A federal district court dismissed a derivative action brought by shareholders of several mutual funds (the “Plaintiffs”) against the funds’ investment adviser and distributor (together, the “Defendants”) for allegedly charging excessive advisory and Rule 12b-1 fees in violation of Section 36(b) of the Investment Company Act of 1940 (“1940 Act”). Applying the Gartenberg standard, the court found that the Plaintiffs failed to establish a genuine issue of material fact regarding whether the fees charged were so disproportionately large that they bore no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.

The Plaintiffs primarily alleged that the Defendants’ advisory fees were excessive because institutional accounts were charged fees that were lower than those charged to the mutual funds. The court noted that the Gartenberg court rejected the plaintiffs’ assertion that “the lower fees charged by investment advisers to large pension funds should be used as a criterion for determining fair advisory fees for money market funds,” and that the nature and extent of the services required by each type of fund were different. The court explained that, since Gartenberg, courts have held that other mutual funds provide the relevant comparison for measuring fees -- not non-mutual fund institutional clients. The court stated that, even if comparing mutual fund fees to non-mutual fund fees is relevant, the Plaintiffs did not demonstrate that the services provided to the different types of clients are comparable, and the evidence instead shows that the Defendants provided the Board with a report indicating that the services provided to the funds in question were different than those provided to the institutional clients. The court quoted a recent Illinois district court decision, which stated that “[e]ven assuming for the mere sake of comparison that the services [the adviser’s] institutional clients received were indistinguishable from those the [f]unds received, the amounts paid by different parties establish a range of prices that investors were willing to pay.”

In granting the Defendants’ motion for summary judgment, the court also noted that: (1) the board set the Defendant’s fees at or below the median amount charged to comparable funds, (2) the fees included breakpoints to capture potential economies of scale, and (3) the fees were subject to performance adjustments whereby the fees would decrease if a fund’s performance did not exceed its benchmark.

The Plaintiffs also asserted that the Defendants breached their fiduciary duty under Section 36(b) with respect to distribution fees by failing to provide the directors with all necessary information required by Rule 12b-1, specifically a cost-benefit analysis of the Rule 12b-1 plans showing no material benefit to the shareholders. The court responded that the evidence showed that approximately 85% of the Defendants’ Rule 12b-1 fees were paid for services to existing shareholders and not for marketing the funds to new shareholders, and the Board had, in fact, considered the benefits of the full set of services financed by the Defendants’ Rule 12b-1 fees.

See, In re John E. Gallus et al. v. Ameriprise Financial, Inc., RiverSource Investments LLC, and Ameriprise Financial Services, Inc. (Civil No. 04-4498) (D. Minn. 2007); See also, Investment Company Institute Memo, “Federal District Court Dismisses Lawsuit Alleging Excessive Fund Fees,” July 25, 2007.

NYSE Regulation, Inc. announced that it censured and fined a registered broker-dealer (the “Respondent”) for market timing activities. These activities involved the use of deceptive trading practices to conceal the identities of the Respondent’s financial consultants and of their customers to effect market timing trades. Without admitting or denying guilt, the Respondent consented to certain findings, and to a fine totaling $50 million.

NYSE alleged that the Respondent’s representatives engaged in a variety of elaborate schemes to hide market-timing activities, which included changing their registered representative numbers and client account numbers. NYSE further alleged that the Respondent’s representatives broke up their trades into smaller trades and used multiple account numbers to avoid market-timing scrutiny. According to the complaint, approximately 150 registered representatives using more than 200 rep numbers in 60 branches engaged in approximately 250,000 market-timing exchanges in more than 1,500 accounts, which generated approximately $32.5 million in gross revenues.

The Respondent consented to findings that it violated: (1) NYSE Rule 342 by failing to reasonably supervise the trading of mutual fund shares and variable annuity mutual fund sub-accounts; (2) NYSE Rules 401(a) and 476(a) by failing to prevent certain brokers from engaging market timing activities prohibited by the mutual funds; and (3) Section 17 of the 1934 Act, Rule 17a-3 and 17a-4 thereunder, and NYSE Rule 440, by failing to maintain adequate books and records.

NYSE Hearing Board Decision 07-107, July 13, 2007, can be obtained at: http://www.nyse.com/pdfs/07-105.pdf.

In a speech addressed to the Town Hall of Los Angeles, SEC Chairman Cox discussed the integrity of the municipal market and potential reform. He explained that today’s investors in municipal securities in many respects get second-class treatment under current law. He noted that, although the SEC has anti-fraud authority, neither the SEC nor any other federal regulatory currently has the authority in the municipal market to insist on full disclosure of all material information to investors at the time such securities are being sold. He stated that recent SEC enforcement actions in the municipal area, together with the expert observations of the SEC staff, indicate an urgent need to improve the quality and the availability of disclosure documents and financial information for municipal securities. He highlighted the need to take immediate steps to improve governmental accounting and implement disclosure controls, policies and procedures for municipal securities. He explained that, under current law, the SEC does not have the same authority to require the use of proper accounting standards by municipal issuers that it does for issuers of corporate securities and, as a general rule, issuers of municipal securities do not issue their financial statements as promptly or frequently as corporate issuers.

Chairman Cox noted that the best way to address the problems and needs of municipal securities investors in a coherent manner is through legislation, which would mandate disclosure in the offering documents and periodic reports for municipal securities that is similar to the disclosure required for other securities most investors typically own. He stated that such legislation could focus on making this information available on a more timely basis and mandate that municipal issuers use generally accepted governmental accounting standards. Chairman Cox also noted that a more aggressive use of existing regulatory authorities would also help address certain deficiencies relating to the municipal securities market. He stated that, in the coming months, SEC examiners will be conducting focused reviews in the municipal market.

Speech by SEC Chairman, “Integrity in the Municipal Market,” can be obtained at: http://www.sec.gov/news/speech/2007/spch071807cc.htm 

On July 26, 2007, the SEC gave final regulatory approval on the consolidation of the member firm regulatory functions of NYSE Regulations, Inc., a wholly-owned subsidiary of New York Stock Exchange LLC and the National Association of Securities Dealers, Inc. The SEC approved rule changes that allow for the consolidation of member firm regulation into a single, consolidated self-regulatory organization. The consolidated organization will be known as the Financial Industry Regulatory Authority (“FINRA”). The consolidation is intended to help streamline the broker-dealer regulatory system, combine technologies, and permit the establishment of a single set of rules governing membership matters, with the aim of enhancing oversight of U.S. securities firms and assuring investor protection.

FINRA will operate under SEC oversight. FINRA will be responsible for regulating all securities firms that do business with the public, including with respect to professional training, testing and licensing of registered persons, arbitration and mediation. FINRA also will be responsible, by contract, for regulating the Nasdaq Stock Market, Inc., the American Stock Exchange LLC, and the International Securities Exchange, LLC. Finally, FINRA will be responsible for operating industry utilities, such as trade reporting facilities and other over-the-counter operations. NYSE regulation, Inc., will continue to be responsible for the regulatory oversight of trading on the NYSE.

SEC Press Release, dated July 26, 2007, “SEC Gives Regulatory Approval for NASD and NYSE Consolidation.” A copy of the SEC order approving the amendments to NASD By-Laws can be obtained at: http://www.sec.gov/rules/sro/nasd/2007/34-56145.pdf 

FINRA’s website can be accessed at: http://www.finra.org 

On July 27, 2007, the SEC published proposed amendments to the rules under the 1934 Act relating to shareholder proposals and electronic shareholder communications, as well as the disclosure requirements of Schedule 14A and Schedule 13G. The proposed Rule 14a-8 amendments would enable shareholders to include in an issuer’s proxy materials their proposals for by-law amendments regarding the procedures for nominating candidates to the issuer’s board of directors. Schedule 14A and Schedule 13G would be amended to require shareholders to be provided with additional information about the proponents of these proposals and any shareholders that nominate a candidate under such an adopted procedure. Finally, the proposed amendments would revise the proxy rules to clarify that participation in an electronic shareholder forum that may constitute a solicitation would be generally exempt from the proxy rules.

The SEC also published a companion release, which provides an interpretation of and proposes a rule change to affirm the SEC’s Division of Corporation Finance’s historical application of Rule 14a-8(i)(8) under the 1934 Act, which permits the exclusion for shareholder proposals relating to the election of directors.

A detailed summary of the SEC’s proposed rules and related interpretations will be provided in a future WilmerHale Investment Management News Summary.

SEC Proposed Rules and Interpretations, “Shareholder Proposals” (Release Nos. 34-56160; IC-27913; File No. S7-16-07) and “Shareholder Proposals Relating to the Election of Directors (Release Nos. 34-56161; IC-27914; File No. S7-17-07). A copy of the proposed rules and interpretations can be obtained at: http://www.sec.gov/rules/proposed/2007/34-56160.pdf and http://www.sec.gov/rules/proposed/2007/34-56161.pdf 

The SEC recently adopted amendments to the proxy rules under the Securities Exchange Act of 1934 (“1934 Act”), which will require issuers and other soliciting persons to post their proxy materials on an internet website and provide shareholders with a notice of the internet availability of these materials. Under the amendments, an issuer may select either of the following two options to provide proxy materials to its shareholders: (1) the “notice only option” or (2) the “full set delivery option.” The “notice only option” requires issuers to post their proxy materials on an internet website and send a notice to shareholders to inform them of the electronic availability of proxy materials at least 40 days before the shareholder meeting. If an issuer follows this option, it must respond to shareholder requests for copies of proxy materials, including a shareholder’s permanent request for paper or email copies of proxy materials for all shareholder meetings. The “full set delivery option” requires issuers to deliver a full set of proxy materials to shareholders, along with the notice of electronic availability of proxy materials. However, the issuer does not need to prepare and deliver a separate notice if it incorporates all of the information required to appear in the notice into its proxy statement and proxy card. Also, the issuer need not respond to requests for copies as required under the notice only option.

A detailed summary of the final rule amendments will be provided in a future WilmerHale Investment Management News Summary.

SEC Final Rules, “Shareholder Choice Regarding Proxy Materials” (Release Nos. 34-56135; IC-27911; File No. S7-03-07). A copy of the final rules can be obtained at: http://www.sec.gov/rules/final/2007/34-56135.pdf 

The United States District Court for the Northern District of California issued an order granting class certification to plaintiffs who allege that the defendant sponsors, advisers, and managers of three mutual funds violated Section 10(b) under the 1934 Act and Rule 10b-5 thereunder by charging excessive fees. The plaintiffs allege that the defendants omitted material facts from the funds’ prospectuses regarding the revenue sharing payments made by the funds’ advisers to broker-dealers in return for “shelf space” for the funds. Judge Alsup held that: “the primary concealments were (i) that some portion of the advisory (and other) fees imposed on the fund (and thus the investors) was not for the stated purpose but was a charade and really just a conduit for financing the undisclosed program of revenue sharing and (ii) that the undisclosed revenue-sharing program had reached such magnitude that the advisers had a conflict of interest in extracting fees from the fund, having a duty to subtract only justifiable fees.”

Judge Alsup’s analysis of whether the plaintiffs met all four elements for class certification under Rule 23 focused on whether the plaintiffs met the “commonality of a claim” element as required under Rule 23(a)(2). The plaintiffs’ fraud claim was based primarily on Section 10(b) of the 1934 Act. For plaintiffs to base their claim on Section 10(b), the plaintiffs must meet the following elements: (a) an alleged misrepresentation or omission; (b) scienter; (c) a connection with the purchase or sale of a security; (d) reliance by the plaintiffs on such material misrepresentation of omission; (e) economic loss; and (f) the loss having been caused by the defendant’s actions. Judge Alsup focused much of his analysis on the question of whether the plaintiffs relied on the material misrepresentation or omission by the defendants. Judge Alsup reasoned that the plaintiffs’ could not use the “fraud-on-the market theory” to show reliance because the funds were priced daily using the funds’ net asset value rather than a price based on a market price that could be effected by information regarding the funds. However, in a controversial decision that will be cited in future class action litigations against mutual funds and fund advisers, Judge Alsup found that the plaintiffs need not show actual reliance by each individual investor because the class members were relying on the defendant’s alleged omission of a material fact from the funds’ prospectuses. In coming to this conclusion, Judge Alsup found that the plaintiffs met the test for establishing reliance based upon a material omission as set forth in Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 153-54 (1972).

On July 5, 2007, the defendant and the plaintiffs executed a proposed stipulation of settlement of a class action lawsuit. The court has scheduled a hearing on July 25, 2007 to approve preliminarily the settlement.

As consideration for dismissal of the claims, the defendant agreed to pay the class $1,098,500, of which $400,000 is proposed to be distributed to the plaintiffs’ counsel for attorneys’ fees. The defendant also agreed to pay one of the affected funds $50,000 on the excessive fee claim.

The defendant further agreed to augment its revenue sharing disclosures in both the prospectuses and Statement of Additional Information (“SAI”). The new prospectus disclosures describe revenue sharing payments as “significant,” that they may differ among selling and shareholder servicing agents, and that compensation may be based on a percentage of sales or customer assets. The new SAI disclosures list the NASD member firms to which the defendant makes revenue sharing payments. The SAI further discloses that the defendant may make to revenue sharing payments to selling and shareholder service agents, including banks, insurance companies and plan administrators.

The order granting class certification is Siemers v. Wells Fargo & Co., No. 05-04518. Order (N.D. CA June 1, 2007).

The stipulation and settlement is Siemers v. Wells Fargo & Co., No. 05-04518 WHA, Stipulation of Settlement (July 5, 2007)

The Massachusetts Securities Division of the Office of the Secretary of the Commonwealth (the “Securities Division”) filed a complaint against a prime broker for allegedly “providing gifts and gratuities to the advisers for certain hedge funds, including below market rent, personal loans with below market interest rates, and tickets to sporting events and other entertainment events.” The Securities Division alleged that the gifts and gratuities were provided to induce the hedge fund advisers to increase and maintain prime brokerage fees resulting from the hedge funds’ business. The Securities Division further alleged that some of the gifts and gratuities received by the hedge fund advisers were not disclosed to the hedge fund clients, which was in contravention of the terms of a memorandum of understanding (the “MOU”) between the Securities Division and the predecessor entity of the prime broker. The MOU provided that the prime broker’s predecessor entity would ensure that all state-registered investment advisers that received below market rent would disclose such fact to their investors. The Complaint asserted that the prime brokers’ actions violated a Massachusetts law prohibiting dishonest and unethical business practices because the prime broker violated NASD rules relating to gifts and gratuities, supervision, and recordkeeping.

The Massachusetts Securities Division Complaint can be found at: http://www.sec.state.ma.us/sct/sctubs/ubsidx.htm.

On July 6, 2007 the SEC settled with an investment adviser for allegedly trading U.S. mutual funds and annuities through an illegal market timing strategy executed by the adviser’s trading desk. The SEC alleges that the adviser violated Section 17(a)(3) of the 1933 Act by engaging in deceptive tactics to hide the adviser’s identity from the mutual funds and annuities it was timing. The adviser agreed to pay disgorgement of $3,300,000, prejudgment interest of $1,180,000 and a civil penalty in the amount of $100,000.

The release announcing the settlement, Securities Act Release No. 8820 (July 6, 2007) can be found at: http://www.sec.gov/litigation/admin/2007/33-8820.pdf

On June 25, 2007 the SEC settled an action brought against certain investment advisers and distributors to mutual funds and variable insurance issuers (together, the “Funds”) in connection with revenue sharing agreements. The SEC alleged that the advisers violated Section 206(2) of the Advisers Act when they did not disclose to the boards of directors of the Funds the conflict of interest created by directing the Funds’ brokerage commissions to pay for marketing expenses incurred by the distributors that were over and above the distribution expenses authorized by the Funds’ boards. The SEC also alleged that the distributors willfully aided and abetted and caused violations of Section 206(2) of the Advisers Act when they offered products while knowing that brokerage commissions generated by the Funds were used to pay marketing expenses and knew or should have known that the advisers did not disclose this use of Fund assets to the Funds’ boards. The SEC also alleged that the advisers violated Section 34(b) of the 1940 Act by making untrue statements of material facts in the Funds’ registration statements, and that the advisers and the distributors violated Section 17(d) of the 1940 Act and Rule 17d-1 thereunder for each of their participation in the arrangements.

The release announcing the settlement, Securities Exchange Act Release No. 55946 (June 25, 2007), can be found at: http://www.sec.gov/litigation/admin/2007/34-55946.pdf

June 26, 2007 the SEC settled a civil action in the U.S. District Court for the District of Columbia against a hedge fund adviser for short sales that allegedly violated Rule 105 of Regulation M under the Securities Exchange Act of 1934, as amended (the “1934 Act”). The SEC alleged that the adviser caused four of the hedge funds that it manages to sell securities short during the five business day “black-out period” before the pricing of public offerings and then covered such short positions with securities purchased in the offerings. The adviser allegedly violated Rule 105 on 16 occasions in 14 different public offerings. In the related administrative proceeding, the adviser agreed to cease and desist from committing or causing any violations and any future violations of Rule 105 and to pay disgorgement of $2,214,180 and prejudgment interest of $489,455.

The release announcing the settlement, Securities Exchange Act Release No. 55956 (June 26, 2007) can be found at: http://www.sec.gov/litigation/admin/2007/34-55956.pdf 

On June 29, 2007, the SEC published for comment proposals that would mandate the electronic filing of information required by Form D of the Securities Act of 1933, as amended (the “1933 Act”). Form D is the official notice filed with the SEC by an issuer of an offering of securities made without registration under the 1933 Act in reliance on an exemption provided by Regulation D. The proposed revisions to both Form D and Regulation D would simplify and restructure Form D and update and revise its information requirements. The proposed rule would make Form D electronically accessible on the SEC’s website. The proposed Form D would require any issuer that is a “pooled investment vehicle” to identify whether it is an investment company registered under the 1940 Act or relying on an exclusion from the definition of investment company, in which case it would have to identify the exclusion. The new Form D also would require issuers to identify whether the interests being offered are pooled investment fund interests. The proposed Form D would no longer require reporting of 10% holders of equity securities, a name for the offering, and the number of purchasers and the amount of securities purchased in each state.

Comments are due by September 27, 2007.

The proposing release, Securities Act Release No. 8814 (June 29, 2007), can be found at http://www.sec.gov/rules/proposed/2007/33-8814.pdf 

On July 11, 2007 Erik R. Sirri, Director of the SEC’s Division of Market Regulation, testified before the House Financial Services Committee regarding the SEC’s enforcement actions against hedge fund advisers, new rulemaking to clarify the SEC’s ability to bring enforcement proceedings against an investment adviser who defrauds investors or potential investors in a hedge fund or other pooled investment vehicle, new rulemaking to add a new category of “accredited investor” with an increased net worth standard, and the Consolidated Supervised Entity Program’s monitoring and assessment of systemic hedge fund risk.

Enforcement Actions. Mr. Sirri cited recent SEC enforcement actions against hedge fund advisers, including cases alleging fraud by hedge fund managers, insider trading, market manipulation, illegal short selling, and fraudulent market timing and late trading.

Hedge Fund Related Rulemaking. Mr. Sirri noted that the SEC planned to adopt a new antifraud rule under the Advisers Act to clarify its ability to bring actions against advisers who defraud investors in a hedge fund or other pooled investment vehicle (see “SEC Adopts Proposed Antifraud Rule For Investment Advisers” above for an explanation of that rule). Mr. Sirri also explained that the SEC was considering increasing the financial thresholds required for investors in hedge funds by increasing the “accredited investor” standard.

Consolidated Supervised Entities (“CSEs”) and Hedge Fund Risk Monitoring and Assessment. Mr. Sirri explained that the SEC’s CSE program is designed to provide holding company supervision over SEC regulated entities in a manner that is broadly consistent with the oversight provided to bank holding companies by the Federal Reserve. For example, the SEC oversees not only the U.S.-registered broker-dealer, but the consolidated entity (a “CSE”), which may include other regulated entities such as foreign-registered broker-dealers and banks, as well as unregulated entities, such as derivatives dealers and the holding company itself. Mr. Sirri testified that the SEC’s CSE program monitors and assesses the risks relating to hedge funds at each of the CSEs in several ways, including:

• Monthly meetings with senior risk managers at the CSEs to review market and credit risk exposures in general and with respect to hedge funds;
  
• Targeted meetings with the CSEs regarding the challenges of measuring credit exposures to hedge funds and the need for “stress testing” the CSEs exposure to hedge fund counterparties; and
  
• Joint meetings with the Federal Reserve and the U.K. Financial Services Authority to identify current industry practices of banks and broker-dealers in managing exposure to hedge funds.

Finally, Mr Sirri provided the Committee with “some interesting data points” for it to consider, which included:

• “The largest, more systemically important hedge funds are beginning to look more and more like mature financial institutions, diversifying their portfolios beyond leveraged equity or fixed income strategies, and diversifying their activities beyond just proprietary trading.”
  
• “Hedge funds generally have become more sophisticated about liquidity risk management, in part by negotiating more flexible credit terms with dealer banks. …[T]his increase in sophistication is both a blessing and a curse. On the one hand, more favorable credit terms means more flexibility in times of market turmoil, leading to a lower probability of a forced unwinding of positions and destabilized markets. On the other hand, more favorable credit terms mean more concentrated counterparty credit risk for the banks.”
  
• “[I]n some markets, hedge funds are the major providers of liquidity - in short, what they giveth, they can taketh away”; and
  
• “The economics of a margin loan can be replicated in synthetic form through derivatives or achieved through repurchase agreements…. The regulatory focus on excessive leverage is the right one, but this is far from simple in today’s innovative financial markets.”
  

On July 11, 2007 Andrew Donohue, Director of the SEC’s Division of Investment Management, testified before the U.S. Senate Committee on Finance concerning initial public offerings of investment managers of hedge funds and private equity funds. He discussed the Division’s analysis in determining whether an alternative asset manager is an investment company and thus subject to the 1940 Act. Mr. Donohue used the recent IPOs of the Blackstone Group L.P. and Fortress Investment Group LLC as examples of how the Division conducts its investment company status determinations. Mr. Donohue explained that both Blackstone and Fortress were not investment companies because both were primarily engaged in non-investment company businesses and that neither held investment securities with a value exceeding 40% of their total assets (both are key factors in determining whether a company is an investment company). Importantly, Mr. Donohue noted that the general partnership interests held by Blackstone and Fortress were not securities.

The text of Mr. Donohue’s written testimony can be found at: http://www.sec.gov/news/testimony/2007/ts071107ajd.htm 

On June 11, 2007, the SEC unanimously voted to adopt proposed Rule 206(4)-8, a new antifraud rule under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The rule would provide that it is unlawful for any investment adviser (whether or not registered) to a “pooled investment vehicle” to make misleading statements or omissions or otherwise engage in fraudulent or deceptive actions as to an investor or prospective investor in the vehicle. The SEC declined to limit the Rule’s application to advisers to private investment funds relying on Section 3(c)(1) or Section 3(c)(7) for exclusion from the Investment Company Act of 1940, as amended (the “1940 Act”), as the Investment Company Institute and others had suggested. Accordingly, the rule will apply to advisers to registered investment companies. The SEC stated that the rule is intended to clarify the Commission’s ability to bring enforcement actions under the Advisers Act. The release adopting the proposed rule has not yet been published by the SEC; the rule will take effect 30 days after that publication.

The SEC’s press release announcing the adoption of the rule, “SEC Votes to Adopt Antifraud Rule Under Investment Advisers Act” Press Release No. 2007-133, is available at: http://www.sec.gov/news/press/2007/2007-133.htm.

On June 13, 2007 FinCEN issued FIN-2007-G003, “Suspicious Activity Report Supporting Documentation” (the “Guidance”). The Guidance is meant to clarify: (a) the Bank Secrecy Act (“BSA”) requirement that financial institutions provide Suspicious Activity Report (“SAR”) supporting documentation in response to requests by FinCEN and appropriate law enforcement or supervisory agencies (collectively known as “Law Enforcement Agency”); (b) what constitutes “supporting documentation” under SAR regulations; and (c) when legal process is required for disclosure of supporting documentation.

Disclosure of Supporting Documentation.

In connection with the filing of a SAR a financial institution is required to maintain a copy of the SAR and any supporting documentation for a five year period following the filing of the SAR. Upon request by a Law Enforcement Agency, a financial institution must provide all documentation supporting the filing of a SAR. FinCEN also reminds financial institutions that the BSA provides a safe harbor for the disclosure of SARs and all supporting documentation made to a Law Enforcement Agency regardless of whether such reports are mandatory.

With respect to requests for supporting documentation, FinCEN recommends that financial institutions should: (a) verify that a requestor of information is a representative of the Law Enforcement Agency; and (b) develop and incorporate procedures into its BSA compliance or anti-money laundering program for verifying that a requestor of information is a representative of such Law Enforcement Agency.

What Constitutes Supporting Documentation?

“Supporting documentation” includes all documents or records that a financial institution considers in its analysis of whether an activity requires a SAR filing. The exact nature of the supporting documentation will depend on the facts and circumstances of each SAR filing. Financial institutions are required to identify supporting documentation in the SAR narrative, but a document or record may qualify as supporting documentation even if not identified.

No Legal Process Required for Disclosures of Supporting Documentation

The prohibitions on disclosing a customer’s financial records to a government agency without service of legal process, notice to the customer or an opportunity for the customer to challenge the disclosure, as required by the Right to Financial Privacy Act (“RFPA”), do not apply when a financial institution provides financial records or information to a Law Enforcement Agency or if a Law Enforcement Agency requests either a copy of a SAR or supporting documentation underlying the SAR.

FIN-2007-G002, “Suspicious Activity Report Supporting Documentation” can be found at: http://www.fincen.gov/Supporting_Documentation_Guidance.pdf

On June 13, 2007 FinCEN issued FIN-2007-G002, “Requests by Law Enforcement for Financial Institutions to Maintain Accounts” (the “Guidance”). The Guidance provides financial institutions with recommendations as to how to handle a request from a law enforcement agency to maintain a particular account, notwithstanding suspicious or potential criminal activity in connection with such account. For the purposes of the Bank Secrecy Act, “financial institutions” include banks, credit unions, thrifts, broker-dealers, insurance companies, investment companies and certain other intermediaries, but does not include investment advisers. The guidance contains the following reminders and recommendations:

• FinCEN reminds financial institutions that although financial institutions should be mindful that complying with requests from a law enforcement agency to maintain a particular account may further law enforcement efforts to combat money laundering, terrorist financing, and other crimes, the ultimate decision to maintain or close an account should be made by a financial institution in accordance with its own standards and guidelines.
• Financial institutions should require law enforcement agencies to submit requests to maintain a particular account in writing and that such writing should: (a) be from a supervisor at such law enforcement office, an attorney within a United States Attorney’s Office or another office of the Department of Justice or an attorney within the state or local prosecutor’s office; (b) specifically request that the account be maintained and indicate the purpose of such request; and (c) indicate the duration of the request, which should not to exceed six months.
• Financial institutions should maintain documentation of any request to maintain a particular account for at least five years after the request has expired, even though there is no recordkeeping requirement under the Bank Secrecy Act for such correspondence.
• The financial institution should notify law enforcement before making any decision to close an account that the financial institution is aware is under investigation.
• FinCEN reminds financial institutions that even if a financial institution is keeping an account open or maintaining a customer relationship at the request of law enforcement, the financial institution is required to comply with all applicable Bank Secrecy Act recordkeeping and reporting requirements, including the requirement to file Suspicious Activity Reports.

FIN-2007-G002, “Requests by Law Enforcement for Financial Institutions to Maintain Accounts” can be found at:http://www.fincen.gov/Maintaining_Accounts_Guidance.html

On June 25, 2007, the United States Court of Appeals for the District of Columbia Circuit (the “DC Circuit”) granted an order to stay its May 17, 2007 mandate (the “Mandate”) to vacate Rule 202(a)(11)-1 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which stemmed from the DC Circuit’s ruling in Financial Planning Association v. SEC (the “March 30 Decision”). In the March 30 Decision the DC Circuit found that the SEC exceeded its authority in promulgating Rule 202(a)(11)-1, which exempted broker-dealers that provide investment advice to clients with fee-based accounts from the registration requirements of the Advisers Act. The Mandate is stayed until October 1, 2007.

See Financial Planning Association v. SEC, Order No. 04-1242 U.S. Court of Appeals for the DC Circuit (June 25, 2007)

The DC Circuit’s March 30, 2007 opinion in Financial Planning Association v. SEC is available at http://pacer.cadc.uscourts.gov/docs/common/opinions/200703/04-1242a.pdf.

In January 2007, NASD issued Notice to Members 07-02 “Web Site References to NASD Membership by Member Firms” which amended Interpretive Material 2210-4 (“IM 2210-4”), which sets forth limitations on the use of NASD’s name. The amended IM 2210-4 requires firms that refer to their NASD membership on a web site to provide a hyperlink to www.nasd.com. The amendments to IM 2210-4 are effective on July 7, 2007.

The NASD Notice to Members 07-02 can be found at: http://www.nasd.com/web/groups/rules_regs/documents/notice_to_members/nasdw_018275.pdf 

On June 14, 2007, the NASD and NYSE (collectively, “SROs”) proposed for comment Joint Guidance regarding the review and approval of electronic communications by member firms. The SROs proposed the Joint Guidance to provide greater clarity on (i) member firms’ obligations with regard to the review of various types of electronic communications, and (ii) the types of policies and procedures that firms should put in place.
The Joint Guidance is notable in that it: (i) discusses the written policies and procedures that firms must develop for supervising both internal and external communications of registered and unregistered personnel, (ii) permits delegation of certain review functions to non-registered personnel, (iii) describes policies and procedures for third-party platforms and personal devices, and (iv) provides additional guidelines for lexicon-based and random reviews of electronic communications. The comment period expires on July 13, 2007.

The NASD/NYSE Notice to Members can be found at: http://www.nasd.com/web/groups/rules_regs/documents/notice_to_members/nasdw_019298.pdf 

The WilmerHale Briefing Memorandum “SROs Propose Joint Guidance Regarding the Supervision of Electronic Communications” can be found at: http://www.wilmerhale.com/files/Publication/1dac62e4-29f8-4390-95b9-028a9f4f26ef/Presentation/PublicationAttachment/66494631-f330-47dd-bcfe-5c0e84c3fa5a/SecuritiesBrief_June07.pdf 

On June 13, 2007 the SEC voted to amend Regulation SHO in order to: (a) better safeguard investors and protect the integrity of the markets during short selling transactions and (b) reduce the persistent failures to deliver securities by the end of the standard three-day settlement period for trades. The amendments to Regulation SHO include the following:

• Final Amendments to Rules 200 and 203 of Regulation SHO. The SEC adopted final amendments to Rules 200 and 203 of Regulation SHO to address failures to deliver securities in connection with short sales. The amendments are effective 60 days from the date of publication in the Federal Register. The amendments: (1) eliminate the grandfather provision in Rule 203(b)(3)(i) and require fail to deliver positions in threshold securities to be closed out within 13 settlement days; (2) permit grandfathered positions to be closed out within 35 settlement days of the effective date of the amendment; (3) amend Rule 203 to extend the close out requirement from 13 to 35 settlement days for fails to deliver resulting from sales pursuant to Rule 144 of the Securities Act of 1933, as amended; and (4) amend Rule 200(e)(3) to reference the NYSE Composite Index (NYA) instead of the Dow Jones Industrial Average (DJIA), clarify that the two-percent limitation in the rule is to be calculated in accordance with NYSE Rule 80A and provide that the market decline limitation will remain in effect for the remainder of the trading day.
  
• Amendments to Rule 10a-1 and Regulation SHO. The SEC voted to remove Rule 10a-1 (the “Tick Test”) and prohibit any self-regulatory organization from imposing a similar short sale price test. Under the Tick Test, a short sale could only be effected at a price above the last different sale price (on a “plus tick” or a “zero tick”) and could not be effected on a “down-tick” except under certain narrow exceptions. The amendments are effective on July 6, 2007.

SEC Release No. 34-55970, Regulation SHO and Rule 10a-1can be found at: http://www.sec.gov/rules/final/2007/34-55970.pdf

The SEC’s Press Release can be obtained at: http://www.sec.gov/news/press/2007/2007-114.htm

On June 20, 2007 the SEC adopted amendments to Rule 105 of Regulation M, which will strengthen Rule 105 by prohibiting an investor from purchasing shares in a secondary offering if the investor effected any short sales during the Rule 105 restricted period prior to the pricing of such offering.

Rule 105 is designed to deter abusive short selling and market manipulation during public offerings by preventing an investor who expects to receive an issuer’s securities in an offering from selling such issuer’s securities short during the restricted period prior to the offering and subsequently covering the short sale with securities purchased in the offering. Currently, Rule 105 places limitations on covering short sales with shares acquired in a secondary offering if the investor shorted such shares within the Rule 105 “restricted period” of up to five business days prior to the pricing of such offering. According to the SEC’s press release, by amending the Rule to implement a flat prohibition on participating in the offering for investors who short during the restricted period, the SEC is seeking to address a proliferation of non-compliance with the Rule and strategies that are designed to evade the Rule by concealing prohibited trading.

Nevertheless, the amendments to Rule 105 are expected to include certain exceptions (i) to allow an investor who sells short during a restricted period to participate in an offering if such investor makes a bona fide purchase prior to the pricing of such offering and (ii) to allow investment companies and certain other entities that make separate trading and investment decisions not to be aggregated for purposes of the Rule.

The full text of the detailed releases concerning the amendments has not yet been issued by the SEC. The amendments will be effective 60 days after publication in the Federal Register.

The SEC’s Press Release can be obtained at: http://www.sec.gov/news/press/2007/2007-120.htm