On December 7th, DOL announced its semiannual regulatory agenda. The agenda includes a re-proposal of the participant investment advice regulation under the Pension Protection Act (“PPA”) statutory exemption and an additional proposed rulemaking regarding the definition of “fiduciary” under ERISA Section 3(21). The re-proposal of the PPA participant investment advice regulation follows upon the withdrawal of the final regulation that was published in January, 2009. Concerning the proposed rulemaking under ERISA section 3(21) and the definition of “investment advice” fiduciary, the DOL noted that current regulation may inappropriately limit the types of investment advice relationships that give rise to fiduciary duties on the part of the investment adviser. The rulemaking would amend the regulatory definition of the term “fiduciary” set forth at 29 CFR 2510.3-21(c) to more broadly define as employee benefit plan fiduciaries persons who render investment advice to plans for a fee within the meaning of section 3(21) of ERISA. According to the DOL, the amendment would take into account current practices of investment advisers and the expectations of plan officials and participants who receive investment advice.

For more information, please see: http://www.dol.gov/ebsa/regs/unifiedagenda/ebsafall2009/1210-AB35fs.html and http://www.dol.gov/ebsa/regs/unifiedagenda/ebsafall2009/1210-AB32fs.html  

On December 7th, the Supreme Court heard arguments in Free Enterprise Fund v. PCAOB. The Sarbanes-Oxley Act had established PCAOB as an independent entity to oversee accounting firms that audit public companies. Under Sarbanes-Oxley, the SEC has oversight and power over PCAOB. The case concerns whether Sarbanes-Oxley violates the separation of powers doctrine since the President does not have direct control over PCAOB’s members.

For a copy of the transcript, please see: http://www.supremecourtus.gov/oral_arguments/argument_transcripts/08-861.pdf  

On December 11th, the House approved the Wall Street Reform and Consumer Protection Act of 2009 (the “Act”), a complex and sweeping overhaul of financial services regulation. The legislation, among other things, would for the first time regulate the OTC derivatives markets, splitting regulatory oversight between the Commodity Futures Trading Commission (“CFTC”) and the SEC, create a new Consumer Financial Protection Agency (“CFPA”) to regulate consumer financial products and services, require registration of advisers to most types of private investment funds, and substantially enhance the SEC’s oversight and enforcement authorities. House members rejected an amendment that would have granted FINRA oversight and rulemaking authority over advisers that are associated with broker-dealers.

Title III of the Act regulates derivatives. The Act requires major swap and securities based swap (“SBS”) participants to register with the CFTC/SEC and subjects them to various requirements including ones regarding recordkeeping and conduct. The Act defines a major swap/SBS participant as any person who is not a swap dealer and (1) who maintains a substantial net position in outstanding swaps/SBS, excluding positions held primarily for hedging, reducing or otherwise mitigating its commercial risk; or (2) whose outstanding swaps/SBS create substantial net counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets. The Act leaves it to the CFTC and SEC to define what is a “substantial net position.”

Title IV of the Act creates the CFPA, which has authority to regulate persons engaged in a financial activity in connection with consumer financial products and service, defined generally as any financial product or service to be used by a consumer primarily for personal, family or household purposes. Any person “regulated by” the SEC, CFTC or a state securities commission, as defined by the Act, is not subject to CFPA’s authority to the extent that such person acts “in a registered capacity.”

Title V includes the Investor Protection Act, which would provide, among other things, for a uniform standard of conduct for broker-dealers and investment advisers as to personalized investment advice to retail customers. However, broker-dealers would not owe a continuing “duty of care or loyalty” to the customer after providing securities advice. The Act also strengthens the SEC’s powers to oversee and enforce compliance with securities laws. For example, the Act authorizes the SEC to curb the use of pre-dispute arbitration clauses by advisers and broker-dealers.

Title V of the Act also includes the Private Fund Investment Advisers Registration Act, which would require registration under the Advisers Act of most private fund advisers as well as new recordkeeping and disclosure requirements. Advisers to hedge funds, private equity firms, single-family offices, and other private pools of capital with assets under management of at least $150 million would be covered.

• Venture Capital Funds: The Act directs the SEC to engage in rulemaking to exempt from registration advisers to venture capital funds (to be defined by the SEC). Such advisers would still be subject to some disclosure and recordkeeping requirements.
• Foreign Advisers: The Act exempts from registration foreign private fund advisers, which are defined as advisers that (a) had, during the preceding 12 months, (1) fewer than 15 clients and investors in the United States in the private funds of the adviser, and (2) an aggregate of less than $25 million in assets under management attributable to clients and investors in the United States in private funds of the adviser; (b) do not have place of business in the United States; and (c) do not hold themselves out generally to the public as an investment adviser and do not act as an adviser to any registered investment company or business development company.
• Advisers to Mid-Sized Private Funds: The Act directs the SEC to provide registration and examination procedures for advisers to mid-sized private funds, taking into account the level of systemic risk posed by mid-sized funds. The Act does not define mid-sized private funds.
• Records and Reports of Private Funds: The Act requires registered advisers to maintain and file with the SEC records regarding the amount of assets under management, the use of leverage, including off-balance sheet leverage, counterparty credit risk exposures, trading and investment positions, trading practices and any other information the SEC or the Federal Reserve deem necessary and appropriate.

On December 14th, the SEC issued an order instituting administrative proceedings against an adviser, alleging that the adviser engaged in fraudulent trade allocation practices by favoring certain proprietary accounts over certain client accounts in the allocation of securities between 2000 and 2003. The order alleges that the adviser would place orders for securities, but delay allocating the purchases and sales until after the price of the security had been obtained. Using this information, the adviser “cherry-picked” by allocating favorable trades to the proprietary accounts as opposed to client accounts. According to the order, as a result of this fraudulent conduct which was not disclosed to investors, the adviser realized at least $19 million of gains in the form of performance fees from the proprietary accounts. 

For more information, please see: http://www.sec.gov/litigation/admin/2009/ia-2962.pdf  

On December 8th, the SEC made a filing with the U.S. Court of Appeals for the District of Columbia Circuit where it announced that it will postpone for two years the effective date of Rule 151A under the Securities Act of 1933. A group of insurance and marketing companies have challenged the rule. The rule, which was to go into effect for products sold on or after January 12, 2011, requires that certain indexed annuities be treated as securities rather than insurance products.

For more information, please see:
Brief for Respondent, American Equity Investment Life Insurance Company, et al. v. Securities and Exchange Commission (D.C. Cir. 2009), No. 09-1021

On December 10th, the SEC issued an order reinstating filing fees for the Investment Adviser Registration Depository (“IARD”) system. The IARD system will resume collecting filing fees for Form ADV from registered advisers for filings made between January 1 and December 31, 2010. Previously, fees ranged from $100 to $1,100 based on assets under management and the type of filing. For initial applications for registration and Form ADV annual update filings, IARD fees will be $40 for advisers with assets under $25 million, $150 for advisers with assets from $25 million to $100 million, and $200 for advisers managing assets over $100 million.

For more information, please see: http://www.sec.gov/rules/other/2009/ia-2959.pdf  

On December 9th, Andrew J. Donohue, Director of the Division of Investment Management, addressed the 2009 ICI Securities Law Developments Conference. Donohue discussed risk management within the financial services industry and noted that with funds, one should consider whether one (1) has correctly identified the risks to a fund and its shareholders; (2) has eliminated or mitigated risks that are not appropriate for the fund; and (3) has communicated the risks the fund has accepted to the fund’s investors in a manner they can understand and in a way that allows them to make an informed decision about investing in the fund. According to Donohue, instead of “a never ending list of risks without any framework for an investor to understand and evaluate the risks,” funds should consider a description of each risk which includes some analysis as to the likelihood of the risk occurring and the consequences of the risk if it does occur.

Donohue briefly discussed the proposals to amend rule 2a-7 under the Investment Company Act, and rule 206(4)-2 under the Advisers Act. Donohue also noted that the SEC staff is developing a recommendation to the SEC for amendments to the shareholder report disclosure.

Donohue said that the division has not been able to reach its goals on rule 12b-1 reform and investment adviser recordkeeping modernization. He noted that the Chairman has announced the SEC will consider recommendations for rule 12b-1 from the division in 2010. Donohue is hopeful that the division will address the rule proposed by the SEC in March last year to codify and expand relief in ETF exemptive orders, and have a recommendation to the SEC on re-proposed amendments to Form ADV Part 2.

For more information, please see: http://www.sec.gov/news/speech/2009/spch120909ajd.htm  

On December 16th, the SEC adopted rule amendments to enhance information provided in connection with proxy solicitations and in other disclosures or reports filed with the SEC. Many of the new disclosure requirements will apply to public operating companies but not to registered investment companies.

The amendments require registered investment companies to provide additional disclosures in proxy statements and statements of additional information regarding director and nominee qualifications; past directorships held by directors and nominees; legal proceedings involving directors, nominees and executive officers to funds; and new disclosure about leadership structure and the board’s role in the oversight of risk. In addition, registered investment companies will be required to provide additional disclosures in proxy statements about consideration of director diversity. The SEC did not define the meaning of the term “diversity” and left it to companies to formulate their own definition. The requirements imposed by the amendments regarding disclosures on compensation policies and practices that represent material risk are applicable only to public reporting companies and not to investment companies.

Commissioner Casey did not support the amendments. She found the enhancements unduly burdensome and likely to result in boilerplate language, instead of providing “decision-useful” information to investors. In addition, Commissioner Casey thought that the director and nominee disclosures encroach on the decision making authority of boards of directors.

For more information, please see: http://www.sec.gov/rules/final/2009/33-9089.pdf and http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=9336  

On December 16th, the SEC voted unanimously to adopt amendments to rule 206(4)-2 under Investment Advisers Act of 1940 (“Advisers Act”). The SEC had proposed amendments to the custody rule in May 2009, which if adopted would subject to annual surprise examinations registered investment advisers that do not have actual custody of client assets, but are deemed to have custody of client assets solely as a result of the authority to deduct fees from client accounts. The adopted amendments however do not subject such advisers to an annual surprise exam. The SEC noted that such advisers should have procedures to ensure accuracy of fee collection. The adopting release for the amended rule will recommend best practices in this area.

Self- and Affiliated Custody: The amendments require registered advisers that have custody themselves or through a related person to undergo an annual surprise exam by an independent accountant. If evidence reveals missing assets or material discrepancies during the surprise exam, the auditor would be required to notify the SEC within one day.

The surprise exam would not, however, be required if the adviser is deemed to be operationally independent of the affiliated custodian - that is, where the adviser and the affiliate operate as distinct entities with no overlap of personnel, office space or common supervision.

In addition to the surprise exam, all of the entities that hold client assets (advisers, affiliates or operationally independent affiliates) have to undergo an annual review of the controls they have in place regarding custody, to be conducted by an independent accountant registered with Public Company Accounting Oversight Board (“PCAOB”).

Advisers with Enhanced Authority Over Client Assets: Advisers that serve as trustee to a trust, have power of attorney or the ability to write checks on a client’s account are deemed to have significant level of control over clients’ assets, even if the adviser uses an independent custodian. Such advisers - but not advisers that are deemed to have custody by their deduction of fees from client accounts - are required to undergo a surprise exam.

The amendments also require that registered advisers reasonably believe that the client’s custodian delivers the account statements directly to the client, and do not allow account statements to be delivered by the adviser.

The amendments do not require advisers to use fully independent custodians. However, Chairman Shapiro encouraged all advisers to use independent custodians. Robert Plaze from the Division of Investment Management noted during the open meeting that it would be impractical to disrupt current custody arrangements in wrap or other separately managed account programs sponsored by dual registrants.

The amendments require that auditors that audit a private fund be registered with and subject to regular inspection by the PCAOB. Managers of private funds audited by such auditors are not required to undergo a surprise exam.

Commissioners Casey, Walter and Aguilar urged the staff to formulate proposals to strengthen the custody of assets at broker-dealers.

For more information, please see: http://www.sec.gov/news/press/2009/2009-269.htm, http://www.sec.gov/news/speech/2009/spch121609mls-custody.htm and http://www.sec.gov/news/speech/2009/spch121609laa-2.htm  

On November 20, 2009, the Labor Department’s Employee Benefits Security Administration (“EBSA”) published notice withdrawing the final rules that would have extended the provision of investment advice to millions of previously unadvised retirement plan participants and beneficiaries. The final rules were withdrawn in response to concerns about inadequate safeguards to protect against tainted advice being provided to participants as a result of advisers’ conflicted interests. First published in January 2009, the final rules were intended to implement a statutory exemption passed in 2006 to permit certain prohibited transactions under the Employee Retirement Income Security Act (and parallel provisions of the Internal Revenue Code of 1986) in connection with the provision of investment advice to certain unadvised retirement plan participants. The withdrawal of the final rules results in an absence of regulatory guidance on how to implement that statutory exemption, and EBSA is expected in coming months to propose alternative regulations for implementing the exemption. Legislation is also pending consideration by the House of Representatives which would provide for independent investment advice to participants in individual account plans.


For the November 2009 notice of withdrawal of final rules, please see:

http://www.smartpdf.com/register/2009/nov/20/E9-27889.pdf

For the January 2009 notice of final rules, please see:

http://www.setonresourcecenter.com/register/2009/jan/21/E9-710.pdf

On November 19, 2009, the OIG released the results of its review of the process used by the SEC to select for examination registered investment companies and registered investment advisers. The results were provided to the SEC in the report, “Review of the Commission’s Process for Selecting Investment Advisers and Investment Companies for Examination.” The OIG initiated the review of the SEC selection process in response to a report on August 31, 2009, entitled “Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme.”

The report includes 11 OIG recommendations for improving the SEC’s process for identifying registered investment companies and advisers for examination. The recommendations have been endorsed by the SEC’s Office of Compliance Inspections and Examinations and, to the extent applicable, by the SEC’s Office of the Chairman and Divisions of Enforcement and Investment Management. The recommendations include establishing joint protocols between OCIE and Enforcement to improve information sharing and implementing procedures to ensure that OCIE’s risk ratings for an adviser reflect all the information available in SEC databases, offices and divisions. The OIG requests that by early January 2010 the SEC propose a plan for implementing the recommendations.

For more information, please see:http://www.sec-oig.gov/Reports/AuditsInspections/2009/470.pdf

The SEC held on November 20, 2009, that a former salesperson and partial owner of a registered broker-dealer violated Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, by engaging in the “late-trading” of mutual fund shares. Also, the SEC held the individual aided and abetted and caused the broker-dealer to violate Section 17(a)(1) of the Exchange Act, and Rule 17a-3(a)(6) thereunder, by failing to maintain current books and records indicating the time final trade orders were received. The SEC concluded that clients of the individual who were permitted to submit trade orders to purchase or sell mutual fund shares after the 4 pm deadline benefited from the additional information about after-hours market performance available to them, whereas the other investors of the mutual funds suffered a dilution of the value of their shares in proportion to the benefit received by the late-trading clients. The SEC barred the individual from associating with any broker-dealer in the future, ordered a cease and desist, and assessed a civil penalty of $100,000 in addition to disgorgement of the individual’s profits from the late-trading which amounted to in excess of $500,000.

For more information, please see:http://sec.gov/litigation/opinions/2009/34-61039a.pdf

The SEC proposed changes to Regulations NMS and ATS under the Exchange Act and certain joint-industry plans (presently including the Consolidated Tape Association Plan and the NASDAQ Unlisted Trading Privileges Plan) in a release issued November 13, 2009 that are expected to have a profound impact on ATS known as “dark pools.” The amendments are intended to address concerns about public pricing transparency and two-tiered securities markets that have developed in connection with the increased trading volume of ATS.

The SEC is requesting comments on the proposed amendments no later than February 22, 2010.

For a summary of the proposal, please see:http://www.wilmerhale.com/files/upload/Securities%20Alert.pdf

For more information, please see:http://sec.gov/rules/proposed/2009/34-60997.pdf

The SEC adopted a series of amendments on November 23, 2009 that impose additional disclosure and conflicts of interest requirements on NRSROs. The amendments were proposed by the SEC in February 2009.

The SEC says that the amendments are intended to facilitate assessment of an NRSRO’s performance record at accurately assigning credit ratings, increase competition among NRSROs, and enhance the transparency and objectivity of the credit rating processes of NRSROs. The SEC amended Rule 17g-2 under the Securities Exchange Act of 1934 (the “Exchange Act”) to require broader disclosure in eXtensible Business Reporting Language about the accuracy of an NRSRO’s past credit ratings and Rule 17g-5 of the Exchange Act (with conforming changes to Rule 100(b)(2)(ii) of Regulation FD under the Exchange Act) to require an NRSRO that is hired by issuers, sponsors or underwriters (“arrangers”) to determine the initial credit rating of a structured finance product to inform non-hired NRSROs of the fact the arranger has requested a credit rating and to obtain representations from the arranger that the non-hired NRSROs will be given equivalent access to information necessary to determine the product’s credit rating.

The SEC also proposed amendments and a new rule on November 23, 2009. The amendments and rule would require an NRSRO to produce an annual report of the compliance reviews undertaken by the firm’s compliance officer, the material concerns identified, the remediation measures taken, and the persons at the firm advised of the results. An NRSRO also would be required to disclose additional information about its sources of revenues on Form NRSRO and provide the public with a consolidated report of the NRSRO’s revenues attributable to persons paying the NRSRO for the issuance or maintenance of a credit rating.

The adopted amendments have an effective date of February 2, 2010, with a compliance date 180 days after publication in the Federal Register. Comments on the proposed amendments and new rule are requested by the SEC due no later than February 2, 2010.

For more information, please see:http://www.sec.gov/rules/final/2009/34-61050.pdf

For more information, please see:http://www.sec.gov/rules/proposed/2009/34-61051.pdf

On December 4, 2009, SEC Chairman Mary Schapiro reported that she has asked the SEC staff to prepare recommendations to reform the regulation of Rule 12b-1 fees and target-date funds for Commission consideration in 2010. She also said that she believes that retail investors should be given point-of-sale disclosure when they make an investment decision.

As to 12b-1 fees, Chairman Schapiro expressed her belief that investors may not know that 12b-1 fees are being assessed and for what purpose they are used. She said “[t]here is a need for more fundamental change than merely disclosure reforms and the name change. We must critically rethink how 12b-1 fees are used and whether they continue to be appropriate.”

As to target date funds, Chairman Schapiro said that the SEC staff is focusing on marketing materials and the use of target dates in fund names. She said that she has asked the staff to present the Commission with recommendations early in 2010.

Finally, as to point-of-sale disclosure, she said that she believes that investors should receive, at the time of making an investment decision, “information about the compensation the professional will receive on each product being sold –– and information about the conflicts that may be causing the advisor or salesman to steer the investor to a certain investment.” She added that she expected “significant pushback from the industry related to cost and inconvenience.” She did not specify the timing of SEC action on point-of-sale disclosure.

For more information, please see:http://www.sec.gov/news/speech/2009/spch120309mls.htm