The SEC recently approved amendments to the NASD Conduct Rules that will exempt certain interval funds from the filing requirements and limitations on underwriting compensation of NASD Conduct Rule 2710 (the "Corporate Financing Rule") and instead subject such offerings to the sales charge limitations of Rule 2830.
The Corporate Financing Rule regulates the underwriting terms and other arrangements of public offerings of securities, and currently contains an exemption for offerings of securities of investment companies registered under the Investment Company Act of 1940, other than closed-end management investment companies. Under the approved rule change, a closed-end fund that makes periodic repurchase offers pursuant to Rule 23c-3(b) under the 1940 Act and offers its shares on a continuous basis pursuant to Rule 415(a)(1)(xi) under the Securities Act of 1933 will also be exempt from the provisions of the Corporate Financing Rule. Corresponding changes will subject such offerings to the sales charge limitations of Conduct Rule 2830.

According to the SEC release, NASDR will consider individual requests for similar exemptions from the requirements of the Corporate Financing Rule with respect to closed-end investment companies that make periodic self-tenders in compliance with Rule 13e-4 and Schedule to under the Securities Exchange Act of 1934. SEC Rel. 34-42965; File No. SR-NASD-99-74.

NASD Regulation, Inc. ("NASDR")recently issued a Regulatory & Compliance Alert regarding NASD members’ use of graphic presentations of performance. As described below, the Alert summarizes a recent NASD settlement, and outlines areas of concern in the use of graphic performance presentations.

Recent Settlement. The Alert summarizes a recent NASD settlement in which NASDR censured and fined a mutual fund distributor and NASD member $100,000 for distributing allegedly inaccurate mutual fund advertisements and for violating other NASD advertising rules. Specifically, NASDR alleged that the firm published eight advertisements containing inaccurate graphs showing the performance of a mutual fund that, according to NASDR, did not accurately portray increases and decreases in the value of a hypothetical investment. (See Industry News Summary, Week of 5/15/00 to 5/22/00).

Areas of Concern. The Alert also provides brief discussions of five areas of concern in the use of graphic presentations of performance that have surfaced in NASDR's review of member filings of advertisements and sales literature:

• Labeling. Members must ensure that the axes and baselines of graphs are labeled clearly so that the reader can understand how the performance data relates to the graph.
• Disclosure. The text accompanying a graph must clearly state its purpose and significance. Advertisements and sales literature that contain graphs illustrating the historic performance of a hypothetical investment in a product must disclose the relevant assumptions.
• Starting Points or Baselines of Graphs. Members must ensure that the starting point of a graph fairly reflects the performance of the product without exaggeration.
• Scale. While the NASD Conduct Rules do not require that members use a specific scale or format when depicting performance using graphs, the prohibition of exaggerated or misleading statements or claims requires that members exercise care in choosing the appropriate scale for presentations of performance information.
• Comparisons. While members may use graphs that compare an investment in a product with a hypothetical investment in a benchmark index over the same period, in accordance with the NASD Conduct Rules, members must ensure that the comparative index is appropriate and provides the reader with a sound basis for evaluating the facts with respect to the product.

NASD Regulation, Inc., Regulatory & Compliance Alert (Summer 2000).

The U. S. Court of Appeals for the Second Circuit recently affirmed two judgments entered by the U.S. District Court for the Southern District of New York dismissing complaints by certain brokerage customers against their broker-dealers. The plaintiffs had alleged that the broker-dealers violated Section 10(b) of the Securities Exchange Act of 1934 and the rules thereunder by failing to disclose their receipt of Rule 12b-1 fees from money market funds, and of payments from the funds' advisers, for automatic sweeps of customers' free cash balances into those funds. The district court dismissed the plaintiffs' claims, finding that disclosures made in the funds' prospectuses and statements of additional information (SAIs) were sufficient to negate a claim of fraudulent intent.

In affirming the dismissal of the complaints, the Court of Appeals relied heavily on an amicus brief filed by the SEC at the Court's request. The SEC's brief addressed the application of Rule 10b-10 to the payments at issue. Although the SEC disagreed with the district court's Rule 10b-10 analysis, it concluded that the disclosures made in the funds' prospectuses and SAIs satisfied the requirements of Rule 10b-10. (See Weekly News Summary, Week of 2/21/00 to 2/28/00).

In its decision, the Court stated that it is bound by the SEC's interpretation of the regulation, i.e., that the general disclosures made by the fund prospectuses and SAIs are sufficient to satisfy the broker-dealers' duty under Rule 10b-10 to disclose third-party remuneration. The Court found that:

• the SEC reasonably determined that Rule 10b-10 applied to the payments,
• concurred with the SEC’s conclusion that the broker-dealers could rely on prospectus and SAI disclosure to satisfy their Rule 10b-10 requirements, and
• agreed with the SEC that a 1979 no-action letter concerning disclosure of sales charges and other fees under Rule 10b-10 does not apply to payments to broker-dealers made by third parties.

Although the Court questioned whether the general disclosures made in the prospectuses and SAIs (that payments were made by the funds and their advisers to broker-dealers for their assistance) would actually alert an investor that "his broker-dealer received such payments," the Court could not conclude that the SEC's interpretation of Rule 10b-10 is plainly erroneous. The Court also acknowledged that if an investor knows his uncommitted balances are automatically swept by his broker-dealer into a specific money market fund and the prospectus for that fund reveals that the fund and its adviser pay fees to broker-dealers for their assistance, it might be reasonable to expect an investor to piece together this information and conclude that his broker-dealer receives fees from that money market fund. On this basis, the Court adopted the SEC's determination that no Rule 10b-10 violation occurred.

The Court also affirmed the dismissal of the plaintiffs' Rule 10b-5 claims. The Court conceded that the district court's scienter analysis raised "serious concerns," in that the Court has never held that public disclosures may, as a matter of law, negate allegations of fraudulent intent. However, the Court found that the securities fraud claims failed because the information that plaintiffs claimed had been omitted was not material as a matter of law. The Court stated that, because the SEC has decided precisely what type of disclosure is necessary to reveal a conflict of interest arising from third-party payments to broker-dealers in the context of Rule 10b-10, the Court would not undermine the SEC's interpretation of its regulation by requiring even greater disclosure about that conflict of interest under the general antifraud provisions of Rule 10b-5.

Donald Press v. Quick & Reilly, Inc., 2000 U.S. App. LEXIS 15957.

In January the SEC filed a complaint in the U.S. District Court for the Northern District of Illinois against a company and its principal (the "defendants"). The defendants operated a web site that consisted of two areas - one area was accessible to the general public and the other was accessible only to fee paying members. Fee paying members had the option of paying an additional fee to participate in a members-only "chat room" in which the defendant conducted two-way electronic dialogues with members about his stock picks and investment advice.

The SEC's complaint alleged the defendants:

• violated the registration provisions of the Investment Advisers Act of 1940 (the "Advisers Act")
• engaged in a scheme to defraud users of the site, in violation of securities antifraud laws, by, among other things:
• engaging in undisclosed trading, before recommending particular stocks on the web site, of the recommended stocks
• posting of false performance results, and
• recommending the stock of an issuer without disclosing that they had indirectly received compensation from that issuer.

The defendants recently filed a motion to dismiss the complaint, alleging that they are not subject to the Advisers Act because they do not provide personalized investment advice. They also argued that the SEC was attempting to regulate their editorial content regarding investing in violation of their First Amendment rights. They also argued that the SEC's allegation that they failed to disclose material information to investors (i.e., their undisclosed trading) failed to state a claim because the defendants did not have a duty to disclose the alleged information. The court, however, denied the defendants' motion to dismiss, reasoning as follows:

Advisers Act Registration. The court noted that the Advisers Act definition of "investment adviser" includes "those involved in the "business of rendering personalized investment advice, including publishing activities that are a normal incident thereto." The Advisers Act then excludes those that it considers as not engaged in this personalized activity by providing certain exclusions, among them, the "publishers exclusion." To qualify for the publisher's exclusion, however, according to the Supreme Court in Lowe v. SEC, 472 U.S. 181 (1985), the publication must be a "bona fide" publication that had "general and regular" circulation. While the Advisers Act does not define these terms, the court looked to the Lowe decision, in which the Supreme Court stated that a "bona fide" publication contains disinterested commentary and analysis as opposed to promotional material disseminated by a "tout." Moreover, the court noted that, according to Lowe, publications with a "general and regular" circulation do not include bulletins sent out from time to time on the advisability of buying and selling stocks.

Under this standard, the court found that the defendants did not qualify for the publishers exclusion. The defendants argued that they did not provide personalized services because they did not tell subscribers on an individualized basis to buy, sell, or hold securities. However, the court noted that the defendants' publications "may be Internet versions of precisely what the publications in Lowe were not - "personal communications masquerading in the clothing of newspapers, new magazines, or financial publications." The court also noted that, even if the defendants' advice was not tailored to a subscriber's specific needs, it would not make the defendants' publications "bona fide." The court also found that, despite the fact that the defendants made daily postings of stock picks and information, it was not clear that that the defendants' publication had a "general and regular" circulation, as opposed to advice that is "timed to specific market activity, or to events affecting or having the ability to affect the securities industry."

First Amendment. The defendants argued that application of the anti-fraud provisions of the Advisers Act to them would impermissibly limit their speech in violation of the First Amendment. The court found the defendants' argument "without force" and noted that "fraudulent speech is simply not entitled to First Amendment protection of any kind."

Duty to Disclose. The court noted that fraud liability does not attach for failure to disclose material information unless a party is under the duty to so disclose. In this case, however, the court noted that the defendants' subscribers were "apparently placing some degree of trust and confidence in the defendants' particular advice since they were willing to pay a not-insubstantial fee for information and services that they could have acquired practically for free through other web sites, cable t.v. programs, and newspapers." Based upon the defendants' alleged relationship of trust and confidence with their subscribers, the court found that the SEC properly alleged its claims of fraud based on the defendants' failure to disclose their alleged scalping.

SEC v. Park, 2000 U.S. Dist. Lexis 6325.

A bill was recently introduced in Congress that would amend the Internal Revenue Code of 1986 (the "Tax Code") to allow individuals an exclusion from gross income for certain amounts of capital gain distributions from mutual funds. Under the bill, an individual would be permitted to exclude from gross income capital gain distributions (defined for this purpose to include distributions of short-term capital gains) of up to $3,000 for individuals ($6,000 for joint returns) if these gains are automatically reinvested in additional shares of the fund. The shares would, however, have a zero cost basis, effectively deferring the tax payable on the reinvested gain until the newly purchased shares are redeemed.

Representative Jim Saxton (R-NJ), the Vice Chairman of the Joint Economic Committee, introduced the bill, and concurrently released a study of the Joint Economic Committee entitled "Encouraging Personal Saving and Investment: Changing the Tax Treatment of Unrealized Capital Gains." The study, which examines the treatment of unrealized capital gains as they relate to forced distributions from mutual funds, makes the following findings:

In order to increase saving and investment by individuals and to promote tax neutrality among various investment vehicles, the tax treatment of unrealized capital gains should be modified.

For regulated investment companies, the realization point that triggers a capital gains tax liability should be moved from the corporate level down to the individual shareholder level.

Since mutual funds are a popular vehicle for saving and investment of middle-income households, this tax reform would greatly increase the incentives for these people to invest and save for their future by increasing their pre-liquidation rate of return.

The current tax treatment of mutual funds costs the average mutual fund investor between 10 percent and 20 percent a year in lost return.

On a $10,000 investment earning a 10 percent annual rate of return, a 2.3 percentage point reduction in the pre-liquidation rate of return would cost a mutual fund investor almost $82,000 over a 30 year period; on a $26,000 investment a mutual fund investor would forego approximately $213,000 over a 30 year period.

A change in the tax treatment of mutual funds would have a beneficial impact on all owners of mutual funds, but the benefits would primarily help those earning less than $100,000 a year.

The amendments would become effective in tax years beginning after the date the amendments are enacted. H.R. 4723; Report of Joint Economic Committee of United States Congress: Encouraging Personal Saving and Investment: Changing the Tax Treatment of Unrealized Capital Gains (June 2000).

The SEC recently filed suit in the U.S. District Court for the Northern District of Texas against a mutual fund, its investment adviser, and an upstream affiliate, alleging fraud, mismanagement, and breach of fiduciary duty involving an uncollectable receivable.

The complaint alleged that from at least January 1999, the adviser caused the fund to carry a worthless receivable from an upstream affiliate of the adviser. The receivable arose from the affiliate's agreement to pay fund expenses that exceeded a certain percentage of the fund's net assets. Allegedly, even though the receivable was uncollectable from at least January 1999 through June 2000, the adviser caused the fund's books to reflect the receivable at full face value. The receivable grew steadily over this period to a peak of approximately $250,000. This, in turn inflated the net asset value of the fund's three portfolios--by almost 600 percent in one case--causing the fund to sell and redeem shares at improperly high prices.

Moreover, the complaint alleges that the situation became so desperate that the fund improperly suspended redemptions for the portfolio that held the largest portion of the receivable because of a lack of liquidity. No disclosures were made to shareholders regarding the worthless receivable. In fact, the adviser advised its private advisory clients to invest in the fund, and caused the fund's last shareholder report to misrepresent that the affiliate was paying on the receivable, when it was not.

The SEC also alleged that the fund sold shares during most of this period using an outdated prospectus. It said these events "transpired without remedial action by [the adviser] or the fund's directors". SEC v. Rupay-Barrington Capital Management Inc., N.D. Texas, Civil Action No. 3-00-CV1482-D, 7/10/00.

In a recent comment letter to the SEC, the ICI stated that it supports the use of tax rates paid by average fund investors, rather than the maximum federal tax rate, in the SEC's proposed standardized formula. The ICI reasoned that using the highest rate would be misleading to many investors because it would grossly overstate the impact of taxes on them. Further, the ICI stated that in 1999 the highest tax rate--39.6 percent tax rate for ordinary income and short-term gains--applied to less than 1 percent of both taxpayers generally and fund shareholders.

The ICI is generally in favor of requiring standardized numbers for after-tax fund returns in order to permit shareholders to compare the effects of taxes on the performance of different funds and allow a shareholder to determine directly the effects of taxes upon his or her return. The ICI did, however, note that using after-tax returns could be misleading and confusing because they often will not reflect a fund shareholder's own individual circumstances. In addition, the ICI recommended changes to the proposal to avoid overwhelming investors with data or providing information that would overwhelm other important information.

Under the SEC's proposal, a fund would have to disclose after-tax returns in both its prospectus and in the Management's Discussion of Fund Performance, which is typically included in a fund's annual report. Within the prospectus, disclosure would have to be made in the performance table contained in the risk/return summary. The proposed presentation would require after-tax numbers for 1-, 5-, and 10-year periods on both a pre-liquidation and post-liquidation basis, along with a new before-tax number. The new before-tax number would not reflect costs incurred as a result of redemptions, such as contingent deferred sales charges and redemption fees. Altogether, the SEC proposal would require nine new numbers for each class of a fund. The SEC proposal also would require narrative disclosure adjacent to the performance table.

The ICI concluded that disclosure of after-tax returns in both the prospectus and annual report is "neither necessary nor appropriate." Rather, disclosure in the prospectus alone would be appropriate, to help investors make an investment decision about the fund. The ICI reasoned that the annual report is designed primarily for existing shareholders, who already receive personalized year-end tax information. In addition, the ICI reasoned that the sheer volume of the disclosure would overwhelm the annual report.

Moreover, in its comment letter to the SEC, the ICI recommended:

• requiring that the new, after-tax disclosures be included in the tax section of the prospectus, rather than the risk/return summary. The ICI argued that the proposed disclosure would not apply to all investors in a fund, such as investors that hold their mutual funds in a qualified employer-sponsored retirement plan or an Individual Retirement Account. Instead, the ICI recommended that funds be required to disclose in their risk/return summary that the performance data does not reflect the impact of taxes, and that after-tax return information is contained in the tax section of the prospectus.
• requiring only two new sets of numbers - both after-tax, rather than three new sets of numbers--two after-tax and one new before-tax number. This recommendation is consistent with the SEC's alternative approach discussed in its proposing release, under which there would be no new before-tax numbers, and both sets of after-tax numbers would be required to reflect the deduction of any fees and charges payable upon a sale of fund shares. The ICI further recommended that, under this approach, a multiple class fund be required to disclose after-tax returns for only one class, rather than for all classes offered by the prospectus.
• requiring that a fund claiming "tax efficiency" in advertisements and sales literature show standardized after-tax returns in those publications.

ICI Comment Letter Re: Disclosure of Mutual Fund After-Tax Returns (File No. S7-09-00).

An investment advisory firm failed to gain U.S. Supreme Court review of an appeals court ruling affirming SEC sanctions for the adviser's alleged use of a misleading performance chart. The adviser argued in its petition to the Supreme Court that the appeals court failed adequately to consider the credibility of the evidence in an SEC administrative law judge's findings.

In the appellate ruling, the U.S. Court of Appeals for the Second Circuit affirmed SEC sanctions imposed on the adviser and its principal for the alleged deception of customers through the use of the flawed performance figures. The performance chart--provided by the adviser to prospective clients--purported to show the firm's five-year rate of return on its "Total Portfolio," and contained a footnote indicating that the figures represented a "composite of discretionary accounts with a balanced objective." The SEC found the chart materially misleading because:

• a reasonable investor would understand "composite" to include all "discretionary accounts with a balanced objective";
• the chart reflected the performance of only a selected portion of the firm's balanced accounts; and
• the chart showed a 1991 rate of return more than seven percentage points higher than that of all of the adviser's balanced accounts.

In the administrative hearing, the SEC found that the adviser, aided and abetted by its owner, violated the antifraud provisions of the Investment Advisers Act of 1940. It also found that the adviser acted with a deliberate intent to defraud--a conclusion based on findings that the principal of the adviser rejected recommendations from his marketing manager that the chart disclose more facts, such as its methodology, the number of accounts included, and the values of the largest and smallest accounts.

The appeals court, rejecting arguments over the sufficiency of the evidence, recounted the advisers' attempts to "downplay the significance of the adviser's decision to reject the marketing manager's recommendations." The court emphasized that the record shows that the adviser consciously rejected his marketing manager's recommendations to provide more disclosure.

It said the record also shows that the adviser chose to exclude accounts valued under $100,000 because of their higher transaction costs, decided to add accounts with positive returns, struck from the list accounts with negative returns, and created another document which inflated the adviser's performance relative to other investment advisers."

Given this record, the appeals court stated that they could not say that the SEC "lacked such relevant evidence as a reasonable mind might accept as adequate to support its conclusion." Valicenti Advisory Services Inc. v. SEC, U.S., No. 99-1889, 6/29/00; BNA Securities Law Reporter, Volume 32 No. 27, July 10, 2000.

The General Accounting Office ("GAO") recently issued a report on mutual fund fees which was delivered to the House Chairman of the Subcommittee on Finance and Hazardous Materials and the Ranking Member of the Committee on Commerce.

The report stated, among other things, that the SEC should require mutual funds to provide investors with quarterly information on the amount deducted from their accounts on an individual basis Additionally, the report suggested that because these calculations could be made in a number of different ways, the SEC should consider the various costs and burdens of alternative means of making the disclosures. In the report, GAO emphasized that the additional disclosure it recommends ''is intended to supplement, not replace, the existing disclosures, and should serve to reinforce to investors the fact that they do pay for the services they receive from their mutual funds.''

The report acknowledged that current mutual fund disclosures "are comprehensive and useful for investors in comparing the relative fees charged by different funds.'' However, it stated that current disclosures state fees in terms of percentages, and use hypothetical examples, which, in the GAO's view are not good indicators of the specific prices charged to any one investor.

SEC Chairman Arthur Levitt praised the report in a press release. Levitt stated that the report provides a comprehensive analysis of mutual fund fees and the market forces that impact those fees. Moreover, Levitt commended the GAO for the report, stating, that, like the SEC's investor education and disclosure efforts, which are designed to provide mutual fund investors the tools they need to make wise investment choices, the GAO's report also will contribute to the public dialogue on the issue of fee disclosure.

The SEC has mounted an extensive investor education campaign designed to improve the financial literacy of investors. Most recently, the SEC proposed a rule that would require mutual funds to report standardized investment returns on an after-tax basis in prospectuses and shareholder reports so that investors can compare funds and understand the impact of taxes on performance (See Industry News Summary, Week of 3/13/00 to 3/20/00). In addition, press release stated that the SEC is now considering a rule proposal designed to strengthen the role of mutual fund directors and to assist them in performing their duties as watchdogs for the interests of shareholders, including the important duty of overseeing mutual fund fee levels. SEC Press Rel. 2000-92.

The SEC recently adopted Regulation S-P, a new set of rules designed to protect the privacy interests of consumers of financial products and services. The rules implement provisions of the Gramm-Leach-Bliley Act that require the SEC to issue rules implementing notice requirements and restrictions on a financial institution's ability to disclose nonpublic personal information to unaffiliated third parties.

The rules generally require brokers, dealers, investment companies and registered investment advisers to:

• Disclose to individuals the institution's policies concerning the protection of personal information and how individuals can block (or "opt out" of) the transmission of personal information to unaffiliated persons; and
• Establish procedures to protect the security, confidentiality and integrity of customer records and information.

The rules were adopted substantially as proposed, although the SEC made a number of clarifying and technical changes in response to industry comments. For a detailed discussion of the rules as proposed, see Industry News Summary, Week of 2/28/00 to 3/6/00. The following us a summary of the significant changes to the rules as adopted:

Form and Location of Privacy Notices. The release adopting the rules makes clear that privacy notices may be combined with other disclosures. The SEC notes, however, that privacy notices contained in other disclosure documents may be subject to multiple disclosure standards. For example, a fund that includes a privacy notice in its prospectus would have to make the privacy notice clear and conspicuous according to Regulation S-P and would have to prepare the prospectus according to disclosure standards under the Securities Act of 1933.

Timing of the Initial Notices. The SEC has modified the final rules in response to industry comments to eliminate the requirement that a financial institution provide an initial notice "prior to" the time that it establishes a customer relationship with a customer. The adopted rule requires financial institutions to provide a customer with an initial notice not later than the time that the financial institution establishes the customer relationship. There are three exceptions to this rule, one of which permits a fund to delay delivery of the initial notice when a nonaffiliated broker-dealer or registered adviser purchases fund shares on behalf of a customer without the fund's knowledge. In such a case, the initial notice must be provided a reasonable time after establishing the customer relationship.

New "Short-Form" Notice to Accompany the Opt Out Notice. As under the proposal, the final rules require financial institutions to provide each of their consumers with an initial notice and an opt out notice before disclosing the consumer's nonpublic personal information to a nonaffiliated third party. The SEC has created an exception, however, allowing financial institutions to provide a "short-form" initial privacy policy notice along with the opt out notice to consumers with whom the institution does not have a customer relationship. The rule also requires the financial institution to provide a consumer who is interested in the more complete privacy disclosures with a reasonable means to obtain them.

Timing Issues Related to the Opt Out. The final rules add several examples clarifying what would be considered a reasonable opportunity for a consumer or customer to opt out of the sharing of his or her information. However, the SEC refrained from adopting a prescriptive rule in this regard, instead adopting the flexible rule as proposed. The SEC also adopted as proposed the rule requiring financial institutions to honor an opt out request as soon as reasonably practicable. The SEC had sought comment on whether the rule should specify a time within which an institution must stop sharing information.

Householding of Privacy Notices. In response to industry comments recommending that the rule specifically permit householding of privacy notices, the SEC added an example that allows a broker-dealer or fund to include an annual privacy notice with or in a prospectus or shareholder report delivered in accordance with the SEC's householding rules for prospectuses and shareholder reports.

Joint Notices. The SEC clarified that a financial institution is not obligated to provide more than one notice to joint accountholders. A broker-dealer, fund or adviser may, in its discretion, provide notices to each party to the account. However, under the final rule, each of the accountholders must have the right to opt out.

Transfer Agents. The SEC clarified that an individual does not have either a consumer or a customer relationship with an entity acting as an agent for a financial institution. The SEC specifically noted that mutual fund consumers would not become consumers of the transfer agent that services the fund's accounts.

Investment Advisers. The SEC clarified that although registered investment advisers are covered by Regulation S-P, an investment company's adviser does not have customer relationships with the fund's shareholders in the absence of individual advisory contracts with those shareholders.

Retirement Plans. The SEC clarified that Regulation S-P does not apply to employee benefits plans. However, the final rules add an example that an individual will be deemed to establish a customer relationship when a broker-dealer, fund or registered adviser acts as a custodian for securities or assets in an IRA.

Publicly Available Information. The SEC modified the definition of "publicly available information" to include information from an Internet site that is available to the general public "without requiring a password or similar restriction." In the release adopting the rules, the SEC stated that in determining whether distribution occurs through a widely distributed media, the focus should be on whether the information is lawfully available to the general public, rather than on the type of medium from which the information is obtained.

Limits on Reuse of Information. The SEC revised the limits on redisclosure and reuse of information to clarify their scope. Under the final rule, these limits will depend on whether the information was provided in reliance on one of the enumerated exceptions. If a broker-dealer, fund, or registered adviser receives nonpublic personal information in accordance with one of the enumerated exceptions, it may disclose the information to its affiliates or to the affiliates of the financial institution from which it received the information. If a broker-dealer, fund, or registered adviser receives nonpublic personal information outside one of the exceptions, it may disclose the information to (i) its affiliates, (ii) the affiliates of the financial institution that made the initial disclosure, or (iii) any other person if the disclosure would be lawful if made directly by the financial institution from which the information was received. The SEC clarified that financial institutions do not have to monitor compliance by non-affiliated third parties with the redisclosure and reuse provisions of the rule.

Policies and Procedures to Protect Information. The SEC adopted as proposed the rule requiring financial institutions to adopt policies and procedures to safeguard their customers' records and information. The SEC also clarified that a fund complex could, but is not required to, adopt a single set of policies and procedures for the entire fund complex. The SEC noted that the policies and procedures would have to be determined to be appropriate for each institution to which they apply.

Regulation S-P becomes effective on November 13, 2000, although compliance is not mandatory until July 1, 2001. Joint marketing and service agreements that are in effect as of July 1, 2000 will have to be brought into compliance with section 248.13 or Regulation S-P by July 1, 2002.

To be in full compliance with the rules' restrictions on disclosures on July 1, 2001, broker-dealers, funds and registered advisers must have provided their existing customers with an initial privacy notice, an opt out notice, and a reasonable amount of time to opt out before that date. Financial institutions that both provide the required notices and allow a reasonable period of time to opt out before July 1, 2001 may continue to share nonpublic personal information with nonaffiliated third parties after that date for customers who do not opt out. SEC Rel. Nos. 34-42974, IC-24543, IA-1883 (June 22, 2000); Investment Company Institute Memorandum 12113.