to include an assessment of their internal controls over financial reporting and an auditor’s report of that assessment in annual reports. The PCAOB proposal is intended to clarify the circumstances and indicators upon which an audit should focus, and simplify the audit procedures and requirements. The ICI supported the PCAOB efforts to retain the benefits of these audits while trying to reduce costs, and recommended that the PCAOB monitor the proposal’s implementation to ensure that it accomplishes a reduction in effort and cost.

AS No. 2 describes significant deficiencies or indicators that an auditor will consider to be a potential material weakness in an issuer’s internal controls, including a restatement of financial statements to correct a misstatement. Paragraph 140 explains that correcting a misstatement due to error or fraud would be an indicator, but restatements to address new accounting principles or to change accounting principles would not be. The ICI supported the PCAOB proposal that auditors would no longer be required to conclude that there is a significant deficiency if one of the indicators is present, but suggested clarification that a restatement or other indicator will not constitute a material weakness if the auditor concludes that there is no material weakness based on the facts and circumstances. The ICI argued that a restatement may be due to the complexity of GAAP or differences in interpretation, and not to poor internal controls, and that Section 404 and applicable SEC rules do not require an auditor to find a material weakness every time a restatement corrects error.

The ICI also asked the PCAOB to clarify that a required restatement due to a change in the application of an accounting principle would not be a material weakness, provided that the issuer had reasonable controls regarding the application of accounting policies and that the auditor opined that the financial statements were prepared in conformity with GAAP.

Audits of Internal Control Over Financial Reporting; PCAOB Rulemaking Docket Matter No. 021, Investment Company Institute Comment Letter (Feb. 26, 2007), available at http://www.ici.org/statements/cmltr/07_pcaob_audit_com.html.

[1] Registered direct offerings are private offerings of securities through effective shelf registration statements issued by public companies.

ICI Provides Comments Regarding SEC Studies of Mutual Fund Board Independence
March 9, 2007 2:27 PM

The ICI commented on studies conducted by the SEC’s Office of Economic Analysis (“OEA”) regarding the independence of mutual fund boards, and stated that it concluded that the findings do not justify requirements that fund boards have an independent chair or that 75 percent, rather than two-thirds, of a fund’s board be independent. The OEA conducted the studies following opinions by a federal appeals court finding that the SEC’s rulemaking process to promulgate rules requiring independent chairs and that 75 percent of funds’ boards be independent was deficient.

The ICI observed that: (1) the evidence presented in the OEA reports was mixed and the studies did not conclude that the additional independence requirements would improve fund governance, better protect shareholders, or improve current regulations that address several market imperfections noted in the studies; (2) market forces that help to align the interests of mutual fund advisers and investors are stronger than suggested by the studies; (3) statistical tests and data were stronger than the studies implied; (4) the studies suggest that an optimal board structure may vary among firms; and (5) the studies did not reach a consensus about the optimum number of independent directors. Additionally, the ICI asserted that its research showed that the costs of these independence requirements affect small funds disproportionately and increase barriers to entry in the fund industry. The ICI concluded that the SEC’s studies challenge and do not support a mandate that fund boards have an independent chair and that 75 percent of their members be independent. The ICI suggested that the SEC abandon this rulemaking.

The ICI also addressed the SEC’s “top-to-bottom review” of its process for analyzing proposed rules’ economic impact, recommending that early in the rulemaking process the OEA should regularly perform an economic analysis for each significant rule proposal, and that the analysis be available to the public when a new rule is first proposed.

Investment Company Governance File No. S7-03-04, ICI Comment Letter (Mar. 2, 2007), available at http://www.ici.org/statements/cmltr/07_sec_oea_studies_com.html#TopOfPage.

CFTC Amends Enforcement Advisory on Cooperation
March 9, 2007 2:15 PM

The CFTC Division of Enforcement amended its Enforcement Advisory on Cooperation to clarify the Division’s view of materials subject to the attorney-client or work product privileges, and to encourage parties’ meaningful cooperation in enforcement proceedings without eroding these privileges. The amendments do not change the Division’s long-standing practice of giving credit for cooperation when determining sanctions, and are effective immediately.

The Advisory is intended to assist defendants and counsel in assessing settlement and litigation risks, and includes lists of types of cooperative conduct and uncooperative conduct that the Division will consider in assessing sanctions. The amended Advisory no longer refers to waiving the attorney-client or work product privileges as evidence of cooperation, explains that the Division recognizes the importance of these privileges, and states that the Advisory is not intended to change these rights. The amended Advisory also describes three categories of cooperation that the Division will consider: “(i) good faith in uncovering and investigating misconduct; (ii) cooperation with the Division’s staff in reporting misconduct and the company’s actions with respect to it; and (iii) efforts to prevent future violations.”

Cooperation Factors in Enforcement Division Sanction Recommendations, CFTC Enforcement Advisory, available at http://www.cftc.gov/files/enf/enfcooperation-advisory.pdf; Commodities Futures Trading Commission’s Division of Enforcement Clarifies Cooperation Advisory with Respect to the Attorney-Client and Work Product Privileges, CFTC Press Release (Mar. 1, 2007), available at http://www.cftc.gov/opa/enf07/opa5296-07.htm.

NASD Investor Education Foundation Launches New Grant Program and Second Cycle of General Grant Program
March 9, 2007 2:13 PM

The NASD Investor Education Foundation announced a new grant program to fund projects by non-profit groups and researchers that protect investors from fraud through education about fraud tactics, taking precautions to safeguard personal information, and encouraging due diligence before investing. Projects may include reports, papers and articles exploring practical outcomes for investors, regulators and personal finance nonprofit organizations, tools to communicate with investors, and turnkey programs. Proposals are due by June 11, 2007. The NASD Foundation also announced that from June 14 through August 10, it will accept proposals for the second cycle of the General Grant Program for projects addressing behavioral finance, the security of retirement income, and investor education marketing and distribution. Information about the NASD Foundation’s programs and grant guidelines is available at www.nasdfoundation.org.

NASD Foundation Announces Targeted Investor Protection Grant Program, NASD News Release (Mar. 2, 2007), available at http://www.nasd.com/PressRoom/NewsReleases/2007NewsReleases/NASDW_018723.

SEC Settles Civil Injunctive Action Against Hedge Fund Adviser and Adviser’s Managing Member
March 9, 2007 2:10 PM

On February 26, 2007, the SEC filed a settled civil injunctive action alleging that a hedge fund adviser and its managing member violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder, by making fraudulent representations in subscription agreements executed on behalf of hedge funds managed by the adviser. The SEC alleged that the hedge funds invested a total of $2.65 million in two registered direct offerings.[1] Each of the subscription agreements contained a representation that the investor had not shorted the issuers’ stock during the ten days before executing the agreements. Although the funds had sold short 108,218 shares of one issuer and 255,000 shares of the other in the prior ten days, the managing member allegedly signed the subscription agreements on behalf of the funds. The funds allegedly earned $197,320 in profits from the transactions.

Without admitting or denying the SEC’s allegations, the adviser and managing member agreed to a civil injunction, the adviser agreed to hire an independent consultant to monitor its compliance policies and to pay disgorgement and civil penalties totaling $394,640, and the managing member agreed to pay a civil penalty of $120,000. The U.S. District Court for the Northern District of Illinois also entered final judgments against the adviser and managing member.

SEC Files Settled Securities Fraud Charges Against Hedge Fund Adviser and One of Its Managing Members, SEC Litig. Rel. No. 20017 (Feb. 26, 2007), available at http://www.sec.gov/litigation/litreleases/2007/lr20017.htm.

PWG Releases Principles and Guidelines for Private Investment Pools to Address Investor Protection and Systemic Risk
March 5, 2007 3:25 PM

The PWG, comprised of the Treasury Secretary (chair of PWG), chairman of the Federal Reserve Board, chairman of the SEC, and chairman of the CFTC, released an agreement among PWG and U.S. agency principals containing principles and guidelines to assist regulators to address issues associated with private investment pools. The principles focus on investor protection and systemic risk, and the responsibilities of investors, public agencies, and persons performing supervisory roles.

According to the principles:

Public agencies should institute public policies supporting market discipline, participants’ awareness of risk, and prudent risk management, and should limit investment in private investment pools to more sophisticated investors.
Supervisors should use their authority and influence to foster market discipline among creditors, counterparties, investors and fiduciaries.
Investors and fiduciaries should understand their investments, the risks of those investments, and the suitability of an investment in a private pool, and should obtain sufficient information about the pool to make an informed decision.
Creditors and counterparties should measure and limit their own exposure to private pools and enhance their risk management.
Managers of private pools should provide accurate, detailed information and should have information, valuation and risk management policies and practices that comply with sound industry practices.

The principles also suggest that due diligence by fiduciaries of pension funds, fund-of-funds, and other pooled investment vehicles can best address concerns that less sophisticated investors are exposed to private investment pools, and creditors and counterparties should limit margin, collateral and other credit terms to the extent that a private pool does not provide sufficient information.

Agreement Among PWG and U.S. Agency Principals on Principles and Guidelines Regarding Private Pools of Capital (Feb. 22, 1007), available at http://www.treasury.gov/press/releases/reports/hp272_principles.pdf; Common Approach to Private Pools of Capital Guidance on Hedge Fund Issues Focuses on Systemic Risk, Investor Protection, Department of the Treasury, Press Release (Feb. 22, 2007), available at http://www.ustreas.gov/press/releases/hp272.htm.

ICI Comments on Proposed Definition of “Person” in Rule 105 of Regulation M
March 5, 2007 2:53 PM

In a comment letter regarding the SEC’s proposed amendments to Rule 105 of Regulation M, the ICI recommended that the SEC clarify the definition of “person”. Rule 105 provides that a person may not cover a short sale with securities sold in an offering if the person sold short within five days before the pricing of the offering or during the period from the filing of the registration statement until the pricing, whichever is shorter. The SEC proposed an amendment to prohibit a “person” from effecting a short sale during the five-day period and then buying the security in an offering. The ICI recommended that the SEC clarify that “person” would mean each fund within a fund complex, each series of a fund, or each subadvised portion of a fund.

The ICI explained that if “person” includes all funds within a fund complex or all series of a fund, funds would violate Rule 105 if one fund or series effects a short sale and another fund in the same complex or another series buys the security in the offering. A fund also would violate Rule 105 if all of the portions of a fund with multiple subadvisers are considered a “person” and one subadviser enters into a short sale and another subadviser to the same fund purchases a security in the offering. The ICI argued that allowing these activities by funds would not interfere with independent market dynamics before an offering or raise any other concerns that the proposal was designed to address. Additionally, subadvisers would not be able to prevent a violation because they are prohibited from consulting with each other pursuant to certain exemptive rules under the 1940 Act.

Investment Company Institute, Comment Letter, SEC Short Selling Proposal (File No. S7-20-06) (Feb. 12, 2007), available at http://www.iciorg/statements/cmltr/07_sec_short_sell_com.html.

Maryland Securities Commissioner Charges Hedge Fund Manager Acted as an Unregistered Broker-Dealer and Investment Adviser
March 5, 2007 2:51 PM

The Maryland Securities Commissioner filed a complaint in the Prince George’s County Circuit Court, charging a hedge fund, the general partner, the investment adviser, and the principal of the general partner and adviser with fraud and acting as an unregistered broker-dealer, broker-dealer agent, investment adviser and investment adviser representative, among other charges, in connection with the sale of at least $5.9 million in interests in the hedge fund to 90 investors and almost $4 million in interests and promissory notes of another private fund to 50 investors between April and December 2006. The court granted a consent order for a permanent injunction, the freeze of the defendants’ assets and the appointment of a receiver. The Commissioner also is seeking restitution, civil monetary penalties, and a permanent bar.

The complaint alleges, among other facts: the defendants misrepresented the terms of the hedge fund offering, the fees charged, and the fund’s performance; many of the investors in the hedge fund were not accredited investors; several “marketing reps” received a fee for selling interests in the fund; the manager received a performance fee that did not meet Maryland’s requirements; and the manager continued to receive the performance fee after the fund was no longer profitable. The complaint also alleges fraud in connection with the sale of a second private fund’s securities and promissory notes, and alleges that the sale was an unregistered offering of securities.

Securities Commissioner v. Williams, Case No. CAE07-04436 (Feb. 21, 2007) (consent order), available at http://www.oag.state.md.us/Securities/permanent_injunction_Ord.pdf; Securities Commissioner v. Williams, Case No. CAE07-04436 (Feb. 20, 2007) (complaint), available at http://www.oag.state.md.us/Securities/ComplaintMel.pdf; Attorney General Gansler Shuts Down Multimillion Dollar Hedge Fund, Maryland Attorney General Press Release (Feb. 22, 2007), available at http://www.oag.state.md.us/Press/2007/022207.htm; David Cho, Hedge Fund Manager Charged in Fraud, Washington Post (Feb. 23, 2007).

CFTC Amends Advertising Regulations
March 5, 2007 2:42 PM

The CFTC amended Regulation 4.41, the advertising regulation applicable to commodity pool operators, commodity trading advisors and their principals. Under the amended rule, if an advertisement of past performance refers to a testimonial, the advertisement must prominently disclose the following, which are similar to the disclosures required by NASD Rule 2210(d)(2): (1) the testimonial may not represent other clients’ experiences; (2) “the testimonial is no guarantee of future performance or success;” and (3) that it is a paid testimonial if more than a nominal sum was paid. The CFTC also provided that a required disclaimer for simulated or hypothetical performance must be placed “in immediate proximity” to the performance information, which means that it must be clear to someone viewing the advertisement that the disclaimer refers to those performance results. Finally, the CFTC expanded the regulation’s coverage to advertising through electronic media. The amendments will be effective March 26, 2007.

Advertising by Commodity Pool Operators, Commodity Trading Advisors, and the Principals Thereof, CFTC, 72 FR 8106 (Feb. 23, 2007) (final rule); CFTC Adopts Amendments to Advertising Regulations for CPOs, CTAs, and Their Principals.

NASD Proposes Amendments to Branch Office Designation (Rule 3010(g)) and New Definition of “Initial Public Offering (Rule 2711)
March 5, 2007 2:39 PM

The NASD proposes to amend Rules 3010(g) and 2711 in connection with a plan to harmonize the rulebooks of the NASD and the New York Stock Exchange (“NYSE”). Rule 3010(g)(1) defines an “Office of Supervisory Jurisdiction” (“OSJ”) as a location where several functions are conducted, including the final review of research reports, and provides that an OSJ is a branch office. The NYSE deems a location where a member solely reviews research reports as a “non-sales location” excluded from the definition of a branch office. The NASD proposes to delete the definition of OSJ and adopt definitions of four classifications for member offices, “supervisory branch office,” “limited supervisory branch office,” “non-supervisory branch office” and “non-branch locations.” Branch offices would not include locations that only conduct the final review of research reports.

Rule 2711, among other things, limits the activities of a member and research analysts with respect to certain initial public offerings, but does not define the term “initial public offering”. The NASD proposes to codify its interpretation that “initial public offering” has the same meaning as in NYSE Rule 472: “the initial registered equity security offering by an issuer, regardless of whether such issuer is subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, prior to the time of the filing of such issuer’s registration statement.”

Comments from members and interested persons are due March 26, 2007. As announced on November 28, 2006, the NASD and the NYSE also plan to consolidate member regulation into a single, new self-regulatory organization.

Rule Harmonization, NASD Notice to Members 07-12 (Feb. 2007) (request for comment), available at http://www.nasd.com/web/groups/rules_regs/documents/notice_to_members/nasdw_018691.pdf

NASD Fines Brokerage Firm for Failure to Supervise Branch Managers and Bars Branch Manager for Unsuitable Recommendations of Mutual Funds and Variable Annuities to Elderly Customers
March 5, 2007 2:37 PM

In related actions, the NASD fined a brokerage firm $2.75 million for maintaining a supervisory system that did not adequately supervise its branch managers’ sales activities and the sales of variable annuities, and permanently barred a branch manager of that firm for allegedly making misleading statements to customers and recommending unsuitable mutual funds and variable annuity products to elderly customers. The brokerage firm and branch manager consented to the NASD’s findings, without admitting or denying the charges.

The NASD alleged that the brokerage firm allowed more than 1,000 branch managers to review and approve their own transactions and correspondence, open and accept new accounts, review and accept new customer account documents, and perform other activities commonly associated with daily supervision. The firm used an electronic system and exception reports to supervise and flag transactions for review, and appointed three sales managers responsible for supervising over 1,000 producing branch managers. The NASD found that the system of supervision was inadequate to ensure compliance with the securities laws. Additionally, the NASD alleged that the exception reports used to screen variable annuity purchases did not consider sufficient information, the firm did not maintain systems to review the suitability of variable annuity sub-account transactions, the firm’s branch audit program was deficient, and the firm did not maintain certain required books and records.

NASD Fines Raymond James Financial Services, Inc. $2.75 Million for Lax Supervision of Producing Branch Managers, NASD News Release (Feb. 21, 2007), available at http://www.nasd.com/PressRoom/NewsReleases/2007NewsReleases/NASDW_018681.

SEC Reduces Fees for Securities Transactions and Registrations
March 5, 2007 2:33 PM

The SEC reduced fees charged to issuers for securities transactions and securities registrations by more than 50 percent. Effective February 20, 2007, the fee rates will be reduced for the registration of securities, the repurchase of securities, proxy solicitations, statements in corporate control transactions, and the Annual Notice of Securities Sold required by Rule 24f-1 under the Investment Company Act of 1940, as amended (the “1940 Act”). Additionally, the fee rate for securities transactions on the exchanges and over-the-counter markets and the fee for security futures transactions will decrease, effective March 17, 2007. The SEC said that it would determine by March 1, 2007 whether a mid-year adjustment will be necessary to the fee rate for securities transactions on the exchanges and over-the-counter markets.

The SEC will announce new fee rates for fiscal year 2008 by April 30, 2007, and the new rates will become effective on October 1, 2007 or when Congress enacts the SEC’s appropriation for fiscal year 2008.

SEC Chairman Cox Announces $700 Million Fee Cut to Benefit Investors, SEC Press Release 2007-24 (Feb. 16, 2007), available at http://www.sec.gov/news/press/2007/2007-24.htm.

MSRB Files with SEC Amendment to Rule G-21 Filing Regarding Advertisements of Municipal Fund Securities
March 3, 2007 8:54 AM

The MSRB filed with the SEC an amendment to proposed changes that the MSRB originally filed with the SEC on November 21, 2006. The 2006 proposed changes included amendments to Rule G-21, which establishes standards for advertisements of municipal securities and municipal fund securities, amendments to Rule G-27, which establishes standards for supervision, and a proposed interpretation regarding general advertising disclosures, blind advertisements and annual reports for municipal fund securities. The recently filed amendments related to municipal fund securities and are intended to conform the MSRB advertising rules more closely to the SEC and NASD advertising rules. The changes included an amended definition of “advertising”, requirements for generic advertisements, and disclosure requirements relating to performance advertising.

The MSRB requested an effective date of April 1, 2007 for these changes.

MSRB Files Amendment to Rule Filing Relating to Advertisements of Municipal Fund Securities, MSRB Notice 2007-08 (Feb. 12, 2007). See also MSRB Files Amendments and Interpretive Guidance Relating to Advertisements of Municipal Fund Securities, MSRB Notice 2006-32 (Nov. 21, 2006).

[1] These assets include securities that would have to be registered under the Securities Act of 1933 if distributed, securities issued by entities in countries that restrict securities holdings by non-nationals or require transactions on local exchanges, and any assets that must be traded in the market or with a counter-party.

[2] See Citigroup Global Markets Inc. (pub. avail. Sept. 26, 2006); Signature Financial Group, Inc. (pub. avail. Dec. 28, 1999).

[3] “Historic Complaints” include customer complaints reported on the Forms that are more than two years old and have not been settled or adjudicated, and customer complaints, arbitrations and litigations that were settled for less than $10,000 and are not still reported on the Forms. Only matters that became a Historic Complaint on or after March 19, 2007 will be reported on BrokerCheck, provided that the most recent Historic Complaint or other reported complaint or proceeding is less than ten years old and the reporting person has at least three Historic Complaints or reportable complaints, regulatory actions, or proceedings.

NASD Issues Guidance Regarding a Registered Representative’s Recommendations After Changing Firms
March 3, 2007 8:51 AM

When registered representatives leave one brokerage firm to join another firm and retain customers from their prior firm, the existing customers may own mutual funds or variable products that only the prior firm was authorized to sell, or for which the prior firm and the representative are entitled to receive continuing marketing or servicing fees (“trail commissions”). The representative may not be able to sell or service these investments when the representative changes firms, and the new firm may not be entitled to receive the trail commissions on products that the representative previously sold.

NASD stated that the representative and the new firm may not recommend that customers replace an existing investment with another investment based solely on the fact that the firm and representative will not receive trail commissions for the customer’s current investment or that a new investment will generate more income for the representative and new firm. Recommendations regarding existing investments must be suitable and must be based on: the customer’s investment needs; the existing product’s characteristics, including any contingent deferred sales charge, required holding period, or other features affecting its value or liquidity; and the fees and expenses of a new product. The firm may consider other factors that preclude the representative from being able to sell or provide services for the product (e.g., the firm does not have a dealer or servicing agreement with the sponsor).

When hiring a new representative, firms should consider whether they need to enter into an agreement with a broker or a product’s sponsor so that a representative may continuing selling or servicing the product. Firms also should have policies and procedures to review a new representative’s recommendations regarding mutual funds and variable products, with special consideration given to “bonus variable annuity” products that offer representatives a specific percentage of the purchase price. Before recommending the liquidation or surrender of an existing investment, the representative should disclose all of the relevant facts and the bases for the representative’s recommendation to the customer.

Supervision of Recommendations after a Registered Representative Changes Firms, NASD Notice to Members 07-06 (Feb. 2007).

SEC Approves Changes to Information Provided Through NASD’s Public Disclosure System “BrokerCheck”
March 3, 2007 8:49 AM

The SEC approved amendments to NASD Interpretive Material 8310-2, which will expand the information that NASD releases regarding NASD members and their registered representatives, and change the way that the information is delivered to the public through NASD’s BrokerCheck (formerly NASD’s Public Disclosure Program). The amendments will go into effect on March 19, 2007.

BrokerCheck will release to the public certain information included in the most recently filed Form U4, Form U5, Form U6, Form BD and Form BDW (together, “Forms”) regarding current or former NASD members, persons registered with an NASD member, and persons who were registered with an NASD member during the last two years. The information will include: current registrations and qualification examinations passed; name, succession history and control persons of firms; summaries of arbitration awards against firms; the date of NASD registration withdrawal; and the funds owed after withdrawal. BrokerCheck also will include information concerning certain “Historic Complaints”.[3]>

NASD will not release personal information, information provided solely for regulators’ use, information about investigations or proceedings that were vacated or withdrawn by the regulatory authority, information about internal reviews and reasons for a representative’s termination that are reported on Form U5, information about branch offices, or information provided in error or that are determined not to be relevant to securities registration or licensure. Additionally, NASD will not release disclosure information contained in Form U5 for fifteen days after the information is filed to give persons an opportunity to provide comments.

Persons may submit comments regarding information provided through BrokerCheck on Form U4 if the person is registered with a member firm, and on a Broker Comment Request Form if the person was registered with an NASD member during the last two years but is no longer registered. NASD will add the comments to the BrokerCheck report and to the information available through the Central Registration Depository if the comments meet the NASD’s criteria.

BrokerCheck reports will continue to be available via U.S. mail and will be made available as PDFs following inquiries on the Web site. Reports will not be sent via e-mail. NASD also will provide to the public a compilation of information from Forms BD and BDW upon written request.

NASD BrokerCheck: SEC Approves Changes to NASD Interpretive Material 8310-2 Regarding the Release of Information through NASD BrokerCheck, NASD Notice to Members 07-10 (Feb. 2007). See also Securities Exchange Act Rel. No. 55127 (Jan. 18, 2007).

SEC Approves NASD Codes of Arbitration Procedure for Customer and Industry Disputes
March 3, 2007 8:46 AM

The SEC approved the NASD Codes of Arbitration Procedure for Customer and Industry Disputes (together, the “Codes”), which reorganize and amend the provisions of the NASD Code of Arbitration Procedure (the “Former Code”), and codify common practices. The Codes will apply to claims filed on or after April 16, 2007. The new provisions concerning the lists of potential arbitrators will apply to claims filed before April 16, 2007 if a list of arbitrators has not been generated and sent to the parties or if a new list must be generated after that date.

Reorganization

NASD created three procedural codes: the “Customer Code” for customer arbitrations (12000 series), the “Industry Code” for industry arbitrations (13000 series), and the “Mediation Code” for mediations (14000 series). Generally, the rules in the Customer and Industry Codes are identical. However, the document production lists apply only to customer cases; the employment discrimination and injunctive relief rules apply only to industry claims; and the panel composition requirements differ among the Codes.

Codifying Common Practices

NASD added to the new Codes practices that were not codified in the Former Code, including procedures governing sanctions, hearing locations, when a statement of claim may be considered deficient and how to cure deficiencies, and filing, responding to and ruling on motions. Additionally, the Codes prohibit ex parte communications with arbitrators, permit expert witnesses to attend hearings, discourage depositions, and codify the current initial prehearing conference practice.

Discovery

The Codes also codify many of the discovery guidelines previously contained in the NASD Discovery Guide, Notice to Members 99-90, and add some substantive changes. Documents included on the “Document Production Lists” are still presumed to be discoverable under the Customer Code, but now responses to the requests are mandatory and parties have 60 days, rather than 30 days to respond.

Code of Arbitration Procedure: SEC Approves Revision of Customer and Industry Portions of NASD Code of Arbitration Procedures, NASD Notice to Members 07-07 (Feb. 2007). See also Securities Exchange Act Rel. No. 55158 (Jan. 24, 2007); www.nasd.com/rulefilings/customercode; www.nasd.com/rulefilings/industrycode.

SEC Staff Grants No-Action Relief to Affiliate Offering In-Kind Redemption of Registered Investment Company
March 3, 2007 8:39 AM

The staff of the SEC’s Division of Investment Management granted no-action relief to certain unit investment trusts (“UITs”), permitting them to pay their sponsor, or any of its affiliates, for units they redeem by distributing the redeeming holder’s proportionate share of every asset in the trust’s portfolio. The trustee could exclude certain assets[1] from the in-kind redemption if the trustee determined that distributing those assets would cause an undue burden or adverse impact on the UIT or its investors, and would sell or liquidate those assets to satisfy the redemption with cash.

This no-action position differs from prior SEC staff no-action positions regarding redemptions in kind. The no-action letter that the SEC staff granted to Signature Financial Group, Inc. involved an open-end investment company, and the letter to Citigroup Global Markets Inc. involved UITs under a narrower set of circumstances and slightly different conditions.[2]

The definition of redeemable securities under the Investment Company Act of 1940, as amended (“1940 Act”) contemplates that redemptions of interests in an investment company may be effected in cash or in kind. However, redemptions in kind with an affiliate may be viewed as prohibited under Section 17(a)(2) of the 1940 Act, which prohibits affiliated persons, promoters, or principal underwriters of a registered investment company and their affiliates from purchasing securities or other property from the investment company while acting as principal. The SEC staff said that it would not recommend enforcement action, reasoning that the risk of cherry-picking was mitigated because the redeeming person and other persons with the ability to influence the in-kind redemption would not select the distributed assets, the trustee would choose to withhold assets only if the trustee is not affiliated with the redeeming person, and the redeeming investor would receive cash for any withheld assets. The applicant also represented that: the redemption would be at the investor’s proportionate share of the UIT’s current net asset value, would not dilute the remaining investors’ interests in the UIT, and would not favor the redeeming person over the interests of any other investor; the assets would be valued the same way that the UIT valued assets to compute net asset value; and the redemption would be consistent with the UIT’s redemption policies described in the UIT’s prospectus.

Van Kampen Funds Inc., SEC No-Action Letter (Jan. 31, 2007).