Investment Management Industry News Summary - October 2004

Investment Management Industry News Summary - October 2004

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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Securities and Exchange Commission ("SEC") votes to adopt final rules requiring registration of hedge fund advisers

October 29, 2004 11:26 AM

At an open meeting held October 26, 2004, the SEC voted 3-2 to adopt rules and rule amendments requiring advisers of hedge funds to register with the SEC as investment advisers under the Investment Advisers Act of 1940 ("Advisers Act") by February 1, 2006. Specifically, the new rule will require advisers of hedge funds with more than $25 million in assets and 15 or more investors, determined on a "look-through" basis, to register with the SEC under the Advisers Act. Previously, advisers were able to count each fund as a single client (and not look through) for purposes of the exemption for advisers with fewer than 15 clients. According to an SEC press release, registration under the new rule will permit the SEC to:

  • collect information about the operations of hedge fund advisers;
  • conduct examinations of hedge fund advisers to identify compliance problems, identify practices that may be harmful to investors and provide a deterrent to unlawful conduct;
  • require all hedge fund advisers to adopt basic compliance controls to prevent violation of the federal securities laws;
  • improve disclosure made to prospective and current hedge fund investors; and
  • prevent felons or individuals with other serious disciplinary records from managing hedge funds.

In its press release, the SEC noted that the new rule contains provisions for advisers located outside the United States that are designed to limit the extraterritorial application of the Advisers Act to offshore advisers to offshore funds that have U.S. investors.

As of the date of this Industry News Summary, the final rule release had not been published.

A more detailed summary of the rule will appear in the Industry News Summary following the release of each rule. SEC Press Release 2004-150 (October 27, 2004).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

NASD fines broker-dealer in connection with hedge fund sales practices

October 24, 2004 12:40 PM

On October 25, 2004, the NASD announced that it settled charges with a broker-dealer resulting in a censure and fine in the amount of $250,000 for disseminating over a one-year period sales literature, which, according to the NASD, was "inappropriate" in that it:

1. Cited a targeted rate of return without providing a sound basis for evaluating the reasonableness of the stated target.

2. Improperly used hypothetical returns in charts or graphs:

According to the NASD, the broker-dealer used sales pieces showing results for a fund before commencement of operations calculated by selecting a portfolio of individual advisers with whom the fund intended to or had recently begun to invest, and combining the historical performance results of these selected advisers, using a hypothetical allocation of assets. Additionally, certain pieces of sales literature presented hypothetical performance results in a chart or graph in combination with actual historical performance of funds or hedge funds, creating the inaccurate impression that such funds or hedge funds had longer investment track records than they actually possessed.

3. Failed to include adequate risk disclosure:

According to the NASD, certain pieces of sales literature did not contain risk disclosure required in order for the disclosure to be considered full and complete, including that:

  1. the funds are speculative and involve a high degree of risk;
  2. an investor could lose all or a substantial amount of his or her investment;
  3. there is no secondary market nor is one expected to develop for investments in the funds;
  4. there may be restrictions on transferring fund investments;
  5. the funds may be leveraged;
  6. the funds' performance may be volatile;
  7. the funds have high fees and expenses that would reduce returns; and
  8. there are other specific risks related to the particular funds' investment strategies.

The NASD noted that its recent enforcement actions with regard to hedge fund sales by broker-dealers "underscore [its] commitment to making certain that firms provide the investing public with a sound basis for evaluating hedge fund investments, and adequately disclose all of the risks."

NASD News Release (October 25, 2004).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Massachusetts Securities Division of the Office of the Secretary of the Commonwealth (the "Division") files complaint against mutual fund company

October 24, 2004 12:36 PM
On October 25, 2004, the Division filed a complaint charging a mutual fund company with civil fraud in connection with an SEC filing on Form 8-K giving notice of its settlement with the SEC regarding market timing permitted by one of its subsidiaries, an investment adviser. In the filing, the company included a common disclaimer stating that it "did not admit or deny engaging in any wrongdoing." Although the company entered into a separate settlement with the SEC in which it did not admit or deny the SEC's findings, in its settlement with the Division, the Division required the company to "admit to the Division's Statements of Fact," which included admitting to allowing a known market timer to trade in a fund advised by the investment adviser despite an express prohibition against market timing in the fund's prospectus. The complaint noted that although the company was not required to disclose its settlement with the SEC on Form 8-K, once it determined to do so, it is required under the Massachusetts Uniform Securities Act (the "Act") not to make any material misstatements or omissions. According to the Division, by stating in a public filing that it did not admit or deny engaging in any wrongdoing, the company depicted "a false and misleading portrayal of the settlement to Massachusetts investors."


The complaint asked for the company to: (1) cease and desist from further violations of the Act, and (2) pay an unspecified administrative fine. The case will be ruled upon by a director or hearing officer in the Office of the Secretary of the Commonwealth of Massachusetts.

In the matter of Franklin Resources, Inc. Commonwealth of Massachusetts Administrative Complaint, Docket No. E-2004-0044 (October 25, 2004).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC proposes amendments to Regulation M, prohibiting certain market activities that undermine the integrity and fairness of the offering process

October 22, 2004 12:51 PM

On October 13, 2004, the SEC proposed amendments to Regulation M under the 1934 Act, which governs the activities of underwriters, issuers, selling security holders and others in connection with offerings of securities and is designed to prohibit activities that have the potential to artificially influence the market for the offered security. The amendments would: (1) prohibit certain market activities believed to undermine the integrity and fairness of the offering process, particularly with regard to the allocation of initial public offerings ("IPOs"), and (2) enhance the transparency of aftermarket activities engaged in by underwriters.

Specifically, according to an SEC press release issued October 13, 2004, the proposed amendments would:

  • lengthen the "restricted period" for IPOs, which is the period during which distribution participants must refrain from activity that could stimulate the market for the security in distribution. Under the amendments to Regulation M, the restricted period for an IPO generally would begin when an issuer reaches an understanding with an underwriter to proceed with a distribution, and the restricted period would be lengthened beyond the current period of 5 days;
  • require syndicate covering bids, indicating that the underwriter is buying shares to cover its short position, to be publicly disclosed to the market. The required disclosure would be similar to what is currently required for stabilizing bids under Regulation M;
  • prohibit the use of penalty bids, which occur when an underwriter reclaims a selling concession from a syndicate member if the offering security is immediately sold by the initial purchaser. Penalty bids also can function as an undisclosed form of stabilization;
  • adopt a new rule under Regulation M that would expressly prohibit certain IPO abuses that occurred in the late 1990's and in other "hot issue" periods, including conditioning or "tying" an allocation of shares on agreement by the customer to buy shares in another less desirable offering, or to pay excessive trading commissions on unrelated securities transactions;
  • require recordkeeping in connection with Regulation M's "de minimis exception," which excepts inadvertent bids and purchases during the restricted period that total less than 2% of the distributed security's average daily trading volume ("ADTV"); and
  • update the ADTV value and public float value thresholds, which are used to determine a security's restricted period and the availability of the exception for actively-traded securities, to reflect the increase in market value since Regulation M's adoption in 1996.

SEC Press Release No. 2004-145 (October 13, 2004).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC approves changes to rules regarding NASD supervisory and control procedures

October 15, 2004 1:24 PM

The SEC has granted accelerated approval to proposed rule changes to the previously approved (in June 2004) amendments to certain rules regarding NASD members’ supervisory and control procedures. The changes are intended to conform certain parts of the new rule requirements to the New York Stock Exchange’s (NYSE’s) recently approved internal control amendments.

In their entirety, the approved rule changes:

  • Eliminate Rule 3010(a)(8), which required a member to identify one or more principals who will review the member’s supervisory system, procedures, and inspections and take or recommend action to achieve the member’s compliance with applicable securities laws and regulations and with NASD rules;
  • Create Rule 3012 to require a member to designate one or more principals who will establish, maintain, and enforce a system of supervisory control policies and procedures that test and verify that the member’s supervisory procedures are reasonably designed to achieve compliance with applicable securities laws and NASD rules and amend those supervisory procedures where necessary. Rule 3012 also requires that a person senior to or “otherwise independent” of a producing manager perform the day-to-day supervisory reviews of the producing manager’s account activity. However, if a member is so limited in size and resources that it cannot comply with this general supervisory requirement, the member may have a knowledgeable principal perform the supervisory reviews. In addition, a member must have in place heightened supervisory procedures for the supervision of a producing manager who is responsible for 20 percent or more of the revenue generated by the business units supervised by the producing manager’s supervisor.
  • Amend Rule 3010(c) to codify the minimum inspection cycles for a member’s offices and to require that office inspections include, without limitation, the testing and verification of the member’s policies and procedures, including supervisory policies and procedures in certain specified areas. There is a general requirement that an office inspection may not be conducted by the branch office manager for that office, any person within that office who has supervisory responsibilities, or any individual who is directly or indirectly supervised by such persons. However, if a member is so limited in size and resources that it cannot comply with this limitation, the member may have a knowledgeable principal perform the inspections. Depending upon the position of the person within the member who conducts the inspection, a member must have in place heightened inspection procedures for the inspection of an office if the producing manager is responsible for 20 percent or more of the revenue generated by the business units supervised by the producing manager’s supervisor.
  • Amend Rule 3110 to require that before any customer order is executed, the account name/designation must be placed upon the memorandum for each transaction. Additionally, no changes to the account name/designation can be made unless previously authorized by a member or a person designated under NASD rules (who must pass a qualifying principal exam). This person, before giving such approval, must be informed of the essential facts and indicate his/her approval in writing on the order or similar record. The facts relied upon by the person in approving the change must be documented in writing and preserved for a period of not less than three years, with the documentation preserved for the first two years in an easily accessible place, as the term “easily accessible place” is used in Rule 17a-4 under the Securities Exchange Act of 1934.
  • Amend Rule 2510(d)(1) to require that time and price discretionary authority be limited to the day it is granted, absent a specific, written indication signed and dated by the customer. The limitation does not apply to time and price discretion exercised for orders in an institutional account pursuant to valid “good-till-cancelled” instructions issued on a “not held” basis. Any exercise of time and price discretion must be reflected on the order ticket.
  • The NASD’s Notice to Members provides interpretive guidance on these rule changes and explains the relationship between recently approved (but not yet effective) Rule 3013 and Rules 3012 and 3010. The effective date of the rule changes is January 31, 2005.

NASD Notice to Members 04-71: SEC Approves New Rules and Rule Amendments Concerning Supervision and Supervisory Controls (posted October 4, 2004)

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC official indicates that inspections may focus on fund directors

October 15, 2004 1:22 PM

According to recent remarks made at the Practising Law Institute conference by Gene Gohlke, associate director of the SEC’s Office of Compliance, Inspections and Examinations (“OCIE”), OCIE is considering a number of changes to the inspection process for mutual funds, including requiring fund directors to participate in one-on-one interviews with the SEC inspection staff. According to Mr. Gohlke, these interviews would cover a range of topics, from a board’s self-examination process to the process surrounding contract negotiations. In addition, Mr. Gohlke noted that the inspection staff will be comparing board minutes to the information provided in shareholder reports both for consistency, and to determine whether such minutes are “boilerplate.” Mr. Gohlke also noted that the inspection staff will place more emphasis on the disclosure of the factors that the board considered in approving management contracts and whether all such factors have been included in order to “paint a full picture.” Mr. Gohlke also noted that the staff of OCIE is considering whether it should change the structure of its examination process, perhaps focusing more on segmenting by types of funds or on fund groups that present greater risks.

Fund Directions, Vol. 13 No. 10, October 2004.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC adopts rule amendments requiring self-regulatory organizations (“SROs”) to file proposed rule changes with the SEC electronically and post all current rules on their Websites

October 15, 2004 12:57 PM

On October 4, 2004, the SEC adopted certain amendments to Rule 19b-4 and Form 19-b-4 under the Securities Exchange Act of 1934 that require SROs to file all proposed rule changes electronically with the SEC. In addition, the amendments require SROs to post all proposed rule changes, as well as current and complete sets of all rules, on their websites. Proposed rule changes must be posted within two business days after these changes are filed with the SEC, and current and complete versions of rules must be posted within two business days after electronic notification by the SEC that is has approved any proposed changes.

Each duly authorized signatory to an SRO’s proposed rule change will be required to manually sign Form 19b-4, authenticating, acknowledging or otherwise adopting his or her electronic signature. The SRO will be required to retain each manual signature page for not less than five years after the Form 19b-4 is filed with the SEC.

In addition, the amendments will require plan administrators for each of the seven National Market System (“NMS”) Plans to post on their Websites, or on a separate plan Website, a current version of each NMS Plan, as well as proposed amendments to such plan within two business days after the plan participants have been notified by the SEC of the effectiveness of the plan.

According to the SEC release adopting the rule amendments, the SEC believes the amendments will have the following benefits:

  • a reduction in the amount of time and labor required to process SRO rule filings by eliminating paper delivery, photocopying and distribution;
  • a reduction in costs for SROs;
  • more efficient use of SEC resources; and
  • more efficient and accurate monitoring by SEC staff of proposed rule changes due to the integration of SRO electronic filing with the internal SEC database that tracks these filings.

Effective Date: Commencing at 5:30 p.m. (Eastern time) on November 5, 2004, SROs will be required to file all Forms 19b-4, and any amendments to these forms, electronically, and the SEC will no longer accept SRO proposed rule changes in paper format.

SEC Release No. 34-50486; File No. S7-18-04 (October 4, 2004).

 
 



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

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

DOL proposes amendments to prohibited transaction exemption of Employee Retirement Income Security Act of 1974 (“ERISA”)

October 8, 2004 3:15 PM

On September 14, 2004, the DOL proposed certain amendments to Prohibited Transaction Exemption (“PTE”) 84- 24, which is a class exemption that provides relief for certain transactions relating to the purchase, with plan assets, of investment company securities or insurance or annuity contracts, and the payment of associated sales commissions to insurance agents or brokers, pension consultants, or investment company principal underwriters that are parties in interest with respect to such plan. The proposed amendments to PTE 84-24 would extend the exemption to allow these transactions when an affiliate of the insurance agent or broker, pension consultant or investment company principal underwriter is a trustee with investment discretion over plan assets that are not involved in the transaction. In addition, the proposed amendments would modify the current definition of “nondiscretionary trust services” to specifically include services performed as a directed trustee.


The DOL reportedly proposed these amendments to address concerns regarding recent consolidation in the financial services industry.

Comments: comments must be received by the DOL on or before November 15, 2004.

Federal Register, Vol. 69, No. 177 (September 14, 2004).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC proposes rule regarding amendments to allow voluntary submission of supplemental tagged financial information using eXtensible Business Reporting Language (“XBRL” format)

October 8, 2004 3:10 PM
On September 27, 2004, the SEC issued proposed rule amendments to permit registrants to voluntarily submit supplemental tagged financial information using the XBRL format as exhibits to specified EDGAR filings under the Exchange Act and the Investment Company Act of 1940 (the “Investment Company Act”). According to the proposed rule release, the SEC intends to use the program to help it evaluate the usefulness of data tagging in general, and specifically the XBRL format, to registrants, investors, the SEC and the marketplace. The program is part of the SEC’s initiative to assess the benefits of tagged data and its potential for improving the timeliness, accuracy and analysis of financial disclosure in SEC filings. The SEC anticipates that the program will allow it to further examine the extent to which XBRL enhances:

  • the search capability of the EDGAR database to allow more efficient and effective extraction and analysis of specific data;
  • the capability to perform financial comparisons among registrants within industries; and
  • the ability to perform financial analysis of registrant financial data (e.g., ratio analysis), and whether it would reduce the resources necessary for data analysis.

The SEC noted that registrants choosing to participate in the program, which is expected to begin in early 2005, also will continue to file financial information in HTML or ASCII format, as currently required.

Comments: comments on the proposed rule amendment must be received by the SEC on or before November 1, 2004.

SEC Release Nos. 33-8496, 34-50453, 35-27894, 39-2498, IC-26622; File Number S7-35-04 (September 27, 2004).

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC staff issues legal bulletin narrowing ability of a company to exclude shareholder proposals

October 8, 2004 3:06 PM

On September 15, 2004, the SEC staff issued a legal bulletin providing guidance on Rule 14a-8 of the Securities Exchange Act of 1934 (the “Exchange Act”) regarding the grounds on which a company may exclude a shareholder proposal from proxy materials. The staff noted that its discussion of Rule 14a-8 in previous legal bulletins has resulted in companies inappropriately excluding from proxy materials certain shareholder proposals. In the September 15, 2004 legal bulletin, the staff stated that, going forward, it would not be appropriate for a company to exclude a shareholder proposal and/or supporting statement language in reliance on Rule 14a-8(i)(3) in the following circumstances:

  1. the company objects to factual assertions because they are not supported;
  2. the company objects to factual assertions that, while not materially false or misleading, may be disputed or countered;
  3. the company objects to factual assertions because those assertions may be interpreted by shareholders in a manner that is unfavorable to the company, its directors or its officers; and/or
  4. the company objects to statements because they represent the opinion of the shareholder proponent or a referenced source, but the statements are not identified specifically as such.

 The staff instead believes it would be appropriate for companies to address the above objections in their statements of opposition.

The staff stated that modification or exclusion of a shareholder proposal or a statement in a shareholder proposal may be appropriate under Rule 14a-8(i)(3) in the following circumstances:

  1. statements directly or indirectly impugn character, integrity or personal reputation, or directly or indirectly make charges concerning improper, illegal or immoral conduct or association, without factual foundation;
  2. the company demonstrates objectively that a factual statement is materially false or misleading;
  3. the resolution contained in the proposal is so inherently vague or indefinite that neither the shareholders voting on the proposal nor the company implementing the proposal, if adopted, would be able to determine with any reasonable certainty precisely what actions or measure the proposal requires. The staff noted that this objection also may be appropriate where the proposal and supporting statement, when read together, have the same result; and/or
  4. substantial portions of the supporting statement are irrelevant to a consideration of the subject matter of the proposal, such that there is a strong likelihood that a reasonable shareholder would be uncertain as to the matter on which such shareholder is being asked to vote.

The staff noted that a company seeking to exclude a shareholder proposal or statement on the basis that it contains materially false or misleading statements bears the burden of demonstrating objectively that the proposal or statement is materially false or misleading before the staff will concur with the company’s reliance on Rule 14a-8.

SEC Staff Legal Bulletin No. 14B (CF), September 15, 2004.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC settles enforcement action with adviser for improperly charging performance-based fees to registered funds

October 8, 2004 3:03 PM
In a no-action letter to Institutional Shareholder Services, Inc. dated September 15, 2004, (the “ISS Letter”) the SEC expanded upon a prior no-action letter to Egan Jones Proxy Services (the “Egan Jones Letter”). The Egan Jones Letter had indicated that an investment adviser may demonstrate that its vote of its clients’ proxies was not a product of a conflict of interest if the adviser voted the proxies in accordance with a pre-determined policy based on the recommendations of an “independent third party.” In the Egan Jones Letter, the staff noted that, under certain circumstances, a proxy voting firm may be considered an independent third party for purposes of making proxy voting recommendations for an adviser’s clients, even though the firm receives compensation from an issuer. The staff noted, however, that an investment adviser could breach its fiduciary duty of care to its clients by voting in accordance with a proxy service’s recommendations if the proxy service votes the proxies in its own interests (e.g., to further its business relationship with the underlying issuer). In the ISS Letter, the staff expanded upon the Egan Jones Letter by stating that a determination as to whether an investment adviser breached or fulfilled its fiduciary duty of care to fund shareholders when employing a proxy voting firm depends upon an evaluation of all relevant facts and circumstances, which will dictate what steps the adviser should take in evaluating the firm. The staff indicated that the process may include a case-by-case evaluation of the firm’s potential conflicts of interest as well as the following:

  • an assessment of the adequacy of the firm’s conflict procedures in light of the particular conflicts of interest the firm faces in making voting recommendations, including whether the procedures effectively (1) preclude the natural persons who make the firm’s proxy voting recommendations from obtaining access to information about the firm’s business relationships with issuers, and (2) insulate those persons from direct or indirect influence by the firm’s employees who know of those relationships;
  • an evaluation of the frequency with which the firm recommends voting in favor of the management of issuers that have engaged the firm to provide corporate services; and
  • a consideration of other means reasonably designed to ensure the integrity of the proxy voting process.

In addition, the staff noted that because a firm’s business and conflict procedures could change, an adviser should establish and implement measures reasonably designed to identify and address the firm’s conflicts that can arise on an ongoing basis, such as a requirement that the firm update the adviser of any relevant change in its business or conflict procedures.

Institutional Shareholder Services, Inc. NO-ACT, WSB File No. 0920200406 (September 15, 2004). See also, Egan Jones Proxy Services, NO-ACT, WSB File No. 0601200409, May 27, 2004.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC staff issues guidance on proxy voting conflicts of interest

October 8, 2004 2:59 PM
In a no-action letter to Institutional Shareholder Services, Inc. dated September 15, 2004, (the “ISS Letter”) the SEC expanded upon a prior no-action letter to Egan Jones Proxy Services (the “Egan Jones Letter”). The Egan Jones Letter had indicated that an investment adviser may demonstrate that its vote of its clients’ proxies was not a product of a conflict of interest if the adviser voted the proxies in accordance with a pre-determined policy based on the recommendations of an “independent third party.” In the Egan Jones Letter, the staff noted that, under certain circumstances, a proxy voting firm may be considered an independent third party for purposes of making proxy voting recommendations for an adviser’s clients, even though the firm receives compensation from an issuer. The staff noted, however, that an investment adviser could breach its fiduciary duty of care to its clients by voting in accordance with a proxy service’s recommendations if the proxy service votes the proxies in its own interests (e.g., to further its business relationship with the underlying issuer). In the ISS Letter, the staff expanded upon the Egan Jones Letter by stating that a determination as to whether an investment adviser breached or fulfilled its fiduciary duty of care to fund shareholders when employing a proxy voting firm depends upon an evaluation of all relevant facts and circumstances, which will dictate what steps the adviser should take in evaluating the firm. The staff indicated that the process may include a case-by-case evaluation of the firm’s potential conflicts of interest as well as the following:

  • an assessment of the adequacy of the firm’s conflict procedures in light of the particular conflicts of interest the firm faces in making voting recommendations, including whether the procedures effectively (1) preclude the natural persons who make the firm’s proxy voting recommendations from obtaining access to information about the firm’s business relationships with issuers, and (2) insulate those persons from direct or indirect influence by the firm’s employees who know of those relationships;
  • an evaluation of the frequency with which the firm recommends voting in favor of the management of issuers that have engaged the firm to provide corporate services; and
  • a consideration of other means reasonably designed to ensure the integrity of the proxy voting process.

In addition, the staff noted that because a firm’s business and conflict procedures could change, an adviser should establish and implement measures reasonably designed to identify and address the firm’s conflicts that can arise on an ongoing basis, such as a requirement that the firm update the adviser of any relevant change in its business or conflict procedures.

Institutional Shareholder Services, Inc. NO-ACT, WSB File No. 0920200406 (September 15, 2004). See also, Egan Jones Proxy Services, NO-ACT, WSB File No. 0601200409, May 27, 2004.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Form ADV Part II Update

October 8, 2004 1:30 PM
It was announced at the Investment Adviser Section Forum, during last week’s Annual Fall Conference of the North American Securities Administrators Association, that the National Association of Securities Dealers (“NASD”) is currently working to complete the next rollout of WebCRD by spring of 2005. After that rollout, the NASD will turn to completing the work necessary to enable Form ADV Part II to be filed electronically, which it anticipates will be completed by September of 2005. Although there was no clear indication given as to when the Securities and Exchange Commission (“SEC”) will issue the final rule implementing new Form ADV Part II, the technology to permit electronic filing will likely not be available for approximately one year.
 
 



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 files amicus brief to urge that public availability of information should not be a defense to plaintiff’s claim of inadequate prospectus disclosure

October 1, 2004 3:34 PM
The SEC filed an amicus brief with the United States Court of Appeals (Second Circuit) to support appellant plaintiffs challenging a district court’s ruling that a fund company did not have to disclose certain information in its prospectus it was publicly available elsewhere. The SEC urges in its brief that, contrary to the conclusion of the district court, if a prospectus may be materially misleading without certain information, the mere availability of that information elsewhere in the public domain does not allow the issuer to omit that information from its prospectus and rely upon the investor to find the information in the public domain.
In the district court case, the plaintiff-shareholder alleged that the defendant mutual fund failed to disclose several material facts in its prospectus and registration statement, including: (1) that the fund invested in the securities of companies with which the defendant, an affiliated broker-dealer, had or sought investment banking business; (2) that the affiliated broker-dealer issued misleading research reports about many of the securities held in the fund’s portfolio; and (3) the fund invested in companies at inflated market prices based on these misleading research reports to enhance the affiliated broker-dealer’s ability to obtain investment banking business.

The district court judge granted the defendants’ motion to dismiss on various grounds, including that the plaintiff failed to show that the omitted information was not publicly available. The district court held that the defendants could not be held liable “for failing to disclose that [the broker-dealer affiliate] provided investment banking services to companies in the [f]und’s portfolio if that information was already public.” The district court concluded that the defendants did not have to disclose alleged inherent conflicts of interest concerning the issuance of the affiliated broker-dealer’s research reports and the relationship between the broker-dealer’s research and investment banking department because the information regarding the alleged conflict of interest was public knowledge. The court also ruled that the defendants did not have to disclose that the broker-dealer’s analysts “may have held contrary views regarding the stocks rated” because the information also “was public knowledge.”

The SEC noted in its brief that the district court did not address whether the undisclosed information was actually known to investors, or whether it was so widely disseminated in sources other than the prospectus that its omission was not materially misleading to investors. The SEC stated that “investors should no more be expected to know all the information on EDGAR, or discoverable on the internet, than they would be expected to know all the information that could be found somewhere in the Library of Congress….and it is therefore unrealistic to suggest that investors are to be held responsible for knowing the entire contents of enormous databases.” The brief highlighted various precedents to point out that both the courts and the SEC have recognized that mere public availability of information is not an absolute defense to a claim for failing to disclose “material” information. The SEC also argued that if the district court’s ruling were accepted as a correct interpretation of the applicable law, it would create substantial gaps in the fundamental protections extended to investors by the securities laws, and particularly by the registration and disclosure requirements of the Securities Act of 1933.

Brief of the Securities and Exchange Commission, Amicus Curiae, US Ct. App. (2nd Cir.), No. 03-7978; Investment Company Institute Memorandum, “SEC Amicus Brief Concerning Public Availability of Information as a Defense to Claim of Inadequate Prospectus Disclosure (September 14, 2004).
 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

SEC approves National Association of Securities Dealers, Inc. (“NASD”) rule on broker-dealer CCO designation, CEO certifications, compliance, and supervisory policies and procedures

October 1, 2004 3:17 PM

Specifically, NASD new Rule 3013 requires that (1) each member firm designate a principal to serve as Chief Compliance Officer (“CCO”) and (2) each member’s Chief Executive Officer (“CEO”) certify annually to having in place processes to establish, maintain, review, modify, and test policies and procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules, and federal securities laws and regulations.

Rule 3013 requires the CEO to certify annually that senior executive management has in place processes to:

  • establish, maintain and review policies and procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations;
  • modify such policies and procedures as business, regulatory and legislative changes and events dictate; and
  • test the effectiveness of such policies and procedures on a periodic basis, the timing of which is reasonably designed to ensure continuing compliance with NASD rules, MSRB rules and federal securities laws and regulations.

Rule 3013 also requires the CEO to certify that those processes are evidenced in a report that has been reviewed by the CEO and submitted to the member’s board of directors and audit committee. The processes, at a minimum, must include one or more meetings annually between the CEO and CCO to:

  • discuss and review the matters that are the subject of the certification;
  • discuss and review the member’s compliance efforts as of the date of such meetings; and
  • identify and address significant compliance problems and plans for emerging business areas.

The new rule is intended to enhance investor protection by ensuring that senior management personnel focus increased attention on their firm's compliance and supervisory systems, and by fostering regular interaction between business and compliance officers.

The NASD will publish a Notice to Members regarding the new certification rule no later than November 9, 2004. The effective date of the rule will be 30 days following publication of that Notice to Members. Firms must designate a CEO by the effective date. CEOs of regulated firms must execute their first certifications within one year after that effective date. SEC Release No. 34-50347; File No. SR-NASD-2003-176.

 
 



This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
IRS CIRCULAR 230 DISCLOSURE:
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

ICI issues comment letter on SEC proposal requiring hedge fund advisers to register under the Investment Advisers Act of 1940 (“Advisers Act”)

October 1, 2004 8:29 AM
Registration

The ICI supports requiring hedge fund advisers to register with the SEC because registration will provide the SEC with meaningful information about this significant and growing segment of the securities markets, without adversely impacting the legitimate operations of hedge fund advisers. The ICI also points out that registration will enable the SEC to proactively address potentially fraudulent activities in the hedge fund industry. The ICI also disagrees with the recommendation by the dissenting SEC commissioners to delay SEC action by further study of the hedge fund industry. The ICI noted that the involvement of hedge fund advisers in the recent enforcement actions regarding late trading and market timing of mutual funds underscores the need for SEC oversight of hedge fund advisers. The ICI letter opposes the proposed alternative to the registration requirements of requiring hedge fund advisers to file notices and periodic reports with the SEC, noting that this approach does not provide the SEC with examination authority.

Performance records

The ICI letter notes the importance of the requirement that advisers keep records to support their performance claims, but recognizes that the proposed exception to the record-keeping rule would allow hedge fund advisers to communicate their performance histories to clients for periods prior to their registration with the SEC.

Minimum assets under management

The ICI supports not changing the minimum assets under management that an adviser must have to determine it eligibility to register with the SEC or the appropriate state securities authority. Under the current rules, hedge fund advisers with assets under management of less than $25 million will generally not be eligible for SEC registration, and hedge fund advisers with assets under management between $25 and $30 million will be eligible, but not required to, register with the SEC.

Offshore advisers and funds

The ICI supports the SEC’s proposal to limit the extraterritorial application of the Advisers Act by not applying the substantive provisions of the Advisers Act to offshore advisers to offshore funds; however, the letter urges the SEC to monitor this exception to ensure that there are not any unintended consequences. The letter also recommends that the SEC clarify that it will have access to certain records of offshore advisers to offshore funds to enable it to enforce a registered foreign adviser’s performance of its obligations to its U.S. clients and to ensure the integrity of U.S. markets. The letter supports not requiring advisers of regulated, publicly-offered offshore funds to register with the SEC, but urges the SEC to interpret the exception narrowly and monitor its use so that it cannot be used by hedge fund advisers to avoid registering with the SEC.

Private equity funds and venture capital funds

The ICI supports not requiring advisers to private equity funds and venture capital funds to register under the Advisers Act. The ICI stated that, to its knowledge, the SEC has not encountered significant enforcement problems with advisers to private equity and venture capital funds, and the SEC should focus its resources on hedge fund advisers given the tremendous growth of hedge funds and increase in enforcement cases involving hedge fund advisers.

Recordkeeping

The ICI supports the proposed amendment to the recordkeeping rule to include records of private funds for which the adviser acts as general partner. The letter noted that providing access to all records relating to the adviser’s activities with respect to the fund is essential to enable SEC examiners to determine whether the adviser is complying the Advisers Act.

Performance fee rule amendments

The ICI supports the proposal to permit current investors who are not qualified clients (i.e., those who do not have either a net worth of at least $1.5 million or at least $750,000 of assets under management with the adviser) to retain their existing investment in a hedge fund that charges a performance fee, and to add to their accounts. The letter noted that some current investors in hedge funds may not be qualified clients and the proposal would avoid disrupting existing arrangements with these investors.
 
 



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.