The CFTC recently announced that it is amending its rules to require that commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”) file copies of their disclosure documents electronically with the National Futures Association. CFTC Regulations 4.21 and 4.31 respectively require each CPO and CTA registered or required to be registered with the CFTC to deliver a disclosure document (“Disclosure Document”) to prospective pool participants and clients.

On November 26, 2008, the CFTC proposed to amend Regulations 4.26 and 4.36 in order to require that CPOs and CTAs file Disclosure Documents electronically through the National Futures Association’s electronic Disclosure Document filing system. The CFTC has now determined to adopt the amendments to Regulations 4.26(d) and 4.36(d) as proposed. The new regulations are effective April 6, 2009.

For more information, please see: Securities Law Daily, “CFTC Mandates Electronic Filing of CPO, CTA Disclosure Documents,” March 10, 2009.  

See also: http://www.cftc.gov/newsroom/generalpressreleases/2009/pr5628-09.html; and http://www.cftc.gov/stellent/groups/public/@lrfederalregister/documents/file/e9-4740a.pdf

On March 3, 2009, the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) issued a proposed rule that would broaden the scope of the prohibition against disclosures of suspicious activity reports by financial institutions and the US government. In conjunction with the proposed rule, FinCEN also issued proposed interpretive guidance that would expand the ability of certain institutions to share suspicious activity reports with certain of its U.S. affiliates.


For more information, please see: WilmerHale Financial Institutions Practice Group Alert, dated March 10, 2009, available at: http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8825  

On March 9, 2009, the SEC’s OCIE wrote letters to the Investment Adviser Association and the Managed Funds Association requesting that they inform their members of a recent investment adviser examination request for the independent confirmation of investor assets. The letters state that the SEC may contact various third-parties, including custodians, administrators, auditors, hedge fund investors and advisory clients, to confirm asset levels.

The letters state that the SEC examination staff will, among other things:

• seek confirmation from third parties of cash and securities held by certain advised clients as of a specific date and of transactions in such accounts over a period of time;
• ask clients to confirm that their account balances as of a specific date were consistent with their records, and that their contributions to and withdrawals from their accounts over a period of time were transactions they authorized; and
• in requesting confirmations from investors in hedge funds managed by registered advisers, the staff will request that such investors confirm that their capital account balances, as shown by the funds’ records, are consistent with the investors’ records.

On March 5, 2009, SEC Chairman Mary L. Schapiro announced that the SEC is conducting a comprehensive review of its internal procedures to improve the handling of whistleblower complaints and enforcement tips. The review will scrutinize the SEC’s processes for receiving, tracking, analyzing, and acting upon the tips, complaints, and referrals from many outside sources. The goal of the review is to improve the efficiency, effectiveness, and management of how the SEC addresses tips, complaints, and referrals.


For more information, please see: http://www.sec.gov/news/press/2009/2009-44.htm 
 

On February 26, 2009, the SEC published for comment proposed amendments to NYSE Rule 452. Rule 452 currently allows discretionary broker voting with respect to certain matters deemed “routine” by the NYSE, including uncontested director elections. Based on the recommendations from the NYSE’s Proxy Working Group, the proposed amendments would eliminate broker discretionary voting for the election of directors. However, investment companies registered under the 1940 Act would be excepted from the proposed amendment, and brokers would retain the power to vote uninstructed shares for the election of fund directors in uncontested elections.

The proposed amendments to Rule 452 would also codify the NYSE’s long-standing interpretation that discretionary broker voting is not permitted for any proposal that requires, under the 1940 Act, shareholder approval with respect to an investment advisory agreement. This would include situations where there is an “assignment” of an investment advisory agreement due to a change of control of the investment adviser.

If approved, the proposed amendments will apply to proxy voting for shareholder meetings held on or after January 1, 2010.

For more information, please see: http://www.sec.gov/rules/sro/nyse/2009/34-59464.pdf
(SEC Release No. 34-59464; File No. SR-NYSE-2006-92).

The SEC announced that, effective after designated times on March 13, 2009, the fee rate for the following will increase to $55.80 per million dollars:

•  the registration of securities under Section 6(b) of the Securities Act of 1933,
•  the repurchase of securities under Section 13(e) of the Securities Exchange Act of 1934 (the “Exchange Act”), and
• proxy solicitations and statements in corporate control transactions under Section 14(g) of the Exchange Act.

For investment companies, the Section 6(b) rate is used to calculate the fees for the annual notice of securities sold pursuant to Rule 24f-2 under the Investment Company Act of 1940, as amended (the “1940 Act”).

For more information, please see:http://www.sec.gov/news/press/2009/2009-56.htm

On March 6, 2009, Mark D. Cahn was appointed as Deputy General Counsel in the SEC’s Office of the General Counsel. Prior to joining the SEC, Mr. Cahn was a partner in the Securities Department at WilmerHale. At the SEC, Mr. Cahn will be the Deputy General Counsel for Litigation and Adjudication, overseeing enforcement matters, appellate cases, and adjudications.

For more information, please see: http://www.sec.gov/news/press/2009/2009-48.htm  

On March 6, 2009, Mark D. Cahn was appointed as Deputy General Counsel in the SEC’s Office of the General Counsel. Prior to joining the SEC, Mr. Cahn was a partner in the Securities Department at WilmerHale. At the SEC, Mr. Cahn will be the Deputy General Counsel for Litigation and Adjudication, overseeing enforcement matters, appellate cases, and adjudications.

For more information, please see: http://www.sec.gov/news/press/2009/2009-48.htm  

On March 3, 2009, the ICI published a white paper outlining its recommendations for modernizing and strengthening the regulatory oversight of the U.S. financial services industry. The ICI recommends, among other things, the establishment of a “Systemic Risk Regulator” and a new “Capital Markets Regulator.”

The ICI recommends that the Systemic Risk Regulator should have responsibility for:

• monitoring the financial markets broadly;
• analyzing changing conditions in domestic and overseas markets;
• evaluating the risks of practices as they evolve, and identifying those that are of such nature and extent that they implicate the health of the financial system at large; and
• acting to mitigate such risks in coordination with other responsible regulators.

The ICI recommends that the new Capital Markets Regulator should encompass the combined functions of the SEC and CFTC, and be responsible for setting regulatory standards for all registered investment companies, including money market funds. The Capital Markets Regulator should also be granted authority to regulate areas where certain gaps in regulation currently exist – particularly with respect to hedge funds, derivatives, and municipal securities – and should also be charged with harmonizing the legal standards applicable to investment advisers and broker-dealers.

The ICI also recommends that Congress consider consolidating the regulatory structure for the banking sector and authorization of an optional federal charter for insurance companies.

For more information, please see: ICI Memorandum, “ICI outlines Detailed Regulatory Reform Proposal,” March 3, 2009, which can be obtained at: http://members.ici.org/doclink.do?file=23285; http://www.ici.org/pdf/ppr_09_reg_reform.pdf

On February 26, 2009, the European Commission announced that it will propose legislation to regulate both hedge funds and private equity groups, despite new commitments from the financial services sector to increase transparency and disclosure obligations. European Parliament member, Poul Nyrup Rasmussen, who coordinates policy on financial issues, said that the upcoming EU proposal must include strict reporting requirements on the following:

• capital base;
• leverage;
• investment strategy;
• investment portfolio;
• links with systemic financial institutions;
• source of funds; and
• risk management metrics.

Mr. Rasmussen explained that institutions lending money to hedge funds and private equity funds should be subject to risk-weighted capital adequacy requirements based on the complexity and structure of a particular fund.

The Alternative Investment Management Association (AIMA), which represents hedge funds around the world, emphasized the importance of adopting uniform regulations due to the global nature of the industry. Finally, the European Private Equity & Venture Capital Association (ECVA), a Brussels-based private equity industry association, said it was ready to commit to an EU-wide set of professional standards based on the following:

• a code of conduct;
• corporate governance guidelines;
• reporting to investors;
• valuation guidelines;
• transparency and disclosure guidelines; and
• governing principles for the establishment and management of private equity funds.

Although the ECVA is ready to commit to the standards listed above, it does not believe that the proposed regulatory overhaul should apply to both hedge funds and private equity funds because private equity funds do not pose the same systemic risks as hedge funds.

For more information, please see: Securities Law Daily, “As Regulators Urge Tougher Rules, Private Equity Commits to Standards,” March 2, 2009; Securities Law Daily, “European Commission to Seek Regulation Over Hedge Funds, Private Equity Enterprises,” March 4, 2009.

On February 18, 2009, the Connecticut General Assembly proposed three bills aimed at regulating hedge funds. The bills generally would require:
 

• hedge funds established or conducting business in Connecticut to obtain a license from the Connecticut Banking Commissioner;
• hedge funds domiciled in Connecticut and receiving money from Connecticut pension funds to disclose to prospective pension fund investors, upon request, certain financial information, including, but not limited to, detailed portfolio information relative to the assets and liabilities of such funds; and
   
• heightened qualifications for, and information provided to, investors in private funds that have offices in Connecticut

Each bill was referred to the General Assembly’s Committee on Banks. The bills currently indicate that, if enacted, they would become effective on October 1, 2009.
For more information, please see: The Hedge Fund Law Report, Vol.2, No. 9, “Trio of Bills Proposed in Connecticut Legislature Would Introduce Substantial Regulation of Hedge Funds,” March 4, 2009.

A copy of the proposed legislation can be obtained at: http://www.cga.ct.gov/2009/TOB/H/2009HB-06477-R00-HB.htm; http://www.cga.ct.gov/2009/TOB/H/2009HB-06480-R00-HB.htm; and http://www.cga.ct.gov/2009/TOB/S/2009SB-00953-R00-SB.htm 
 

On March 2, 2009, the “Stop Tax Haven Abuse Act” was introduced in the U.S. Senate by Carl Levin (D-MI) and in the House of Representatives by Lloyd Doggett (D-TX). The bill is designed to restrict the use of offshore tax havens and abusive tax shelters to avoid inappropriately U.S. taxation. The bill is an enhanced version of similar bills introduced in 2007.
If enacted, the proposed legislation will, among other things, amend the Internal Revenue Code to impose U.S. federal corporate income taxes on offshore funds which are organized as corporations if: (i) they have assets of $50 million or more, and (ii) “decisions about how to invest the assets are made in the U.S.” The bill would treat such offshore funds as domestic U.S. corporations subject to U.S. federal income tax on their worldwide income. The bill is broadly written and would apply even if the offshore fund is not incorporated in one of the designated “offshore secrecy jurisdictions,” which are the primary target of the legislation. The proposed effective date of this provision is for taxable years beginning two years after the date of enactment. The bill also contains several other provisions aimed at overcoming obstacles to U.S. tax enforcement efforts in respect of offshore companies. The bill has been endorsed by the U.S. Treasury Department and could be enacted this year.

For more information, please see: http://www.govtrack.us/congress/billtext.xpd?bill=s111-506  

FINRA recently filed with the SEC proposed rule changes to amend the Uniform Application for Securities Industry Registration or Transfer (“Form U4”) and the Uniform Termination Notice for Securities Industry Registration (“Form U5”), as well as FINRA Rule 8312 (FINRA BrokerCheck Disclosure). FINRA states that the proposed rule change is designed to address regulatory concerns, to ease, clarify or facilitate industry reporting requirements, and to make technical and conforming amendments.

For more information, please see: http://www.finra.org/Industry/Regulation/RuleFilings/2009/P118053  

FINRA’s Board of Governors recently announced the appointment of Richard G. Ketchum as FINRA’s Chief Executive Officer. Mr. Ketchum replaces Mary L. Schapiro, who resigned after her confirmation as SEC Chairman. Prior to his appointment, Mr. Ketchum served as the CEO of New York Stock Exchange Regulation and as Chairman of FINRA’s Board of Governors. Mr. Ketchum will continue in his role as FINRA’s Chairman.

For more information, please see: http://www.finra.org/Newsroom/NewsReleases/2009/P117991  

On March 9, 2009, the U.S. Supreme Court agreed to review Jones v. Harris Associates, a Seventh Circuit decision rejecting the Gartenberg standard in litigation under Section 36(b) of the Investment Company Act of 1940 and adopting a new test for reviewing advisory fee challenges under Section 36(b).

For more information, please see: WilmerHale Securities and Investment Management Alert, March 9, 2009, http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8823  
and the WilmerHale Securities and Investment Management Alert, May 27, 2008, which discusses the Jones v. Harris case, http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8329  

On March 2, 2009, SEC Commissioner Elisse B. Walter, speaking at a conference held by the Institute of International Bankers, discussed the challenges facing the SEC. She explained that the SEC currently is performing a self-analysis, and she expects an increase in investigations to be one of the outcomes of the review.

Commissioner Walter also noted five guiding principles that she believes should be included in the efforts to restructure the U.S. financial regulatory system:

• the objectives of managing systemic risk and protecting investors should be maintained and pursued in a balanced manner;
• the current framework should be restructured to eliminate regulatory gaps and to increase market transparency;
• investors should receive the same level of protection when they purchase comparable financial products and services regardless of the financial professional involved;
• important gatekeepers such as credit rating agencies and securities analysts should be regulated to minimize conflicts of interest, to increase transparency, and to foster accountability; and
• regulators must be given strong enforcement powers to pursue market wrongdoing, and such powers must be in addition to, not in lieu of, regulatory authority.
• Commissioner Walter specifically noted that Congress should consider:
• giving the SEC clear authority to regulate hedge fund managers;
• giving the SEC authority to regulate the over-the-counter derivatives market; and
• merging the oversight responsibilities of the SEC and Commodities Futures Trading Commission (“CFTC”).

For more information, please see: Securities Law Daily, “Walter Promises that after Self-Analysis, SEC Will Emerge with More Investigations,” March 3, 2009.

See also, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajEyt7d_5xoY

Investors seeking class action status recently brought a suit against a California municipal bond fund alleging that the fund misrepresented its level of risk. The investors claim that the fund failed to comply with its investment objective of seeking capital preservation, which resulted in significantly higher losses than those of similar municipal bond funds. The complaint also alleges that the fund's investment strategies were inconsistent with the preservation of capital, which strategies included investments in “over concentration” in BBB-rated bonds and junk bonds, unrated bonds the sole rating of which was established by the fund's internal models, higher risk securities such as “tobacco bonds, dirt bonds, and inverse floaters,” and California real estate assets where the “market was facing serious financial problems.” The complaint further alleges that the fund made several material omissions, including errors in the fund's internal rating system that resulted in violations of the fund's fundamental investment policy of holding no more than 25% of fund assets in junk bonds, and a material misstatement regarding its concentration policy.

For more information, please see: Rivera v. Oppenheimer California Municipal Fund et al., No. 3:09-cv-00567-SI (N.D. Cal. filed February 6, 2009).

Lawsuits recently were filed by ARPS investors against the trustees of two different closed-end fund families (“funds”). The plaintiffs allege that the trustees breached their fiduciary duties to ARPS holders by refusing to permit ARPS holders to redeem their shares promptly at par value. The plaintiffs argue that the trustees owe fiduciary duties under applicable law to redeem the ARPS holders promptly because the funds have offered no opportunity for ARPS holders to redeem, and the ARPS holders can only sell their shares at an enormous cost. The plaintiffs state that the trustees of other closed-end funds have fulfilled their fiduciary duties by redeeming all or substantial portions of their funds’ outstanding ARPS. The plaintiffs further allege that the trustees breached their fiduciary duties by placing the best interests of the funds’ common shareholders ahead of those of the ARPS holders because the common shareholders continue to benefit from the additional leverage at below market cost, while the ARPS holders are “stranded without the ability to liquidate their investments.” The plaintiffs are requesting that the court order the trustees and directors to redeem ARPS issued by the funds at par value, award the plaintiffs unspecified damages and reimburse the plaintiffs’ legal fees.

For more information, please see: Talarico et al. v. Cavanagh et al., No. 1:09 Civ. 0753 (S.D.N.Y. filed January 27, 2009); Robertson et al. v. Arch et al., No. 1:09 Civ. 754 (S.D.N.Y. filed January 27, 2009).
 

On February 12, 2009, in a case that is of interest to all 401(k) plan service providers, the federal court of appeals affirmed the district court’s dismissal of a suit against a 401(k) plan sponsor, the plan’s directed trustee / service provider and an investment adviser for some of the mutual funds offered as investment options under the plan. The plaintiff employees of the 401(k) plan provider alleged that the defendants violated their fiduciary duties under the Employee Retirement Income Security Act of 1974 (“ERISA”) by (1) providing investment options with excessive and unreasonable fees and costs, and (2) failing to disclose the fee structure to plan participants. In particular, the plaintiffs alleged that the defendants had a duty to disclose revenue sharing arrangements that existed between the trustee / service provider and investment adviser.

The federal appeals court concluded that the complaint failed to state a claim against the plan’s trustee / service provider and affiliated investment adviser because neither served as “functional fiduciaries.” The trustee / service provider successfully argued that as a mere service provider to the retirement plan, it lacked discretionary control over the plan’s assets sufficient for fiduciary status under ERISA. The court particularly found that (based on the facts as alleged by the plaintiffs) the trustee / service provider lacked ultimate authority over selection of plan options and was therefore not a functional fiduciary. The affiliated mutual fund investment adviser successfully relied upon ERISA’s definition of “plan assets,” which expressly excludes assets of a mutual fund. The federal appeals court also affirmed the district court’s dismissal of allegations against the plan sponsor on grounds that: (1) a sufficient mix of investments for participants were offered by the plan and “nothing in ERISA requires every fiduciary to scour the market to find and offer the cheapest possible fund,” and (2) the omission of information about the revenue sharing arrangements was not material because the plan sponsor disclosed to participants the total fees for the funds and directed the participants to the fund prospectuses for information about the fund-level expenses.

For more information, please see: Hecker et al. v. Deere & Company, Fidelity Management Trust Co., and Fidelity Management & Research Co., 2009 WL 331285 (C.A.7 (Wis.)), U.S. Court of Appeals, Seventh Circuit, February 12, 2009.

On February 10, 2009, a federal district court dismissed a complaint brought by a mutual fund investor against the fund’s distributor and adviser alleging a breach of fiduciary duty under Section 36(b) of the Investment Company Act of 1940, as amended (the “1940 Act”) in connection with the improper and unauthorized use of Rule 12b-1 fees and against the fund’s adviser under Section 48 of the 1940 Act for causing the fund’s alleged violation. The plaintiff disavowed the Gartenberg standard and argued that the portion of the Rule 12b-1 fees charged by the adviser for post-sales activities were unlawful per se since post-sales services cannot be “primarily intended to result in the sale of shares issued by the fund.” The plaintiff further argued that the portion of the Rule 12b-1 fees that were “primarily intended” to result in the sale of fund shares were unlawfully excessive and disproportionate because the fees failed to meet the statutory requirement that there is a “reasonable likelihood that the Rule 12b-1 fee will benefit the fund and its shareholders.”

In dismissing the complaint, the district court affirmed that the Gartenberg standard must be met and the plaintiff failed to plead that the Rule 12b-1 fees were “so disproportionately large as to bear no reasonable relationship to the services rendered and could not have been the product of an arm’s-length bargaining.” The district court also stated that “case law has long since rejected the idea that post-sales fees are per se unlawful, and therefore, excessive, under Rule 12b-1.” The district court also disagreed with the plaintiff’s assertion that the use of Rule 12b-1 payments to encourage better shareholder service and to maintain fund size violates Rule 12b-1. The district court concluded that:

“disbursements by the [f]und for shareholder services and maintenance of [f]und size are among the expenditures the SEC wished trustees to consider in the context of Rule 12b-1’s restrictions….Payments to financial consultants to halt the out-flow of assets and improve shareholder service are consistent with this definition, so long as the primary intent is to increase the size of the [f]und. Moreover, even if payments for shareholder service and maintenance of [f]und size are not “distribution payments,” per se, they are made “in connection with” a distribution and are therefore to be regulated by the [Rule] 12b-1 plan.”

For the reasons stated above, the district court concluded that the complaint failed to state a proper claim under Section 36(b) of the 1940 Act. The district court permitted the plaintiff to amend the complaint by March 9, 2009 to satisfy the Gartenberg test. This case underscores the utility of board review of Rule 12b-1 fees using the Gartenberg factors.

For more information, please see: Rachelle Korland v. Capital Research and Management Company et al., Case No. CV-08-4020 GAF (RNBx) (Order Re: Motion to Dismiss, February 10, 2009). Complaint was filed on June 19, 2008 in U.S. District Court, Central District of California.

The Senate Special Committee on Aging (“Committee”) recently held hearings to consider regulation of target date funds. The Committee requested that the Department of Labor and SEC conduct studies and consider regulation on the composition and advertising of target date funds. Target date funds are designed to shift money from riskier investments to more conservative investments as the investor nears retirement. Concern about inadequate oversight of target date funds has arisen following substantial losses experienced by investors approaching retirement who held shares of target date funds believed to be conservatively invested to protect against such losses. Federal lawmakers’ concerns have been heightened by the increasing prevalence of target date funds in defined contribution plans following passage of the Pension Protection Act of 2006, which permits target date funds to serve as qualified default investment alternatives.

For more information, please see:
http://www.bloomberg.com/apps/news?pid=20601213&sid=aj2M3vTmKqzQ&refer=home  

The SEC recently voiced concerns that mutual funds are falling short of their obligations under AML regulations by relying too heavily on service providers, particularly in instances where fund policies are not consistent with the service provider’s procedures. Although mutual funds are permitted to delegate certain aspects of their AML compliance programs to third party service providers, SEC officials emphasized that the mutual funds ultimately are responsible for ensuring that they comply with AML regulations. The SEC recently updated its AML research guide for mutual funds, which can be obtained through the hyperlink below.

For more information, please see:
http://sec.gov/about/offices/ocie/amlsourcetool.htm