Investment Management Industry News Summary - September 2005

Investment Management Industry News Summary - September 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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SEC chairman announces first national ‘CCOutreach’ seminar

September 30, 2005 3:18 PM
SEC Chairman Christopher Cox recently announced that the SEC’s first CCOutreach Program National Seminar for mutual fund and investment adviser Chief Compliance Officers—CCOs will be Nov. 8, 2005, at the SEC’s Washington, D.C., headquarters. According to the SEC’s press release, the CCOutreach program aims to protect investors by enhancing communication and coordination with CCOs and helping CCOs do their “vital” jobs. “With almost half of all U.S. households now invested in mutual funds, insuring compliance with SEC standards is more important than ever before,” said Chairman Cox. “Robust and effective mutual fund and investment adviser compliance is critical to public confidence. CCOs hold the keys to success for the 92 million Americans who own mutual funds. The SEC is committed to helping CCOs excel.”

The National Seminar follows a series of regional seminars held by SEC examination staff. The regional seminars focused on the “nuts and bolts” of the examination process and the SEC resources available to help. The National Seminar will include panel discussions with SEC staff and CCO representatives on the latest policy developments relevant to CCOs and will address questions raised at the regional seminars and elsewhere. The SEC stated that it will soon publish the agenda for the seminar, which will be held from 9 a.m. until 4:45 p.m., Nov. 8, 2005, at the Commission’s headquarters, 100 F Street, NE, Washington, D.C. 20549. Attendance is limited to 500, with CCOs given priority on a first-come, first-served basis. The seminar will also be webcast at www.sec.gov. Registration and other information is also available on the SEC’s website at http://www.sec.gov/info/ccoutreach.htm.

SEC Press Rel. 2005-136
 
 



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 sanctions mutual fund adviser for revenue sharing arrangements

September 30, 2005 3:16 PM
On September 14, the SEC issued a settled administrative and cease-and-desist order against the investment adviser and principal underwriter and distributor of a mutual fund complex. In the order, the SEC found that the adviser and the distributor, without proper disclosure, used brokerage commissions on trades executed for some of the mutual funds that they advised and distributed to reduce the certain revenue sharing obligations with broker-dealers.

The SEC’s order included the following findings, which the adviser and distributor neither admitted nor denied.

  • Between January 1, 2000 and June 2003, and in the case of approximately 25 broker-dealers, the distributor, instead of exclusively using cash from its own resources, used approximately $15.8 million worth of the funds’ portfolio brokerage commissions to reduce cash payments under revenue sharing arrangements. The distributor’s payments for revenue sharing in some cases resulted in placement on certain broker-dealers’ “preferred lists” of mutual funds, increased access to brokers’ registered representatives, placement on the brokers’ websites, and participation in broker conferences, among other things.
  • The adviser failed to disclose the practice of using brokerage commissions to reduce cash payments under revenue sharing arrangements. By reducing some revenue sharing payments with the funds’ brokerage commissions, the adviser permitted its subsidiary, the distributor, to avoid an expense that the distributor otherwise would have incurred. The adviser had an obligation to fully and fairly disclose this practice to the fund boards, so the fund boards could determine if it was in the best interest of fund shareholders.
  • The adviser violated, and the distributor aided and abetted and caused the adviser’s violations of, certain antifraud provisions of the Advisers Act, the Investment Company Act of 1940 and the rules thereunder.
  • In May 2004, the adviser voluntarily paid to the funds approximately $15.8 million, which represented the gross amount of brokerage commissions that had been used to reduce revenue sharing cash payments. In recognition of this prior payment, as well as the adviser’s and the distributor’s voluntary cessation of the practice of directed brokerage, and its cooperation with the SEC staff, the SEC did not order the adviser or the distributor to pay disgorgement of approximately $12.45 million – the distributor’s net benefit, prejudgment interest of approximately $1.4 million, or a civil penalty.

 The SEC censured the adviser and the distributor, ordered the adviser and the distributor to cease and desist from committing or causing any ongoing or future violations of the provisions listed above; and ordered the adviser and the distributor to comply with certain remedial undertakings.

SEC Rels. 34-52420; IA-2427; IC-27065; File No. 3-12038

 
 



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 sanctions mutual fund adviser for retaining redemption fees

September 30, 2005 3:14 PM
On September 23, 2005, the SEC issued a settled administrative and cease-and-desist order under the Investment Advisers Act of 1940 (the “Advisers Act”). The order finds that, during the period April 2002 through April 2003, a mutual fund adviser improperly transferred $156,128 in redemption fees it collected in connection with short-term trading in a fund which it serves as investment adviser to its affiliated distributor instead of paying these fees to the fund as required by the fund’s prospectus. According to the SEC, the adviser transferred the redemption fees to its affiliated distributor because, as the adviser knew or should have known, the adviser utilized a computer system that inaccurately treated the redemption fees as contingent deferred sales charges. Accordingly, the SEC found that the adviser willfully violated the antifraud provisions of the Advisers Act. The SEC’s order requires that the adviser cease and desist from committing or causing any violations and any future violations of Section 206(2) of the Advisers Act; censures the adviser; and requires the adviser to pay a civil penalty in the amount of $300,000. The adviser consented to the issuance of the order without admitting or denying any of the order’s findings.

SEC Rel. IA-2435; File No. 3-12056.
 
 



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 proposes interpretive guidance regarding soft dollars and client commissions

September 30, 2005 3:09 PM
The SEC voted to publish for comment interpretive guidance on investment managers’ use of client commissions to pay for brokerage and research services under Section 28(e) of the Securities Exchange Act of 1934. Section 28(e) creates a “safe harbor” allowing an investment manager who exercises investment discretion to cause a discretionary account to pay more than the lowest available commission if the investment manager determines in good faith that the amount of the commission is reasonable in relation to the value of the “brokerage and research services” received.

According to the SEC’s press release, the proposed interpretive guidance would clarify that the scope of the Section 28(e) safe harbor is limited to brokerage and research services that:

  • satisfy the eligibility criteria in Section 28(e);
  • provide lawful and appropriate assistance to the investment manager in carrying out its decision-making responsibilities; and
  • satisfy the requirement that the investment manager make a good faith determination that commissions paid are reasonable in relation to the value of the products and services provided by broker-dealers in connection with its responsibilities to the advisory accounts for which it exercises investment discretion.
A person attending the SEC’s open meeting reported that the SEC appeared to favor the following changes (which were not described in the SEC’s press release):
  • research services would be limited to advice, analyses, and reports that have intellectual and informational content;
  • market, financial, economic, and similar data would fall within the research safe harbor, but computer hardware and similar items would be excluded;
  • the cost of mixed-use items would have to be reasonably allocated between eligible and ineligible uses, and this allocation would have to be documented; and
  • brokerage services included within the safe harbor would be those related to the “execution of a trade,” which would be defined temporally as m the moment an order is communicated to the broker until the moment that funds or securities are delivered or credited to the investment management account.

The SEC also voted to publish for comment guidance on commission-sharing arrangements.

Comments on the proposal should be received by the SEC within thirty days of the proposal’s publication in the Federal Register. The full text of detailed releases concerning each of these items will be posted to the SEC Web site.

SEC Press Rel. 2005-134

 
 



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.

Hedge Fund Manager Fined For Antitrust Violations

September 30, 2005 3:04 PM
The U.S. Federal Trade Commission (“FTC”) recently ordered a hedge fund manager to pay a $350,000 fine for failing to notify officials of certain large acquisitions stocks in violation of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSR Act”). The FTC charged that the fund manager violated the HSR Act by failing to notify the FTC in advance of causing one of his hedge funds to acquire more than $50 million of stock in two biotech companies. According to the FTC, at one point the fund held more than 50 percent of the voting securities of one biotech company and more than $100 million of voting securities of another.

The HSR Act is intended to address anti-trust concerns, and the notification and waiting periods are designed to allow government officials time to review and approve certain transactions. Among other things, the HSR Act imposes FTC notification requirements and waiting periods before any person or entity (including a hedge fund) can enter into certain transactions subject to the HSR Act. The HSR Act’s requirements typically are triggered by the acquisition of approximately $50 million of an issuer’s voting securities.

Susan Creighton, Director of the FTC’s Bureau of Competition, was quoted as saying “This significant penalty should put hedge funds, their managers, and securities traders on notice that they are not exempt from filing pre-merger notification forms when required to do so.”

Reuters (September 26, 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.

Bank Settles Charges for Allegedly Causing Funds to Trade with Affiliates

September 16, 2005 3:40 PM

A bank has agreed to pay a $500,000 fine, enter into a cease-and-desist order and pledge to make substantial reforms to its compliance program to settle an SEC administrative proceeding in which the SEC claimed that the bank had acted as principal in executing certain transactions with investment companies advised by the bank and a subsidiary of the bank. The bank neither admitted nor denied the charges. According to the SEC, from 1994 to 2001, the bank’s foreign exchange department traded $6.99 billion in currencies with the affiliated funds. The SEC asserted that these transactions violated Section 17(a) of the Investment Company Act of 1940, which generally prohibits an affiliated person of a registered investment company, or an affiliated person of such affiliated person, acting as a principal, from knowingly selling to or purchasing from an investment company any security or other property.

U.S. Bank National Association, Investment Company Act Release No. 27057 (Sept. 2, 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 Permits Global Consents For Certain Principal Trades

September 16, 2005 3:35 PM
The SEC Staff said it would not object under Section 206(3) of the Investment Advisers Act if a dual registrant obtained a global consent from its clients in connection with certain principal transactions. The SEC and its Staff have long taken the position that Section 206(3) requires an investment adviser to obtain client consent each time it enters into a principal transaction with a client.

In this case, the investment adviser runs a program for very high net worth individuals that utilizes covered call options. The investment adviser represented that it entered into, on average, four-to-eight covered call option transactions for each underlying stock position in a client’s portfolio in any one year. In the event that an exchange-listed call option to meet the needs of the client is unavailable, the adviser would seek to enter into over-the-counter covered call transactions for the client. The investment adviser represented that it would solicit bids from two or more third-party dealers on negotiated terms, but before the client could purchase the OTC call, the client had to first establish an account with the third-party dealer. The adviser stated that this was a substantial inconvenience and burden on the client due to the number of OTC calls effected for the client over the course of one year and the number of different third-party dealers.

To get around this burden, the investment adviser proposed to have its clients sell OTC calls to an affiliated OTC derivatives dealer—a principal transaction—when the desired call was not available on the listed market. The adviser would then seek bids from third-party dealers to buy a covered call option from its derivatives affiliate on terms that would be identical to those of the OTC call that the derivatives affiliate would purchase from the adviser’s client. The adviser would sell an OTC call for the client’s account to its derivatives affiliate on the same terms set forth in the best bid from the third party dealer and would direct its derivatives affiliate to simultaneously sell an offsetting OTC call to the third-party dealer on terms that mirror those of the contract purchased from the client (a “Mirror OTC Call”).

The Staff said it would not recommend enforcement action against the investment adviser, subject to conditions including the following:

  • Each client would consent annually to the proposed principal transactions through a written global consent and could withdraw that consent at any time;
  • The global consent would apprise the client of the conflicts of interest raised in the transactions and also the flat fees charged by the derivatives affiliate for each OTC call;
  • Mirror OTC Calls would completely offset the derivatives affiliate’s transactions with the client such that the affiliate could not profit from the OTC call and the affiliate could only exercise the OTC Call upon exercise of the Mirror OTC Call;
  • The variables for each covered call transaction would be shown on the confirmation statement sent to the client and also on the client’s quarterly account statement;
  • The client must commit a minimum of $10 million in underlying stock to the program and in most cases have a net worth exceeding $20 million.

Credit Suisse First Boston, LLC, SEC No-Action Letter (Aug. 31, 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 Establishes Website for Information on Advisers Affected by Katrina

September 16, 2005 3:32 PM
The SEC has established a website, http://www.sec.gov/katrina.htm, that provides alternative contact information for investment advisers affected by Hurricane Katrina. The website allows hurricane victims to contact their investment advisers where normal operations have been disrupted. The website contains information on advisers in Mobile, AL, Covington, LA, Metairie, LA, New Orleans, LA, and Gulfport, MS. Advisers can have their contact information posted on the website by contacting the SEC’s Atlanta District Office.

SEC Press Release No. 2005-128, http://www.sec.gov/news/press/2005-128.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.

SEC Grants Banks Extension to Comply with GLBA Broker Registration Rules

September 16, 2005 3:28 PM
The SEC has extended the date for banks to comply with certain broker registration requirements contained in the Gramm-Leach-Bliley Act (“GLBA”) until September 30, 2006. GBLA repealed a broker-dealer registration exception that allowed banks to engage in securities activities without registering as a broker-dealer. GLBA replaced the exception with new functional exceptions, but the SEC has granted several extensions on the compliance date at the industry’s request.

SEC Press Release No. 2005-130, http://www.sec.gov/news/press/2005-130.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.

SEC Grants Broker-Dealers Extension to Comply with Investment Advisers Act Rule

September 16, 2005 3:20 PM
The SEC has extended the date for broker-dealers to comply with new Rules 202a11-1(b)(2) and (b)(3) under the Investment Advisers Act of 1940 until January 31, 2006. Rule 202a11-1(b)(2) provides that when a broker-dealer provides investment advice as part of a financial plan or in connection with providing financial planning services, the advice is not “solely incidental to” its business within the meaning of Section 202(a)(11)(C) of the Investment Advisers Act if the broker: (i) holds itself out to the public as providing financial planning services; (ii) delivers a financial plan to a customer; or (iii) represents to a customer that its advice is provided in connection with financial planning services. Rule 202a11-1(b)(3) provides if a broker-dealer exercises investment discretion over a customer’s account, the investment advice involved is not “solely incidental to” the broker’s business (except for investment discretion granted by a customer on a temporary or limited basis). The SEC acted based on rulemaking petitions filed by the American Council of Life Insurance, the Securities Industry Association, and the Financial Services Institute seeking more time for their members to take the actions necessary to bring them into compliance with the rule.

Certain Broker-Dealers Deemed Not To Be Investment Advisers, Extension of Compliance Date, Investment Advisers Act Release No. 2426 (Sept. 12, 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 Timer Lacks Standing in Suit Against Fair Value Rules

September 16, 2005 8:29 AM
A company that employs a market timing strategy when investing in mutual funds (“Plaintiff”) brought suit challenging the SEC’s action in two recent rule releases: the new compliance rule adopted in December of 2003 and the new disclosure rule regarding the use of fair value pricing adopted in April of 2004. The Plaintiff alleged that certain statements made by the SEC in those releases pertaining to circumstances under which mutual funds must use “fair value” pricing amounted to the promulgation of a new mandatory requirement to fair value in violation of the Administrative Procedure Act. The Plaintiff also alleged that the new fair value rule conflicts with the plain language of the Investment Company Act and is arbitrary and capricious. The Seventh Circuit did not address the merits of the case but rather found that the Plaintiff lacked standing to assert a claim because the rules only applied to investment companies and investment advisers. The court reasoned that since the Plaintiff is neither an investment company or adviser, standing is substantially more difficult to establish. The Plaintiff was not able to meet the injury-in-fact requirements as set forth in Lujan v. Defenders of Wildlife , 504 U.S. 555, 560 (1992).

DH2, Inc. v. SEC, 2005 WL 2143535 (Sept. 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.

Investment Adviser Files Suit to Enjoin Spitzer’s Actions to Lower Advisory Fees

September 16, 2005 8:27 AM
An investment adviser filed suit against Eliot Spitzer, the New York Attorney General, and his office (“NYAG”) to enjoin them from investigating and issuing subpoenas related to its investment advisory fees. The investment adviser asserted that it was in the midst of settling a market timing matter with both the SEC and the NYAG when the NYAG demanded as a condition of settlement that the adviser turn over control of the negotiation of its advisory fees to a third party and also to subject the advisory fee negotiation process to oversight by the NYAG. When the investment adviser refused to accede to the NYAG’s terms, the NYAG issued a series of subpoenas to the adviser, the funds, the principal shareholder of the fund and the independent directors requesting information related to negotiation of the investment advisory fees. In its complaint, the investment adviser argues that the NYAG, and indeed no state attorney general, has authority over investment advisory fees and that under Section 36(b) of the Investment Company Act, the SEC and the shareholders in the fund are the only parties empowered to bring an action relating to advisory fees.

J. & W. Seligman & Co., Inc. v. Spitzer, No. 05 Civ. (S.D.N.Y. filed Sept. 6, 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.

AICPA Releases Proposal on Internal Control Related Matters

September 9, 2005 9:29 AM
The Auditing Standards Board of the AICPA recently proposed a new Statement on Auditing Standards entitled “Communication of Internal Control Related Matters Noted in an Audit.” The proposal is meant to supersede current Statement on Auditing Standards No. 60 to conform to recent guidance issued by the Public Company Accounting Oversight Board (“PCAOB”) in its Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements. In addition to incorporating the new definitions of “control deficiency” and “material weakness” from the PCAOB’s Auditing Standard No. 2, the proposal would require the auditor to communicate, in writing, to management of an audit client or those people otherwise charged with governance significant deficiencies or material weaknesses in internal control. The proposal also includes a guide and illustrative examples of control deficiencies. Comments on the proposal are due by October 31, 2005.

Proposed Statement on Auditing Standards, Communication of Internal Control Related Matters Noted in an Audit (Sept. 1, 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.

Mutual Fund Directors Forum Survey Finds Low Cost to Comply with Indy Chair Rule

September 9, 2005 9:19 AM
On August 30, 2005, the Mutual Fund Directors Forum released a report on the cost implications of an independent chair and a 75% independent board based on a survey of its membership. The study was undertaken following the controversy that arose after the SEC’s adoption of rule amendments requiring most mutual fund boards to be chaired by independent directors and requiring that at least 75% of directors be independent from the respective funds’ investment adviser. The SEC’s implementation of the rule was stayed when the D.C. Court of Appeals granted a stay requested by the U.S. Chamber of Commerce. The report of the Mutual Fund Directors Forum concluded that the costs incurred by funds in implementing the reforms were at the low end of the range of estimates provided by the SEC in its rule release and that compliance with the rule would have a negligible impact on a fund’s operating costs—less than 1% of the aggregate advisory fees incurred by a fund. Eighty percent of the funds surveyed already had independent chairs.

Report of the Mutual Fund Directors Forum, Cost Implications of an Independent Chair and a 75 Percent Independent Board (Aug. 30, 2005). The report is available at http://www.mfdf.com/UserFiles/File/ReportofSurvey.pdf.
 
 



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.

Revenue Sharing Suit Dismissed

September 9, 2005 8:47 AM
Shareholders in seven mutual funds (“Plaintiffs”) managed by a large investment adviser (“Adviser”) brought suit against the Adviser, the funds, and the directors of the funds (collectively, the “Defendants”) essentially alleging that the Adviser made improper, undisclosed, and excessive payments to brokers, i.e., revenue-sharing payments or “soft dollar” payments, inducing them to aggressively market the funds and that such practice caused the Plaintiffs to suffer a decline in the net asset value of their shares. The Plaintiffs brought these claims directly, not derivatively, and the court held that the Plaintiffs’ form of injury, a decline in the net asset value per share, was sufficient to make the claim directly.

All of Plaintiffs’ state law claims—unjust enrichment, breaches of fiduciary duty and the duties of good faith, loyalty, fair dealing, due care and candor—were dismissed by the court as preempted by the Securities Litigation Uniform Standards Act (“SLUSA”). Relying on Rowinski v. Salomon Smith Barney Inc., 398 F.3d 294 (3d. Cir. 2005), the court found that the nature of the parties’ relationship and the Defendants’ alleged scheme to harm Plaintiffs necessarily involved the purchase or sale of a security, which brought the claims within SLUSA’s ambit.

The court dismissed Plaintiffs’ claims under Sections 34(b) and 36(a) of the Investment Company Act of 1940, holding that no private right of action existed under either provision. The court dismissed Plaintiff’s claim under Section 36(b) of the Investment Company Act, holding that there is no direct cause of action under that section and that any cause of action under Section 36(b) must be brought derivatively. The court also dismissed Plaintiffs’ claim under Section 215 of the Investment Advisers Act of 1940, which provides for the rescission of contracts that, on their face or by their performance, violate other provisions of that Act. The court held Section 215 provides a remedy only for allegedly unlawful contracts, not allegedly unlawful transactions made pursuant to lawful contracts, and Plaintiffs failed to allege that the advisory contract was unlawful.

In re Lord Abbett Mutual Funds Fee Litigation, 2005 WL 2090517 (D.N.J. Aug. 30, 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.

Former Trust Company Officers Plead Guilty

September 9, 2005 8:30 AM
The former CEO and former president of Security Trust Company (“STC”) both pled guilty to felony violations of the New York Martin Act. The former CEO also pled guilty to second degree felony grand larceny. Under a plea agreement with New York Attorney General Elliot Spitzer’s office, both defendants will receive five years’ probation and a $50,000 fine. The former CEO admitted to developing a procedure by which two hedge fund clients, Canary Capital and Samaritan Asset Management, were able to disguise market timing activity in various mutual funds by having their trades intermixed with those of retirement plan clients who trade in omnibus accounts. The former president admitted to developing computer software that allowed the market timing trades and to implementing the trading strategy for the two hedge funds.

New York v. Kenyon, N.Y. Sup. Ct., Indictment Nos. 7449/2003 & 2682/2004 (Aug. 30, 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.

Rule Amendments Regarding Advertising Performance of College Savings Plans

September 2, 2005 9:45 AM
On August 18, 2005, the SEC approved amendments to Rule G-21 of the Municipal Securities Rulemaking Board (“MSRB”). The amendments regulate performance advertisements for municipal fund securities, i.e., Section 529 college savings plans. Under the amendments, unless an advertisement for municipal fund securities that contains performance data lists total return quotations current to the most recent month ended seven business days prior to the date of the advertisement, the advertisement must also contain a telephone number or a website where the investor can obtain such quotations. Any performance data must be calculated as of the most recent practicable date, considering the type of municipal fund securities and the manner in which the information is conveyed. The rule provides two safe harbors for complying with the requirement: (i) total return quotations are current to the most recent calendar quarter ended prior to the submission of the advertisement for publication and a phone number or website is included where more current information is available, or (ii) the total return quotations are current to the most recent month ended seven business days prior to the date of any use of the advertisement and the month to which such information is current is identified. The effective date of the amendment is August 29, 2005. All advertisements of municipal fund securities containing performance data submitted or caused to be submitted for publication by dealers on or after December 1, 2005 must comply with the amended rule.

MSRB Notice 2005-45 (Aug. 23, 2005); SEC Release No. 34-52289 (Aug. 18, 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 Approves Rule G-38 Amendment Prohibiting Dealer Payments to Non-Affiliates

September 2, 2005 9:43 AM
On August 17, 2005, the SEC approved an amendment to Rule G-38 of the Municipal Securities Rulemaking Board (“MSRB”). The new rule prohibits a broker, dealer or municipal securities dealer (“dealer”) from using any outside consultants to solicit municipal securities business. As amended, Rule G-38 prohibits a dealer from making payments to anyone who is not an “affiliated person” of a municipal securities dealer or its corporate affiliates. An “affiliated person” is defined as an employee, partner, or officer of the dealer or its affiliates, or independent brokers who are duly qualified registered persons of a dealer under MSRB or NASD professional qualification requirements. The effective date of the amendment was August 29, 2005.

MSRB Notice 2005-44 (Aug. 18, 2005); SEC Release No. 34-52278 (Aug. 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.

Investment Advice Dispute Covered by Arbitration Clause in Account Opening Documents

September 2, 2005 9:38 AM
Investors sued a financial consulting firm (“Defendant”) acting as an agent for a securities brokerage firm after following the consulting firm’s investment advice and allegedly losing nearly half their life savings. The investors asserted that the provision of the investment advice resulted in misrepresentations, breach of fiduciary duty, and violations of securities laws.

Before obtaining the investment advice, the investors had signed an advisory agreement for investment advice containing a short mediation clause and a new account information form for brokerage services containing a full pre-dispute arbitration agreement. The arbitration provision covered disputes between any of the parties concerning “the continuation, performance or breach of this or any other agreement between us.” The two agreements were signed on the same day. When the investors brought suit, the Defendant moved to dismiss and compel arbitration.

The investors agued that they brought suit solely under the advisory agreement, which does not contain an arbitration provision, and solely to complain about the investment advice they received, and as such the arbitration provision in the new account information form should not apply. The Fifth Circuit disagreed. The court noted that there is a presumption in favor of arbitration and that the arbitration clause could be read in such a way as to cover the investor’s claims. The court also found that because the two agreements were executed on the same day, they were related to each other and constituted one transaction. The court required the parties to submit their dispute to arbitration.

Safer v. Nelson Financial Group, Inc., 2005 WL 1993867 (5th Cir. Aug. 18, 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.

B Share Class Action Suit Dismissed

September 2, 2005 9:35 AM
Investors in Class B shares in a family of mutual funds (“Plaintiffs”) filed a putative class action suit against the mutual fund complex (“Defendant”). Plaintiffs first alleged that the Defendant violated §12 of the Securities Act of 1933 and §10(b) of the Securities Exchange Act of 1934 by failing to disclose the superiority of Class A and/or Class C shares, as compared to Class B shares. Plaintiffs alleged that certain language in the prospectus suggested that investing up to $100,000 in B shares could be a rational investment strategy when it was a mathematical impossibility that B shares can outperform A shares for investments over $50,000. Plaintiffs alleged that this language gave rise to a duty to disclose additional facts clarifying the prospectus language. The Sixth Circuit rejected this proposition, noted that the prospectus fully complied with the requirements of Form N1-A and that the fee table and other language included in the prospectus contained all the information necessary for an investor to deduce the fees associated with each investment choice.

The Plaintiffs next alleged that the Defendant violated Rule 10b-5(a) and (c) because it marketed to investors a false and misleading choice; Plaintiffs essentially argued that it was fraud to offer Class B shares at all. The Court rejected that allegation as well noting that offering certain securities that are more valuable to investors than other securities does not constitute fraud.

Plaintiffs final contention was that the Defendant violated federal securities law by failing to adequately disclose that the broker compensation structure created higher incentives for selling B shares and that brokers received higher commissions for the sale of mutual funds affiliated with the broker than for funds unaffiliated with the broker. The Court noted that current SEC regulations, including Form N1-A, do not impose a disclosure obligation with respect to broker compensation such that the Defendant did not have an obligation to disclose that information. Moreover, the prospectus contained language to the effect that brokers could receive different compensation for selling different classes of shares. This language effectively put investors on notice that there was a possibility that brokers were being compensated more highly for certain share classes and investors could question their financial advisors if they were concerned about broker incentives.

Benzon v. Morgan Stanley Distributors, Inc., 2005 WL 2000927 (6th Cir. Aug. 22, 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.

SLUSA Preemption Purchase and Sale Requirement Encompasses Retention of Securities

September 2, 2005 9:33 AM
An investor (“Plaintiff”) filed a class-action complaint against a brokerage firm (“Defendant”) in state court alleging that the firm’s issuance of false or misleading research reports on tech stocks resulted in investors holding onto the over-valued stocks. The Plaintiff specifically disclaimed that the causes of action were based on any class member’s purchase or sale of any stock, rather the complaint alleged harm solely based on the retention of securities in reliance on the misleading research reports. Defendant moved to remove the state law claims to federal court as preempted under the Securities Litigation Uniform Standards Act (“SLUSA”). To invoke SLUSA, a removing party must show, among other things, that the defendant’s alleged conduct was in connection with the purchase or sale of a covered security. While acknowledging that other circuits had taken a different view, the Seventh Circuit held that plaintiff’s claims were connected sufficiently to the purchase and sale of a covered security for the purpose of SLUSA preemption and removal.

Disher v. Citigroup Global Markets Inc., 2005 WL 1962942 (7th Cir. Aug. 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.