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.
President’s Working Group on Financial Markets Issues Report on Money Market Fund Reform Options
October 26, 2010 9:02 AM
The President’s Working Group (“PWG”) on Financial Markets has issued a report regarding options for further reforming money market funds in the wake of the September 2008 run on the funds. The PWG studied whether further reforms might reduce the systemic risk posed by money market funds’ susceptibility to runs by investors. The report discusses certain options for further reform, and the PWG asked that they be examined by the Financial Stability Oversight Council. Among the options discussed are requiring money market funds to adopt floating net asset values, establishing a private emergency liquidity facility, insurance for money market funds, and converting money market funds into special purpose banks. The report also advocates imposing new constraints on less regulated and unregulated alternatives to money market funds, in order to prevent investors from shifting assets away from money market funds into vehicles that the PWG believes pose a greater systemic risk. The report indicated that the SEC will solicit public comment to assist the Financial Stability Oversight Council in its consideration of the reform options.
The report is available at: http://treas.gov/press/releases/docs/10.21%20PWG%20Report%20Final.pdf
DOL Proposed an Expanded Definition of “Investment Advice” Fiduciary
October 22, 2010 1:20 PM
On October 22, 2010, the Department of Labor issued a proposed regulation that would expand the definition of “investment advice” fiduciary under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) to include potentially a wide array of retirement plan consultants, advisors and others providing services to retirement plans or their participants. An ERISA fiduciary is subject to ERISA’s fiduciary standards and also to the prohibited transaction rules of ERISA Section 406(b), which limit fees and compensation that a fiduciary may receive. The proposal would apply for purposes of Internal Revenue Code section 4975 as well, thus sweeping in brokers and others who provide advisory services to IRAs and other individual plans.
Section 3(21)(A) of ERISA provides a two-part test for determining fiduciary status as it relates to investment advice: (i) a person renders investment advice as to plan assets or it has authority or responsibility to do so and (ii) such person receives a fee or compensation for doing so. The current regulation under this provision has not been updated since its promulgation in 1975. The DOL has noted, however, that the retirement plan community has changed significantly since that time, and as a result, it has released a new proposed regulation to respond to these changes.
The new regulation would provide that a person gives “investment advice” if the person (i) gives advice or makes recommendations as defined by the regulation; (ii) directly or indirectly meets any of the four conditions; and (iii) receives a fee or other compensation for the advice or recommendations. The regulation also provides a list of limitations or exceptions to whether a person has given “investment advice.” Below is a discussion of each of these topics, particularly indicating how the proposed regulation is different than the current regulation.
Definition of Investment Advice
Under the proposed regulation, the types of advice and recommendations that may result in fiduciary status under ERISA section 3(21)(A)(ii) are: (A) advice, appraisals, or fairness opinions concerning the value of securities or other property; (B) recommendations as to the advisability of investing in, purchasing, holding, or selling securities or other property; or (C) advice or recommendations as to the management of securities or other property—to a plan fiduciary, plan participant, or plan beneficiary.
Appraisals and Fairness Opinions. Under the proposed regulation, giving appraisals and fairness opinions could cause a person to be a fiduciary. The proposal would supersede DOL Advisory Opinion 76-65A, which concluded that a valuation of closely held employer securities relied on in the purchase of the securities by an ESOP was not investment advice under the current regulation, although the proposed regulation’s application is not limited to the ESOP context. The DOL stated in the Preamble to the proposed regulation that it would expect “a fiduciary appraiser’s determination of value to be unbiased, fair, and objective, and to be made in good faith and based on a prudent investigation under the prevailing circumstances then known to the appraiser.”
Management of Securities. Advice and recommendations as to the management of securities includes advice and recommendations as to the exercise or rights appurtenant to shares of stock. For example, persons voting proxies for securities held as plan assets could be considered fiduciaries. Also, the proposed regulation provides that advice concerning the selection of investment managers is within the purview of investment advice. This change would capture retirement plan consultants and others who may assist plan committee in the selection of portfolio managers.
Circumstances Giving Rise to Fiduciary Status
A requirement of fiduciary status is that the person giving the “investment advice” must do so for a fee or other compensation, direct or indirect. The term fee or compensation includes, but is not limited to, brokerage, mutual fund sales, and insurance sales commissions.
Limitations or Exceptions
The proposed regulation provides certain limitations or exceptions to being treated as a fiduciary giving investment advice. The DOL has recognized that certain communications given in the context of selling a particular security may involve advice that should not result in fiduciary status, unless such person acknowledges ERISA fiduciary status. A person will be able to take advantage of this limitation if it can show that the recipient of the advice knows or reasonably should know that the person is providing the advice or making the recommendation in its capacity as a purchaser or seller of property, or as a an agent of such a purchaser or seller.
The proposed regulation also describes certain activities that will not, in and of themselves, be treated as rendering investment advice. First, the provision of certain investment education information and material—plan information, general financial and investment information, asset allocation models, and interactive models—alone, will not constitute investment advice. The proposed regulation also limits what constitutes investment advice when a service provider makes available a menu of investments or platform of investments from which a plan fiduciary selects a more limited menu that will be available under the plan.
The DOL provided a 90-day comment period, and the proposal is likely to receive substantial comment. The proposal provides that final regulations would take effect 180 days after their publication.
The proposal may be found at:http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24328
MSRB Interpretive Guidance On Political Contributions by PACs
October 21, 2010 3:57 PM
The MSRB announced on October 21, 2010 that the SEC had approved its proposed interpretive guidance regarding political action committees (“PACs”) affiliated with a broker, dealer or municipal securities dealer under Rule G-37, which addresses political contributions and prohibitions on conducting municipal securities business resulting from certain contributions. Rule G-37 provides generally that certain contributions to elected officials of municipal securities issuers by dealers, municipal finance professionals associated with dealers, and PACs controlled by dealers and their municipal finance professionals may result in the dealers being prohibited from engaging in municipal securities business with such issuers for a period of two years. The MSRB’s interpretation discusses factors that it believes may result in an affiliated PAC being viewed as controlled by a dealer or a municipal finance professional, which would result in its being treated as a dealer-controlled PAC for purposes of Rule G-37. Given the SEC’s approval of the interpretation, and the fact that the SEC explicitly modeled Advisers Act Rule 206(4)-5 after the MSRB’s Rule G-37, this interpretation may give some indication of how the SEC or its Division of Investment Management would view PACs affiliated with investment advisers under Rule 206(4)-5, which defines the term “covered associate” as including a PAC controlled by the investment adviser or by any of its covered associates.
For more information, please see:http://www.msrb.org/Rules-and-Interpretations/Regulatory-Notices/2010/2010-45.aspx
SEC Charges Hedge Fund Managers With Fraud Involving Valuation of Side Pocket Investment
October 19, 2010 2:37 PM
On October 19, 2010, the SEC announced that it has filed a complaint in the federal district court in Atlanta charging two portfolio managers and their investment advisory businesses with defrauding investors in a hedge fund by overvaluing illiquid assets that were held in a side pocket of the fund. In particular, the SEC alleged that the managers placed the fund’s investment in certain illiquid securities in a side pocket and valued them in a manner that was inconsistent with the fund’s valuation policies and contrary to an undisclosed internal assessment. The SEC asserts that this resulted in an overvaluation of the assets by as much as 60% over the managers’ internal valuations. In addition, the SEC also alleges that the managers stole investor money to pay for their personal investments and made material misstatements about their trading positions to an issuer in connection with their participation in a PIPE offering.
For more information, please see: http://www.sec.gov/litigation/litreleases/2010/lr21699.htm
SEC Proposes Rules on “Say on Pay” and Reporting of Proxy Votes
October 18, 2010 2:40 PM
On October 18, 2010, the SEC proposed rules requiring public companies to give shareholders the right to vote periodically on executive compensation and “golden parachute” arrangements. The non-binding votes are called for under provisions of the Dodd-Frank Act, and would be required at least once every three years beginning with a company’s first annual shareholders’ meeting taking place after January 21, 2011. The proposal also requires companies to provide certain disclosures in connection with these votes, including whether, and if so how, the companies have considered the results of previous votes.
The SEC also proposed reporting rules that would require institutional investment managers to report their votes on executive compensation and “golden parachute” arrangements to the SEC at least annually, unless such votes are already reported to the SEC under other rules. The proposed reporting rules would apply to every institutional investment manager that manages at least $100 million, in the aggregate, of certain equity securities. The managers’ reports would need to identify the securities voted, describe the matters voted on, disclose the number of shares over which the manager had voting power and the number actually voted, and indicate how the manager voted. Reports would be due by August 31 of each year, covering the twelve months ended June 30.
The public comment period for both proposals ends November 18, 2010.
For more information, please see: http://www.sec.gov/news/press/2010/2010-198.htm
SEC Staff Grants No-Action Request Under Custody Rule
October 12, 2010 3:19 PM
On October 12, 2010, the SEC’s Division of Investment Management issued a letter indicating that it would not object if an investment adviser that is subject to Rule 206(4)-2 under the Advisers Act and wants to avail itself of the annual audit provision of Rule 206(4)-2(b)(4) engages an auditor that also audits a broker or dealer to audit a private investment fund’s financial statements. Rule 206(4)-2 requires that the audit be conducted by an independent public accountant that is registered with, and subject to regular inspection by the Public Company Accounting Oversight Board (“PCAOB”). However, only auditors to public companies are currently subject to regular PCAOB inspections. The Dodd-Frank Act authorized PCAOB to develop rules to establish an inspection program for auditors of brokers and dealers. The Division said it would not object if an investment adviser uses an auditor that audits brokers or dealers, but only for financial statements issued before the earlier of PCAOB’s adoption rules regarding the inspection of such auditors or July 21, 2011.
The Division’s position is subject to several conditions, including that the auditor must have been registered with PCAOB and engaged to audit the financial statements of a broker or dealer on July 21, 2010, and continue to be registered with PCAOB and engaged to audit the financial statements of a broker or dealer as of the issuance of the private investment fund’s financial statements used to satisfy the custody rule’s annual audit provision. Further, the investment adviser would need to notify each investor in the private investment fund before the financial statements are distributed that the auditor is not subject to regular inspection by PCAOB.
The letter is available at:
SEC Proposes Family Office Exclusion
October 12, 2010 2:18 PM
On October 12, 2010, the SEC proposed Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940 (“Advisers Act”), which would define the term “family office” for purposes of Section 202(a)(11)(G) of the Advisers Act. Enacted by Congress as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), Section 202(a)(11)(G) excludes “family offices,” as defined by the SEC, from the definition of “investment adviser” and therefore from regulation under the Advisers Act. Comments on the proposed rule must be received by the SEC on or before November 18, 2010.
The proposed rule would define a family office generally as a company that has no clients other than “family clients,” defined as including certain “family members,” foundations, trusts and other entities connected with them, and “key employees.” In addition, a family office must be wholly owned and controlled by family members, and must not hold itself out to the public as an investment adviser. The proposed rule would largely codify the conditions of exemptive orders that the SEC has previously issued to family offices, but it does not abrogate those prior orders.
The proposed definition would not include multi-family offices, i.e., family offices providing advisory services to more than one family, from the definition of investment adviser. The SEC asked for comment on this, as well as other matters, such as the scope of the definitions of “family member” and “key employee.” The SEC also stated that family offices that do not satisfy the conditions of the final rule would still be able to seek exemptive orders. As a practical matter, however, seeking an individual exemption is a slow process.
The proposing release is available at: http://www.sec.gov/rules/proposed/2010/ia-3098.pdf
Financial Stability Oversight Council Holds Inaugural Meeting
October 11, 2010 8:49 AM
On October 1, 2010, the Financial Stability Oversight Council (“FSOC”) held its inaugural meeting. The FSOC was established under the Dodd-Frank Wall Street Reform and Consumer Protection Act to (1) identify risks to U.S. financial stability that could arise from the financial distress or failure of large, interconnected bank holding companies or nonbank financial companies; (2) promote market discipline by eliminating expectations on the part of shareholders, creditors, and counterparties of those companies that the government will shield them from losses in a failure; and (3) respond to emerging threats to the stability of U.S. financial markets.
The FSOC’s Chair is the Secretary of the Treasury, Timothy Geithner; the other voting members are the heads of various government agencies. The following voting members were in attendance: Sheila Bair, Chairman of the Federal Deposit Insurance Corporation; Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System; Edward DeMarco, Acting Director of the Federal Housing Finance Agency; Gary Gensler, Chairman of the Commodity Futures Trading Commission; Debbie Matz, Chairman of the National Credit Union Administration; Mary Schapiro, Chairman of the U.S. Securities and Exchange Commission; and John Walsh, Acting Comptroller of the Currency. The head of the Consumer Financial Protection Bureau also will be a voting member of the FSOC.
In the meeting, the FSOC approved (1) the FSOC’s Bylaws; (2) the FSOC’s Transparency Policy; (3) an Advance Notice of Proposed Rulemaking on designating nonbank financial companies for heightened supervision; (4) a Notice and Request for Information regarding the FSOC’s “Volcker Rule” study and recommendations; and (5) an Integrated Implementation Roadmap for both the FSOC and its independent member agencies, which outlines a coordinated timeline of goals to implement the Dodd-Frank Act.
For more information, please see: http://www.ustreas.gov/press/releases/tg888.htm
Court Rules on Morgan Keegan's Motion to Dismiss in Class Action
October 11, 2010 8:46 AM
On September 30, 2010, the District Court for the Western District of Tennessee granted in part and denied in part Morgan Keegan’s motion to dismiss in a class action suit by investors in certain of Morgan Keegan’s short, medium and long duration bond funds. Plaintiffs alleged that Morgan Keegan misled investors through marketing materials that failed to disclose the risks associated with the funds’ investment in sub-prime mortgages. In addition, plaintiffs alleged Morgan Keegan inflated the value of the sub-prime securities to conceal investor losses. Plaintiffs brought claims under the Investment Company Act of 1940, the Securities Act of 1933, and the Securities Exchange Act of 1934. Defendants filed a motion to dismiss, which the court granted in part and denied in part.
The court dismissed plaintiffs’ claims under Sections 13, 22, 30, and 34(b) of the Investment Company Act, holding that there was no private right of action under these sections of the Investment Company Act. The court expressly followed the Second Circuit’s analysis in Olmstead and held that the right to enforce the statute rests with the Securities and Exchange Commission, rather than private litigants. See Olmsted v. Pruco Life Ins. Co. of N.J., 283 F.3d 429 (2d Cir. 2002). The court also dismissed plaintiffs’ claim under Section 47(b) of the Investment Company Act insofar as plaintiffs were not parties to the underwriting agreement between the funds and Morgan Keegan and lacked standing to seek rescission of that contract.
The court also dismissed plaintiffs’ claims under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, finding that the plaintiffs failed to adequately plead scienter.
The court did not dismiss the plaintiffs’ Securities Act claims. Although defendants had urged the court to dismiss the claims on the grounds that investor losses were not the result of any disclosure of allegedly misrepresented information insofar as the portfolios had been marked-to-market on a daily basis, the court concluded that loss causation is an affirmative defense under the Securities Act and that plaintiffs did not need to plead loss causation as an affirmative element of their claim.
Staffs of the SEC and CFTC Issue Flash Crash Report
October 11, 2010 8:43 AM
On September 30, 2010, the staffs of the SEC and CFTC issued a joint report on their findings regarding the market events of May 6, 2010, when the prices of many U.S.-based equity products experienced an extraordinarily rapid decline and recovery. The report will be presented to the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues at the request of the Senate Committee on Banking, Housing, and Urban Affairs, Senate Committee on Agriculture, Nutrition and Forestry, and the House Committee on Financial Services. This report supplements and builds upon the initial analyses of May 6 performed by the SEC and CFTC staffs released in the May 18, 2010 report entitled Preliminary Findings Regarding the Market Events of May 6, 2010 – Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issues.
The report may be found at: http://www.sec.gov/news/press/2010/2010-179.htm
SEC Brings Unregistered Investment Company Case
October 11, 2010 8:39 AM
On September 17, 2010, the SEC instituted administrative cease-and-desist proceedings under Section 9(f) of the Investment Company Act against Daxor Corporation, alleging that Daxor is an unregistered investment company in violation of Section 7(a). Daxor is a public company, which holds itself out as a medical device manufacturing company with additional biotechnology services. The SEC’s Division of Enforcement alleges that Daxor is an investment company as defined in Section 3(a)(1)(C) of the Investment Company Act because it engages in the business of investing and trading in securities and 40% or more of its total assets (other than Government securities and cash items) consist of investment securities.
The Division of Enforcement alleges that although Daxor’s principal product has been developed and available for sale since at least 1998, Daxor has never realized an operating profit or even significant operating revenue. Instead, Daxor generates income from its investment securities, which, as of June 30, 2010, had a reported market value of approximately $49 million and constituted 96% of the company’s assets. Furthermore, the SEC alleges that over the last five and a half years, Daxor’s investment securities have consistently constituted more than 90% of its assets and its net investment income has amounted to more than 750% of its gross operating revenues.
Daxor has indicated that it intends to contest the Division’s allegations.
For more information, please see: http://www.sec.gov/litigation/admin/2010/ic-29417.pdf
MSRB Announces Changes in its Mandate and Mission
October 1, 2010 3:40 PM
On October 1, 2010, the MSRB announced that, consistent with provisions of the Dodd-Frank Act, its mission is no longer solely the protection of investors and the public interest, but henceforth will include the protection of the state and local government entities that issue the instruments whose sale is subject to MSRB regulation. The MSRB also announced its intention to engage in rulemaking to adopt a comprehensive set of rules regulating municipal advisors, as directed by the Dodd-Frank Act, noting that municipal advisors are required to be registered with the SEC initially, but will need to be registered with the MSRB once the necessary rules have been adopted. Currently, MSRB rules apply only to dealers, not municipal advisors.
For more information, please see: