This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
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Cayman Islands Court Reaffirms High Level Supervisory Role of Non-Executive Directors of Cayman Islands Investment Funds
September 12, 2011 9:41 AM
On August 26, 2011, the Grand Court of the Cayman Islands found two non-executive directors of a Cayman Islands hedge fund liable for $111 million in damages for losses due to willful neglect or default of their duties by consciously choosing not to perform their duties to the fund in a meaningful way. The court took the opportunity to outline the duties of non-executive directors noting that such directors were expected to perform a high-level supervisory role. While the court primarily reaffirmed existing law as to the role of directors generally, this was the first time a Cayman Islands court addressed the role of directors in the context of investment funds.
It is noteworthy that the directors had been appointed as “independent,” non-executive directors, when in fact they were the brother and step-father of the principal of the fund’s investment manager. While this met the independent director requirement for the fund’s shares to be listed on the Irish Stock Exchange, the court believed that the principal chose his family members as directors with the intent that they would not provide any real oversight of the fund.
In finding the directors liable for failing to meet their duties, the court noted, among other things, that the directors: failed make a sufficient inquiry as to whether the fund’s offering memorandum was accurate and complete; signed minutes for board meetings that never occurred; signed pro forma minutes prepared by the investment manager in advance of meetings; signed other documents (including the fund’s financial statements, management representation letters and side letters) without making any inquiries regarding the documents; and during their six-year tenure as directors never requested that representatives of the fund’s administrator, auditors, or investment manager (other than the principal) attend a board meeting. The directors’ lack of oversight resulted in the investment manager entering into transactions that violated the fund’s investment restrictions and inflated the fund’s net asset value by entering into transactions with a related party.
While providing valuable commentary on practices expected of directors to investment funds, the case should be viewed in light of its unique facts (e.g., the familial relationship between the directors and the principal of the investment manager and the particularly egregious conduct of the directors). Nonetheless, in light of this case, directors and investment managers should re-evaluate their fund governance practices.
For more information, please see the judgment at:http://www.opalesque.com/files/20110826_Weavering_Judgement.PDF
Reminder - Compliance Date for FINRA “Anti-Spinning” Rule Approaching
September 12, 2011 9:40 AM
On September 26, 2011, the provisions of FINRA Rule 5131(b) will become effective. The rule prohibits, among other things, the practice of “spinning,” or the allocation by certain underwriters of new issues to the executive officers and directors of current or potential investment banking clients in return for such clients’ business. Before the compliance date, advisers to private funds that invest in new issues will need to update fund offering documents and subscription documents and request certain information from fund investors to verify that the investors are eligible to participate in new issues under Rule 5131.For more information, please see the adopting release for Rule 5131 at: http://www.sec.gov/rules/sro/nasd/2010/34-63010.pdf
SEC Seeking Public Comment on Plan for Retrospective Reviews of Existing SEC Rules
September 12, 2011 9:39 AM
On September 6, 2011, the SEC issued a release seeking public comment on the plan it should use to conduct retrospective reviews of existing SEC rules. The release was issued in response to an Executive Order issued by President Obama on July 11, 2011, which suggested that independent regulatory agencies revisit existing regulations to determine whether such regulations need to be revamped. In addition to seeking general comments on the scope and elements of the rule review plan, the release also requests comments on, among other things: the factors to be used in selecting and prioritizing rules for review; the frequency of reviews; the existence of relevant data to be considered in selecting and prioritizing rules for review; the extent to which reviews should include reviewing financial economic literature or conducting empirical studies; how reviews should address data regarding the benefits of SEC rules in preventing fraud or other harms to financial markets and in protecting investors; and how to improve public participation in the rulemaking process.
Comments are due by October 6, 2011.
This process of establishing a plan for retrospective reviews of SEC rules theoretically could have a significant affect on key regulations that apply to the investment management industry.
For more information, please see the release at:
SEC Issues Concept Release on Investment Company Use of Derivatives
September 12, 2011 9:37 AM
As briefly mentioned in the September 1, 2011 Investment Management News Summary, on August 31, 2011, the SEC issued a concept release and request for public comment on a wide range of issues under the Investment Company Act of 1940 to address the use of derivatives by registered investment companies. The concept release discusses and seeks public comment on issues such as: the benefits, risks and costs of using of derivatives; the application of the restrictions on “senior securities” under Section 18 of the Investment Company Act to derivatives; the application of limitations on leverage under the Investment Company Act to derivatives; the application of restrictions on investments in securities-related issuers under the Investment Company Act to derivatives; the application of portfolio diversification and concentration provisions of the Investment Company Act to derivatives; and valuation of derivatives.
A few key observations are:
§ The concept release generally takes an open-minded approach to the regulation of investment company use of derivatives.
§ Surprisingly, however, the concept release does not expressly state or request comment as to whether any substantive regulation of investment company use of derivatives is desirable or authorized by the Investment Company Act or whether the mere disclosure of the extent to which investment companies use derivatives would be sufficient.
§ Although the concept release summarizes many of the existing no-action positions taken by the Division of Investment Management, the SEC expressly disclaims adoption of any of the positions discussed in the release. Accordingly, the concept release does little to indicate a future regulatory approach by the SEC for investment company use of derivatives. This suggests that the current approach of the SEC to not act on exemptive applications for exchange-traded funds that invest to a significant degree in derivatives is likely to continue for the foreseeable future.
Comments on the concept release are due by November 7, 2011.
For more information, please see the concept release at:
Massachusetts Adopts New Regulation Regarding the Use of Expert Networks
September 1, 2011 9:35 AM
On August 8, 2011, the Massachusetts Securities Division adopted new final regulations regarding the use of investing consulting services (the “Expert Network Rule”). The Expert Network Rule becomes effective on December 1, 2011 and will require certain investment advisers who retain investment consulting services for compensation paid either directly to the consultant or indirectly through a firm providing matching or expert-network services, to obtain a signed certification from the consultant. The certification must: (i) describe all confidentiality restrictions that are relevant to the proposed consultation that the consultant has, or reasonably expects to have; (ii) affirmatively state that the consultant will not provide confidential information to the adviser; (iii) be signed and dated by the consultant; and (iv) represent that the certification is accurate as of the date thereof and as of future consultations. In addition, under the Expert Network Rule, investment advisers that receive material confidential information through consultations are prohibited from trading on such information.
The Expert Network Rule defines “matching or expert network service” to mean a firm that matches consultants with investment advisers for compensation and defines “investment consulting services” to mean consultations for the purposes of assisting investment advisers’ decisions as to whether to buy, sell, or abstain from buying or selling, positions in client accounts. Further, the Expert Network Rule defines “confidential information” to mean any non-public information, which one is bound by a confidentiality agreement or fiduciary (or similar) duty not to disclose. It is worth noting that the certification requirement under the Expert Network Rule addresses confidential information and not material confidential information.
The Expert Network Rule will apply to investment advisers that are registered or required to be registered with Massachusetts. While neither the Expert Network Rule nor the adopting release explicitly address the issue, it appears that SEC-registered investment advisers that do business in Massachusetts will not be subject to the Expert Network Rule. At a public hearing held on June 22, 2011, representatives of the Massachusetts Secretary of State’s office made an unofficial statement that the Expert Network Rule was not intended to apply to SEC-registered investment advisers. This position is further supported by the preemption of state regulation of the registration, licensing, or qualification of SEC-registered investment advisers under the National Securities Markets Improvement Act of 1996.
The Division also noted that it will not object to the procurement of electronic signatures for the certification, so long as investment advisers retain the electronic documents in a manner that is consistent with general books and records requirements.For more information, please see: http://www.sec.state.ma.us/sct/sctnewregs/description_of_changes_to_proposed_regs.pdf
SEC and CFTC Joint Study Seeks Comments Regarding Whether Stable Value Contracts Are “Swaps”
September 1, 2011 9:33 AM
On August 18, 2011, as part of a joint study mandated by The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC and CFTC issued a release soliciting comments from industry participants as to whether stable-value contracts (“SVCs”) fall within the definition of “swap” under the Commodity Exchange Act or “security-based swap” under the Exchange Act. SVCs are conditional guarantees issued to stable value funds (“SVFs”) that provide for the redemption of shares of the SVF at a contractual “book value” that is generally less volatile than the market value of the SVFs underlying assets. If SVCs are found to be within the definition of swap or security-based swap, the SEC and CFTC must jointly determine whether an exemption for SVCs from the definition of swap or security-based swap is appropriate. Comments must be received by September 26, 2011.
The release acknowledges the popularity of SVFs in 401(k) and other defined contribution plans among options designed to provide principal preservation, liquidity, and current income. Further, the release acknowledges the central role of SVCs as components of SVFs, providing the guarantee or “wrap” that insures the SVF at book value, and seeks responses to a variety of questions including but not limited to: whether SVCs possess characteristics that would cause them to be defined as swaps; what facts and considerations would support an exemption from the definition of swaps; what benefits and risks do SVCs pose for investors in SVFs; and whether SVC providers and SVFs pose systemic risk concerns.
For more information, please see:http://www.sec.gov/rules/other/2011/34-65153.pdf
“Janus” Standard Does Not Apply to Claims Under Exchange Act Section 17(a) or Investment Company Act Section 34(b) Claims
September 1, 2011 9:32 AM
On August 1, 2011, the United States District Court for the Northern District of California granted a motion for reconsideration of its order in an SEC enforcement action following the decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011) (“Janus”). The court held, among other things, that the principle in Janus that an investment adviser could not be held liable for false statements in an action under Rule 10b-5 for false prospectus statements because the adviser did not “make” the statements, does not apply to claims under Section 17(a) of the Securities Exchange Act of 1934 or Section 34(b) of the Investment Company Act. As to Section 17(a) under the Exchange Act, the court held that Janus does not apply because Section 17(a) does not use the word “make.” As to Section 34(b) of the Investment Company Act, while the word “make” is used in the statute, the court held that Janus does not apply as Janus “was not a touchstone to change myriad laws that happen to use the word “make” — it was a decision interpreting primary liability under Rule 10b-5.”
For more information, please see the order at:
For more information on the Janus case, please see the WilmerHale Update dated June 29, 2011:http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=9874
FINRA Self-Reporting Rule Becomes Effective
September 1, 2011 9:31 AM
On July 1, 2011, Financial Industry Regulatory Authority, Inc. (“FINRA”) Rule 4530 became effective. Rule 4530 requires FINRA member firms to report to FINRA certain internal and external findings of violative conduct and quarterly statistical and summary customer complaint information. Under Rule 4530, investment advisers that are also FINRA member firms (i.e., dual registrants) are now required to report violations of, among other things, securities-, commodities-, financial- or investment-related laws, rules, or regulations even if the conduct relates solely to investment advisory activities (e.g., violations of the Investment Advisers Act of 1940).For more information, please see FINRA Rule 4530 at: http://finra.complinet.com/en/display/display.html?rbid=2403&record_id=13324&element_id=9819&highlight=4530#r13324
SEC Votes to Issue Concept Release on Investment Company Use of Derivatives and Releases on Rule 3a-7 and Section 3(c)(5)(C)
September 1, 2011 9:30 AM
On August 31, 2011, the SEC held an open meeting in which the commission unanimously voted to issue a concept release and request public comment on a wide range of issues under the Investment Company Act of 1940 to address the use of derivatives by registered investment companies. The concept release is another effort by the SEC to address the use of derivatives by registered investment companies. The SEC's efforts in this area date back to an interpretive release issued in 1979, in which it asserted that certain trading practices, such standby commitment agreements, were limited by Section 18 of the Investment Company Act. Since then, the SEC has issued numerous no-action letters attempting to set standards for investment company use of derivatives under Section 18. The SEC's authority under Section 18 is limited to transactions involving the issuance of “senior securities”, however, meaning that most derivatives transactions are not covered by Section 18.
In April 2009, the SEC's then Director of the Division of Investment Management asked the Subcommittee on Investment Companies and Investment Advisers of the American Bar Association’s Section of Business Law’s Committee on Federal Regulation of Securities to address the concerns raised by investment company use of derivatives. In March 2010, the SEC unilaterally announced that it was deferring consideration of applications for exchange traded funds (“ETFs”) relying on derivatives to achieve their investment objectives. It characterized its decision as a chance to rethink the regulatory protections for ETF use of derivatives. In July 2010, the ABA Subcommittee issued the report requested by the SEC, which recommended various changes and clarifications to SEC interpretations as to investment company use of derivatives.
The concept release is expected to seek comment on specific issues related to investment companies’ use of derivatives, such as measuring leverage created by use of derivatives and valuation of derivatives by investment companies.
For more information, please see the concept release at:
In addition, the SEC voted to issue an advance notice of public rulemaking on Rule 3a-7, which excludes certain asset-backed issuers from the definition of investment company and a concept release seeking comment on the application of Section 3(c)(5)(C) to real estate investment trusts and other companies that invest in mortgages and mortgage-related instruments.
For more information, please see the releases at: