The Department of Labor (“DOL”) released a Field Assistance Bulletin regarding the allocation and distribution of the proceeds from SEC late trading and market timing settlements to employee benefit plans and their participants. SEC orders in these cases require distributions to mutual fund investors by an independent distribution consultant (“IDC”) that is appointed to distribute money from a settlement distribution fund to investors. Certain employee benefit plans that were investors in these funds will be eligible to receive settlement proceeds (“Plans”).

DOL stated that an IDC that develops and implements settlement fund distribution plans will not be deemed a fiduciary with respect to the Plans under Section 3(21) of ERISA. DOL reasoned that since IDCs are appointed pursuant to SEC orders, and the SEC must approve the IDCs’ plans prior to implementation, the IDCs are not agents of the Plans. Additionally, fund investors, including the Plans, will not have an interest in or claims against the proceeds before they are distributed to fund shareholders, so the proceeds will not be Plan assets before they are distributed to the Plans.

Some Plans invested in the funds through omnibus accounts maintained by an intermediary. These intermediaries will receive settlement proceeds on behalf of their omnibus account customers, and will be fiduciaries under ERISA with respect to those proceeds, because the intermediaries will have discretionary authority or control to administer or manage those proceeds, which must be held in trust and managed in accordance with ERISA. Intermediaries may avoid becoming fiduciaries if they implement the directions of plan fiduciaries to receive, allocate and distribute the proceeds.

If a fiduciary uses a particular method required by an IDC’s distribution plan to allocate the proceeds among omnibus account clients and plan participants, DOL will view the application of this method as satisfying the requirements of Section 404(a) under ERISA. If an IDC provides a method to allocate proceeds but does not require fiduciaries to use the method, the use of the method will satisfy the requirements of prudence under Section 404(a)(1)(A) and (B), but fiduciaries will have to ensure that the method is implemented in a prudent manner. If the IDC does not provide a method for distributing the proceeds, fiduciaries must be prudent in selecting an allocation method. Fiduciaries should consider the impact that the late trading and market timing activities had on the plan, as well as the costs and benefits to the plan and participants. A fiduciary may treat participants or groups of participants differently without violating section 404(a)(1) of ERISA, and may weigh their competing interests and the effects of the allocation on those participants, provided that any allocation method is “reasonable, fair and objective.”

Employers, fiduciaries, intermediaries, or other parties in interest may not use the proceeds of the settlement for their own benefit. An intermediary may charge plans for direct expenses due to the receipt and allocation of the proceeds, but cannot compensate itself from plan assets beyond direct expenses. Employers may not use the proceeds to offset their future contributions to a plan, unless the plan permits this use and it does not violate the Internal Revenue Code. A plan fiduciary that concludes that certain participant-level allocations are not cost-effective can use these allocations for other plan purposes, such as paying expenses of administering the plan.

DOL stated that generally a fiduciary will be required to accept the proceeds to fulfill their fiduciary duties under ERISA. However, DOL also noted that in some instances, the cost to receive and distribute the proceeds may exceed the value to the plan’s participants, and if there is not another permissible use for the proceeds, the fiduciary may be able to decline the settlement proceeds.

Field Assistance Bulletin 2006-01, U.S. Department of Labor (Apr. 19, 2006); Employee Benefits Security Administration Issues Guidance on Distributions of Mutual Funds Late Trading and Market-Timing Settlement Proceeds; U.S. Department of Labor News Release (Apr. 20, 2006).

A brokerage firm consented to the entry of the NASD’s findings that the firm committed violations in connection with operating a call center, without admitting or denying the charges. The NASD alleged that (1) during a period of three years, registered representatives at the call center improperly recommended that customers switch from unaffiliated mutual funds to proprietary mutual funds, (2) some switches were not suitable, and (3) the call center representatives misrepresented and omitted facts to customers. The NASD further alleged that the firm did not disclose that call center representatives had less than five years of brokerage experience and only provided recommendations regarding mutual funds.

The NASD found that the firm had inadequate written supervisory procedures addressing mutual fund recommendations and switch transactions, the firm did not conduct annual compliance audits for the call center, and principals of the firm did not adequately review mutual fund switches. The NASD also found that call center supervisors did not have the proper securities licenses and qualifications, and the firm did not employ a sufficient number of properly trained and qualified supervisors to monitor the call center’s activities. The NASD also alleged that the firm held sales contests that provided representatives with non-cash compensation for the sale of the firm’s proprietary mutual funds in violation of its non-cash compensation rule.

The NASD fined the firm $5 million, prohibited the firm from holding sales contests for the call center’s employees for three years, required the firm to institute special supervisory procedures for the call center, including monitoring employees’ calls with customers, and required the firm to engage an independent consultant to make recommendations about the firm’s policies, supervisory procedures and compliance systems for the call center.

NASD Fines Merrill Lynch $5 Million for Call Center Supervisory Failures, Sales Contest Violations, NASD Disciplinary and Other NASD Actions, 16 (Apr. 2006).

A brokerage firm consented to sanctions and the entry of findings that the firm engaged in market timing and did not establish or enforce written procedures or a supervisory system to detect and prevent prohibited market-timing activities. NASD alleged that the firm did not respond adequately to “red flags” indicating improper market timing activity by hedge fund clients. The sanctions included censure, a fine of $175,000, and the payment of restitution of $150,000 for profits that hedge funds allegedly obtained by their market timing activities. The firm also must certify to NASD that it reviewed its procedures and established systems to comply with laws, regulations and rules regarding market timing, late trading, responses to regulatory inquiries, record keeping, and enforcing funds’ trading limits and provisions in selling agreements.

Paulson Investment Company, Inc., NASD Case # EAF0400370002, NASD Disciplinary and Other NASD Actions, 5 (Apr. 2006).

Effective October 1, 2006, (or 5 days after the date on which the SEC receives its fiscal year 2007 regular appropriation, whichever date comes later), the Section 6(b) fee rate applicable to the registration of securities, will decrease to $30.70 per million from the current rate of $107.00 per million. This rate is also used to calculate the fees payable with the Annual Notice of Securities Sold Pursuant to Rule 24f-2 under the Investment Company Act of 1940. As noted in the SEC Press Release discussing the fee reduction, fees to register securities with the SEC will be reduced by 71.3%.

SEC Press Release (dated May 3, 2006) available at http://www.sec.gov/news/press/2006/2006-64.htm ; SEC Release No. 33-8681, 34-53737 (dated Apr. 28, 2006) available at http://www.sec.gov/rules/other/2006/33-8681.pdf

The SEC declared the registration statement for the first silver-backed ETF effective on April 27, 2006. This followed the SEC having approved rule changes in connection with the exchange-listing and trading of the ETF shares in March, 2006. These proposed rule changes had generated over 250 comment letters, including letters from commenters concerned about potential disruption to the silver markets. The SEC, however, concluded that the silver-backed ETF would increase the efficiency and transparency of the market for silver. The registration statement for the silver-backed ETF had initially been filed in June, 2005.

iShares Silver Trust, available at http://www.sec.gov/edgar/searchedgar/webusers.htm; SEC Release No. 34-53521 (Mar. 20, 2006), available at http://www.sec.gov/rules/sro/amex/2006/34-53521.pdf

Rep. Richard Baker (R-LA), Chairman of the Congressional Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, recently sent a letter to SEC Chairman Cox voicing his concerns regarding the SEC’s delay in approving exchange-traded funds (“ETFs”). Noting that some ETFs have been waiting over two years for approval of the exemption applications that are necessary for their operation, Chairman Baker noted that this provides a disincentive for market participants to develop ETFs even though the market for this product is growing rapidly. Chairman Baker noted his concern that the regulatory delays may result in the migration of these products to other markets, such as Asia and Europe, where such regulatory barriers may not exist. Chairman Baker pointed out that the SEC Staff has publicly recognized this problem and he encouraged the SEC to consider solutions, such as developing standardization through rule-making or otherwise expediting the approval process.

Letter from Chairman Baker to SEC Chairman Cox, dated Apr. 26, 2006.

The SEC filed a contested insider trading action against a hedge fund manager and others in connection with trading for hedge funds in advance of a public announcement of a merger agreement. In a complaint filed in the US District Court for the Southern District of New York, the SEC alleged that the hedge fund manager directed the purchase of stock of the company to be acquired in accounts of hedge funds he managed after being tipped by another defendant, who in turn had been tipped by another defendant. The SEC is seeking injunctions, disgorgement, and other sanctions.

SEC v. Nelson J. Obus et al., Civil Action No. 06-3150 (GBD) (S.D.N.Y. filed Apr. 25, 2006) available at http://www.sec.gov/litigation/litreleases/2006/lr19667.htm.

John Walsh, the Associate Director of the Office of Compliance Inspections and Examinations (“OCIE”), recently spoke to compliance professionals regarding issues that (1) mutual funds and investment advisers should address after completing their first annual compliance review, and (2) broker-dealers should address after completing their first annual supervisory control report and obtaining their first annual CEO compliance process certification. Mr. Walsh stated that firms should consider the lessons to be learned from the annual review and work to implement any recommendations resulting from the review.

Regarding funds and advisers, Mr. Walsh explained that while standard published checklists may be helpful in assessing risks, each firm should assess whether it has unique risks that must be included. OCIE also found that some firms do not appropriately test compliance and provided examples: (1) not comparing brokerage allocations to sales of fund shares; (2) not reviewing personal trading and aggregate IPO allocations over time; and (3) not comparing over time the performance of similarly managed accounts, particularly if the firm’s compensation differs among those accounts. Mr. Walsh also admonished compliance personnel not to overwhelm board members with large amounts of information; they should provide summaries sufficient to explain risks and important features of the compliance program.

On April 25, 2006, SEC Chairman Christopher Cox testified before the Senate Committee on Banking, Housing and Urban Affairs on improving the utility and value of financial disclosures to individual investors. He announced four SEC initiatives: (1) going from legalese to plain English in every document intended for retail consumption; (2) moving away from long, hard-to-read disclosure documents to web pages that are easy to navigate; (3) simplifying accounting rules and regulations; and (4) focusing education and enforcement efforts on scams aimed at seniors.

In connection with the second initiative above, Chairman Cox also articulated a new SEC agenda to promote the use of interactive, easy web-based tools. The SEC will shortly hold a series of roundtables to assess what types of interactive data would be most useful to investors, how to encourage development of interactive tools by the industry and utilization by industry and investors.

As to the fourth initiative, Chairman Cox noted that the SEC will work closely with state regulators to prevent scams that target older Americans through investor education, targeted examinations and aggressive enforcement efforts.

Chairman Cox also addressed matters relating to two SEC regulations subject to legal challenge – the hedge fund adviser registration rule and the mutual fund independent chair rule. He commented that the SEC has adequate resources and training programs to regulate the increased numbers of hedge fund advisers registered with the SEC as a result of the hedge fund adviser registration rule. Separately, with respect to the mutual fund independent chair rule, Chairman Cox suggested that the SEC would shortly seek additional public comment on the rule.

SEC Chairman Christopher Cox, Testimony before the Senate Committee on Banking, Housing and Urban Affairs, “Improving Financial Disclosures for Individual Investors” (Apr. 25, 2006), available at http://www.sec.gov/news/testimony/ts042506cc.htm.