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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Massachusetts Data Breach Law Takes Effect
March 19, 2010 3:36 PM
Final regulations implementing Massachusetts’ security breach law, Massachusetts General Law c. 93H, went into effect on March 1, 2010. Companies that own or license “personal information” about residents of Massachusetts must have adopted a compliant “Information Security Program” by March 1, 2010 to protect that information. New contracts for vendors or service providers who will access covered information that are executed after March 1, 2010 must obligate the service provider to implement safeguards that are consistent with the Massachusetts requirements. All vendor contracts must include these provisions by March 1, 2012.
Under the regulations, “personal information” encompasses an individual’s first name and last name or first initial and last name in combination with any of the following sensitive information: (a) Social Security number; (b) driver’s license number or state-issued ID; or (c) financial account number, or credit or debit card number, with or without any required security code, access code, personal identification number or password, that would permit access to a resident’s financial account, excluding public records data. The regulations cover personal information whether stored in electronic or paper form.
A covered entity that owns or licenses personal information about a Massachusetts resident must develop, implement, maintain and monitor a comprehensive, written “Information Security Program” that is appropriate to (a) the size, scope, and type of the covered business; (b) the covered business’s resources; (c) the amount of stored data; and (d) the need for security and confidentiality of consumer and employee information to be protected.
In addition to establishing their Information Security Program, covered entities should ensure new vendor or service provider contracts executed after March 1, 2010 comply with the data protection obligations in the new regulations. Existing service provider contracts need not be amended immediately, but must be updated by March 1, 2012.
For more information, please see:
DOL Reproposes Regulations on Investment Advice
March 19, 2010 3:34 PM
On February 26th, the DOL issued revised proposed regulations intended to implement the statutory exemption added by the Pension Protection Act of 2006 (“PPA”). The exemption relates to the provision of investment advice rendered by an adviser to participants in benefit plans and individual retirement accounts (“IRAs”).
Under Section 406 of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and Section 4975 of the Internal Revenue Code of 1986, as amended (the “Code”), a fiduciary is prohibited from rendering advice to participants regarding investments that result in the payment of additional advisory and other fees to the fiduciary or its affiliates. The Pension Protection Act of 2006 (“PPA”) amended ERISA and the Code to add a statutory exemption from the prohibited transaction rules for investment advice provided that the advice was provided subject to a level-fee model or a computer model.
On January 21, 2009, the DOL published final regulations providing general guidance on the statutory exemption. The 2009 regulations included a class exemption, in addition to the PPA statutory exemption. The class exemption required level fees at the individual level rather than across the advisory entity. The class exemption caused significant disagreement among those commenting on the regulations with many expressing concerns about the effectiveness of the regulations to combat conflicts of interest. The DOL withdrew these final regulations on November 20, 2009. These new proposed regulations replace the prior final regulations and do not include such a class exemption. The new proposed regulations provide an exemption from the prohibited transaction rules for “eligible investment advice arrangements” that use level-fee or computer models. The new proposed regulations provide a set of disclosure requirements which would meet the requirements in the PPA.
The effective date of the proposed regulations is 60 days after the publication of the final regulations. The DOL will accept written comments on the proposed regulations until May 5, 2010.
For more information, please see:
Geithner Expresses Concerns to European Commission (“EC”) on Hedge Fund Proposals
March 19, 2010 3:29 PM
On March 1st, Secretary of the Treasury, Timothy F. Geithner, sent a letter to European Commissioner for Internal Market and Services, Michel Barnier, expressing concern that certain EU proposals for the regulation of hedge funds operating in the European Union (“EU”) would “discriminate against US firms and deny them the access to the EU market.”
The EU proposals include regulations addressing:
· risk management;
· prudential oversight;
· leveraged funds; and
· funds located in third countries.
The final point is troubling to funds based in non-EU countries such as the United States and gave rise to Geithner’s concerns. Geithner included reference to the players’ commitment “to fulfill our G-20 commitment to avoid discrimination and maintain a level playing field.” On March 11th, the EC responded to Geithner’s perceived claims of protectionism with EC spokesman Amadeu Altfaj Tardio stating “the EU decision to act on hedge funds is in line with a G-20 decision to reinforce transparency…The new hedge fund rules do not discriminate against foreign players and are not protectionist.”
New regulation is not expected until mid-2010 at the earliest. If EU member states agree to terms for the regulations, it still must gain approval in the European Parliament, which is not expected to finalize its version of the bill until the middle of 2010.
For more information, please see:
For a copy of the statement by Secretary Geithner, please see:
Underwriters Not Liable under Rule 10b-5 for Implied Statements
March 19, 2010 3:27 PM
On March 10th, the U.S. Court of Appeals for the First Circuit dismissed an SEC claim brought against two former executives of the principal underwriter and distributor of a mutual fund complex, finding that they cannot be held liable for implied statements. The case was initially dismissed by the district court in 2006. In 2008, a panel of the U.S. Court of Appeals for the First Circuit reversed the dismissal of the SEC’s section 17(a)(2), Rule 10b-5(b), and aiding and abetting claims.
The action alleged that the former executives committed fraud and aided and abetted the distributor’s fraud by entering into, approving, and permitting arrangements allowing preferred customers to engage in short-term trading in mutual funds, while at the same time offering those funds using prospectuses that represented that such short-term trading was prohibited. The district court dismissed the action in December 2006, holding, among other things, that the executives could not be primarily liable for false statements contained in the prospectuses because they did not make the statements themselves.
The First Circuit panel reversed, holding that the scope of conduct prohibited by Section 17(a)(2) of the Securities Act is broader than the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 thereunder. The First Circuit panel held that under Section 17(a)(2), a defendant may be held liable for “using” a false or misleading statement as a means “to obtain money or property,” regardless of the source of the statement. The SEC’s allegations thus fell within the prohibitions of Section 17(a)(2), and should not have been dismissed. The First Circuit further held that the SEC adequately alleged a primary violation under Rule 10b-5, which “renders it unlawful ‘to make any untrue statement of a material fact … in connection with the purchase or sale of any security.” The court stated that underwriters have a statutory duty to review and confirm the accuracy of the prospectus, such that an underwriter “impliedly makes a statement” to investors that the information contained in the prospectus is accurate. Judge Selya dissented with regard to Rule 10b-5, characterizing the court’s opinion as “nothing less than a rewriting of that rule.” The defendants filed petitions for en banc review, challenging all of the panel’s holdings. The full court withdrew the panel opinion but ordered rehearing en banc only on the Rule 10b-5(b) issues.
Upon its review, the full court described the issue at hand as a two-part question of whether a securities professional can be said to “make” a statement, such that liability under Rule 10b-5(b) may attach, either by (i) using statements to sell securities, regardless of whether those statements were crafted entirely by others, or (ii) directing the offering and sale of securities on behalf of an underwriter, thus making an implied statement that he has a reasonable basis to believe that the key representations in the relevant prospectus are truthful and complete. The court decided the answer to both questions was no.
In looking purely at the use of the language in the statutes and rules, the court noted that Section 10(b) of the Exchange Act grants broad authority to the SEC to proscribe conduct that “use[s] or employ[s]” any “manipulative or deceptive device or contrivance,” in connection with the purchase or sale of any security. The court further noted that in Rule 10b-5(b), the SEC prohibits a specific subset of all “manipulative or deceptive device[s] or contrivance[s],” namely, untrue or misleading statements of material fact. It also prohibits a specific subset of all conduct that might be said to “use or employ” such a manipulative device or contrivance: the making of untrue or misleading statements of material fact. Considering this, the court found that the SEC’s assertion that one can “make” a statement by merely using a statement created entirely by others cannot follow. That assertion ignores the distinction between the verbs contained in the statute (“use,” “employ”) and the different verb contained in Rule 10b-5(b) (“make”).
In looking further at Section 10(b), the court noted that it confers upon the SEC the authority to prohibit the “use or employ[ment]” of any manipulative device or contrivance in connection with the purchase or sale of any security. The SEC has utilized this authority in another setting. In Rule 10b-5(a) the SEC rendered it unlawful “to employ” a device, scheme, or artifice to defraud. That the SEC wrote this prohibition in a different subparagraph of the rule and selected a more inclusive verb is a telling combination.
The court determined that the SEC’s arguments are also in tension with established Supreme Court precedent. See Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 173 (1994). As described in Central Bank, much turns on the distinction between primary and secondary violators. See Id. at 191. The court provided that the definition of “make” that it proposes is compatible with Central Bank as it holds the line between primary and secondary liability. While the Exchange Act does not explicitly confer a private right of action for section 10(b) violations, the Supreme Court has found a private right of action to be implicit in the statute and Rule 10b-5. Central Bank provides that private plaintiffs are permitted to bring suit under Rule 10b-5 against only “primary” violators. See Id. at 177-78. In order to ensure that the differentiation the Supreme Court established in Central Bank is not destroyed, the court here indicated that “courts must be vigilant to ensure that secondary violations are not shoehorned into the category reserved for primary violations.” In the current case, the SEC “seeks to impose primary liability on the defendants for conduct that constitutes, at most, aiding and abetting (a secondary violation).” The court found that “[A]llowing courts to imply that “X” has made a false statement with only a factual allegation that he passed along what someone else wrote would flout a core principle that underpins the Central Bank decision. We decline the SEC’s invitation to go down that road.”
For more information, please see:
SEC v. Tambone, No. 07-1384, 2010 WL 796996 (1st Cir. Mar. 10, 2010)
SEC v. Tambone (Tambone II), 550 F.3d 106, 149 (1st Cir. 2008)
SEC v. Tambone, 473 F.Supp.2d 162 (D. Mass. 2006)
Reserve Primary Fund Distributes Assets to Investors
March 19, 2010 3:22 PM
On January 27th, the Reserve Primary Fund completed distribution of $3.4 billion in assets to investors who held shares of the fund when it “broke the buck” in September 2008. This distribution represents the bulk of the fund’s remaining assets. The distribution means that investors have recovered more than 98 cents on the dollar of their investments in the fund.
For more information, please see:
SEC Settles Actions With Collective Funds Operator In Connection With Subprime Mortgage Investments
March 19, 2010 3:17 PM
On February 4th, the SEC settled actions with a large bank over allegations that the bank misled investors in its collective trust funds (“Collective Funds”) regarding the Collective Funds’ exposure to subprime mortgage-backed securities. The SEC alleged that the bank’s actions violated Section 17(a)(2) and Section 17(a)(3) of the Securities Act of 1933, as amended (the “Securities Act”).
The bank established the Collective Funds in 2002 and marketed the Collective Funds by indicating that they utilized an “enhanced cash” investment strategy that was an alternative to a money market fund. The Collective Funds were almost entirely invested in or exposed to subprime residential mortgage-backed securities. The bank described the Collective Funds to investors as having better sector diversification than a typical money market fund, but did not disclose the extent of their exposure to subprime investments. When the subprime market imploded, investors in the Collective Funds lost money.
As part of the settlement of this matter, the bank agreed to pay $250 million to compensate investors and agreed to cease and desist from committing or causing any violations, and any future violations of Section 17(a)(2) and Section 17(a)(3) This $250 million dollar settlement is in addition to actions the bank has already taken as part of cooperation and remediation, these actions included:
For more information, please see:
SEC Approves Short Sale “Alternative Uptick Rule”
March 19, 2010 3:07 PM
On February 24th, the SEC voted to amend Rule 201 under Regulation SHO and impose a new price restriction on short sales in securities experiencing sudden and significant price declines. Specifically, the SEC voted to adopt a circuit breaker version of the so-called “alternative uptick rule.” In voting to amend Rule 201, the SEC staff, and the Commissioners in favor of the rule (two Commissioners dissented), repeatedly cited the aim of bolstering investor confidence in the fairness and integrity of the markets. The Commissioners and staff also noted the potential for legitimate short selling to provide liquidity and price efficiency, describing the circuit breaker approach as “narrowly tailored” to preserve these market benefits.
The revised Rule 201 will include the following components:
· Scope. The rule will apply to “covered securities,” which are defined as NMS stocks. As such, it generally will apply to any security, except an option, that is listed on a national securities exchange, whether traded on an exchange or over-the-counter;
· The Circuit Breaker. The price restriction will be imposed for a covered security that experiences a 10% intraday price decline, measured by reference to the prior day’s closing price on the listing market. A staff member from the SEC’s Division of Trading and Markets explained that the listing market will be responsible for identifying a 10% intraday decline and immediately notifying the single NMS plan processor that consolidates information about the security. The single plan processor will then be responsible for disseminating this information to the markets;
· The Price Restriction. When triggered, the alternative uptick rule will permit short sales only at a price above the current national best bid. In contrast to former NASD Rule 3350 and the “modified uptick rule,” the alternative uptick rule will restrict short sales without regard to how the current national best bid compares to the previous national best bid. Once triggered, the price restriction will be in effect for the remainder of the trading day, as well as the following trading day;
· Exceptions. The revised rule will contain certain limited exceptions to permit the display and execution of certain short sales at or below the national best bid when the price restriction is in effect. There are exceptions for: (a) orders identified by a broker-dealer as being above the national best bid at the time of submission; (b) sales where a seller owns the security, but there is a delay in delivery; (c) certain odd-lot transactions; (d) certain domestic and international arbitrage transactions; (e) over-allotments and lay-off sales; (f) riskless principal transactions; and (g) transactions on a “value-weighted average price” basis. There will not be an exception for market making activity;
· Policies and Procedures. Trading centers will be required to establish, maintain and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale. Trading centers also must have policies and procedures to permit the execution of an order marked “short exempt” by a broker-dealer in accordance with an exception under the rule. In addition, trading centers must monitor their policies and procedures regularly for effectiveness and take prompt action to remedy any deficiencies. A broker-dealer relying on the exception for orders identified as above the national best bid at the time of submission will be required to have policies and procedures to ensure that such reliance is reasonable, and to monitor these policies and procedures and remedy any deficiencies;
· Marking Requirement. The SEC also voted to amend Rule 200(g) of Regulation SHO to require that a broker-dealer relying on an exception from the short sale restriction mark a sell order “short exempt”; and
· Implementation. There will be a 6-month implementation period. Robert Cook, Director of the SEC’s Division of Trading and Markets, stated that market participants likely would be able to build on existing policies and procedures, such as those aimed at compliance with Regulation NMS, to achieve compliance with the revised rules. The discussion at the Open Meeting did not delve into the specifics of implementation, however. The Commissioners and staff indicated that they will continue to monitor closely the operation and effects of rules relating to short selling, including the effect of revised Rule 201 on the options markets.
For a summary of the open meeting, please see:
For a discussion of compliance with the amended rules, please see:
For the webcast of the open meeting, please see:
For a copy of the statement by the SEC Chairman, please see:
For the SEC press release regarding the adopted provisions and link to the Final Rule, please see: