Reed Smith LLP George F.Magera Investment Adviser News ... · Highlights included new rules regarding investment adviser codes of ... The compliance dates for many of these rules

Investment Management Group February 2005

Reed Smith LLP Investment Adviser News 2004 Annual Update

The Investment Adviser News 2004 Annual Update chronicles the past year's regulatory

developments and other news stories of interest to investment advisers and the

investment management industry. The developments and stories are summarized and,

where possible, contain links to more information. A review of the 80+ developments summarized herein leaves no doubt that 2004 was

another year of unprecedented rulemaking. Not only did the SEC make great strides in

implementing its reform agenda, but other government agencies, self-regulatory

organizations and industry groups issued a spate of regulations and/or

recommendations. Highlights included new rules regarding investment adviser codes of

ethics, investment adviser and investment company compliance programs, portfolio

manager compensation disclosure, board approval of investment adviser contract

disclosure, and the registration of hedge fund advisers. The compliance dates for many

of these rules loom in the upcoming months, making implementation the critical task of

the day. In the meantime, we'll continue to keep you apprised of the industry's relevant

legal developments on a quarterly basis.

Looking ahead, the SEC has advised that its initiatives in the new year will include an

outreach to investment adviser and mutual fund chief compliance officers,

improvement of the oversight of investment advisers and mutual funds, reconsideration

of the use of soft dollars, disclosures related to portfolio transaction costs, a full-scale

review of the mutual fund disclosure regime, an overhaul of Rule 12b-1, and substantial

revisions to Form ADV. Stay tuned . . .

Legal Update:

If you have questions or would like additional information on the material

presented herein, please contact

George F.Magera 412.288.7268

[email protected]

or

Frederick C. Leech 412.288.4178

[email protected]

Investment Management Group

C. Grant Anderson Omar-Saeed M. Blayton

G. Andrew Bonnewell Byron F. Bowman Michael J. Budicak

Andrew P. Cross Gregory P. Dulski

Timothy S. Johnson Gail C. Jones

Stephen A. Keen Lisa D. McAnany Daniel M. Miller

Kary A. Moore Donald J. Myers

Jay S. Neuman Thao Ngo

Stacey C. Palmer Alicia G. Powell

Michael B. Richman Leslie K. Ross

Victor R. Siclari Travis E. Williams Nelson W. Winter

Rana J. Wright Todd P. Zerega

…or the Reed Smith attorney with whom you regularly work

This text is presented for informational purposes and is not intended to constitute legal advice.

“Reed Smith” refers to Reed Smith LLP, a limited liability partnership formed in the state of Delaware.

© Reed Smith LLP 2005. All Rights Reserved.

Reed Smith LLP Investment Adviser News

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DATE TOPIC SUMMARY 1.5.04 AGENCIES PROVIDE GUIDANCE ON FINANCIAL

INSTITUTIONS PROVIDING FINANCIAL SUPPORT TO PROPRIETARY FUNDS http://www.reedsmith.com/library/publicationView.cfm?itemid=66562&catid=14 (Copy of Reed Smith bulletin) http://www.fdic.gov/news/news/financial/2004/FIL0104.html (Copy of Interagency Statement)

♦ The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision jointly issued an “Interagency Policy on Banks/Thrifts Providing Financial Support to Funds Advised by the Banking Organization or its Affiliates” (the “Interagency Statement”).

♦ The Interagency Statement warns financial institutions, and their boards of directors and senior management, of the safety and soundness implications of, and the legal impediments to, financial institutions providing financial support to investment funds advised by the financial institutions, its subsidiaries or affiliates.

1.7.04 SEC CHAIRMAN SPEAKS ABOUT MUTUAL FUND INDEPENDENT DIRECTORS http://www.sec.gov/news/speech/spch010704whd.htm (Chairman's speech) http://www.sec.gov/news/speech/spch010804pfr.htm (Division of Investment Management Director Paul Roye's speech)

♦ Securities and Exchange Commission (“SEC”) Chairman Donaldson spoke at a Mutual Fund Directors Forum about the need for mutual fund directors to be more diligent.

♦ He noted that independent directors are investors' first line of defense in ensuring that their interests are being served, that conflicts of interest are being appropriately managed and disclosed, and that investors' money is being managed responsibly.

♦ He noted that recent industry events demonstrate that fund directors must be proactive and continually challenge and question fund management in other high-risk areas, such as portfolio management, pricing, sales of fund shares (including the use of fund assets to facilitate distribution), and the overall program of compliance and internal controls.

1.15.04 NEW FUND GOVERNANCE RULES PROPOSED http://www.sec.gov/rules/proposed/ic-26323.htm (Copy of rule proposal)

♦ The SEC proposed rules under the Investment Company Act of 1940 (“1940 Act”) to require registered investment companies to adopt certain governance practices.

♦ The proposed rules, which apply to funds relying on certain widely used exemptive rules, are designed to enhance the independence and effectiveness of fund boards.

♦ Key elements of the proposals include: • Independent directors will have to constitute at least

75 percent of the board of directors; • The chairman of the fund board will have to be

independent; • Fund directors will have to perform an evaluation, at

least once annually, of their effectiveness; • Independent directors will be required to meet at

least once quarterly in a separate session (no interested persons of the fund present); and

♦ The independent directors will have the authority to hire employees and others to help them fulfill their fiduciary duties.

1.20.04 SEC PROPOSES RULE REQUIRING ADVISERS TO HAVE CODE OF ETHICS http://www.sec.gov/rules/proposed/ia-2209.htm

♦ The SEC proposed a new rule under the Investment Advisers Act of 1940 (“Advisers Act”) that will require registered investment advisers to adopt codes of ethics.


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(Copy of rule proposal)

♦ The codes of ethics would set forth standards of conduct expected of advisory personnel, safeguard material nonpublic information about client transactions, and address conflicts that arise from personal trading by advisory personnel.

♦ The rule also would require advisers' supervised persons to report their personal securities transactions, including transactions in any mutual fund managed by the adviser.

1.21.04 SEC POLICY ON DEFICIENCY LETTERS AND FUND BOARDS

♦ In a letter dated January 21, 2004, addressed to the General Counsel of the Investment Company Institute, the Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) set forth the OCIE’s policy with respect to providing copies of “deficiency letters” to investment company boards of directors.

♦ Following inspections, SEC examiners send deficiency letters to funds and other registrants “to document and bring to the firm’s attention violations of law and regulations, and weaknesses in risk management and control processes” in the areas reviewed during the examination.

♦ The letters ask registrants to resolve the noted issues and provide a prompt written response to the SEC describing how each deficiency and weakness will or has been addressed.

♦ The OCIE’s policy is to provide deficiency letters to the fund’s board (by mail to the fund’s chairman or chief compliance officer, with a directive that the letter is provided to the fund board).

♦ If the examination reveals serious findings, the deficiency letter may ask the board to review the issue and to respond in writing directly to the staff, indicating its intended action to address the deficiency or violation.

♦ Examination staff may also request to meet directly with fund boards to address particularly significant problems and issues.

1.27.04 SENATE HOLDS HEARING ON MUTUAL FUND FEES http://www.senate.gov/~gov_affairs/index.cfm?Fuseaction=Hearings.Detail&HearingID=146 (Copy of statements made by Senate committee members) http://www.ici.org/statements/tmny/04_sen_stevens_tmny.html (Copy of ICI's testimony)

♦ The Senate held a hearing entitled "Oversight Hearing on Mutual Funds: Hidden Fees, Misgovernance, and Other Practices That Harm Investors.”

♦ The purpose of this hearing was to examine the fee structure of mutual funds to identify conflicts of interest, mislabeled costs and other practices in the industry that may be harmful to investors.

1.31.04 SEC PROPOSES NEW BROKER-DEALER POINT-OF-SALE RULES http://www.reedsmith.com/library/publicationView.cfm?itemid=66553&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/proposed/33-8358.htm (Copy of rule proposal)

♦ The SEC proposed new rules and rule amendments that are designed to enhance the information broker-dealers provide to their customers in connection with transactions in certain types of securities.

♦ Proposed rules 15c2-2 and 15c2-3 under the Securities Exchange Act of 1934 would require broker-dealers to provide customers with certain specified information in transaction confirmations and at the point-of-sale regarding costs and conflicts of interest that arise from the distribution of mutual fund shares, unit investment


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trust interests (including insurance securities), and municipal fund securities used for education savings (529 plans).

♦ The proposed amendments to rule 10b-10 exclude securities covered by proposed rule 15c2-2, and would also provide investors with additional information about call features of debt securities and preferred stock.

♦ The proposed amendments to Form N-1A, the registration form for mutual funds, would improve disclosure of sales loads and revenue sharing.

♦ The proposals were subject to a 60-day public comment period prior to being considered for final adoption by the SEC.

2.3.04 PUBLIC COMPANIES MUST RESPOND TO NEW SEC DISCLOSURE RULES http://www.reedsmith.com/library/publicationView.cfm?itemid=64355&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/final/33-8340.htm (Copy of adopting release)

♦ Effective January 1, 2004, the SEC adopted new disclosure requirements regarding the operations of board nominating committees and the means by which security holders may communicate with directors.

♦ The new disclosure requirements apply to proxy or information statements that are first sent or given to security holders on or after January 1, 2004, and for Forms 10-Q and 10-K filed for periods ending after January 1, 2004.

2.3.04 STAFF RESPONSES TO QUESTIONS ABOUT CUSTODY RULE http://www.sec.gov/cgi-bin/txt-srch-sec?text=custody+rule+amendment&section=Entire+Website&sort=date (Scroll to “Investment Management (see more…) Staff Responses to Questions About Custody Rule” for staff responses) http://www.sec.gov/rules/final/ia-2176.htm (Copy of amended custody rule)

♦ The staff of Division of Investment Management set forth responses to frequently asked questions about the custody rule under the Advisers Act (amended Rule 206(4)-2).

2.4.04 NASD ISSUES OMNIBUS TASK FORCE REPORT http://www.reedsmith.com/library/publicationView.cfm?itemid=66552&catid=14 (Copy of Reed Smith bulletin) http://www.nasd.com/pdf_text/omnibus_report.pdf (Copy of the report)

♦ The National Association of Securities Dealers issued the Omnibus Account Task Force Report.

♦ The Task Force was formed to consider how omnibus processing of mutual fund transactions might affect the imposition of a mandatory redemption fee, in light of the fact that mutual fund complexes typically do not have information that identifies customers who acquire and dispose of mutual fund shares through omnibus accounts held at intermediaries.

♦ The Task Force “generally concluded” that, absent a significant holding period requirement (e.g., 30 to 90 days), redemption fees alone will not deter market-timing abuses.

2.6.04 USING CATEGORICAL STANDARDS TO DETERMINE DIRECTOR INDEPENDENCE UNDER NEW NYSE AND NASDAQ RULES http://www.reedsmith.com/library/publicationView.cfm?itemid=64652&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/sro/34-48745.htm

♦ On November 4, 2003, the SEC approved rule changes filed by the New York Stock Exchange and NASDAQ to amend director independence requirements for NYSE and NASDAQ companies.

♦ In both cases, the new rules are, with certain exceptions, effective on the date of a company’s first annual meeting of shareholders after January 15, 2004, but no later than October 31, 2004.

♦ Both the NYSE and NASDAQ rules require


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(Copy of adopting release) companies to have a majority of “independent” directors; however, the rules differ in their approach to defining “independence” for these purposes.

2.11.04 DISCLOSURE RULES ADDRESSING APPROVAL OF MUTUAL FUND ADVISORY CONTRACTS PROPOSED http://www.reedsmith.com/library/publicationView.cfm?itemid=66555&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/proposed/33-8364.htm (Copy of release proposing the rule and form amendments)

♦ The SEC proposed rule and form amendments designed to improve the disclosure provided by mutual funds about how their boards of directors evaluate, approve, and recommend shareholder approval of investment advisory contracts.

♦ The proposed amendments would require a mutual fund to provide disclosure in its shareholder reports regarding the material factors, and conclusions with respect to those factors, that formed the basis for the board’s approval of advisory contracts during the reporting period.

♦ The shareholder report disclosure would be required for any new investment advisory contract or contract renewal, including subadvisory contracts, approved during the semi-annual period covered by the report, other than a contract that was approved by shareholders.

2.12.04 SEC PROVIDES ANTI-MONEY LAUNDERING GUIDANCE IN A NO-ACTION LETTER http://www.sec.gov/divisions/marketreg/mr-noaction/sia021204.htm (Copy of no-action letter)

♦ On April 28, 2003, the Financial Crimes Enforcement Network, Department of the Treasury, proposed an AML Rule for registered investment advisers; nevertheless, the SEC stated in this letter that broker-dealers are permitted to treat registered investment advisers as if they are subject to an AML Rule for purposes of paragraph (b)(6) of the CIP Rule, provided: • Such reliance is reasonable under the circumstances; • The investment adviser is regulated by a federal

functional regulator; and • The investment adviser enters into a contract

requiring it to certify annually to the broker-dealer that it has implemented an AML program, and that it will perform (or its agent will perform) specified requirements of the broker-dealer CIP.

♦ The SEC stated that this letter is withdrawn without further action on the earlier of: (1) the date upon which an AML Rule for advisers becomes effective, or (2) February 12, 2005.

2.13.04 BROKER-DEALERS CHARGED IN FEE BREAKPOINT CASES http://www.sec.gov/litigation/admin/33-8383.htm (Copy of administrative action) http://www.sec.gov/news/press/2004-17.htm (Copy of release announcing actions)

♦ The SEC found that HD Vest Investment Securities, Inc. (“Vest”) failed to deliver mutual fund breakpoint discounts (volume discounts applied to front-end sales loads) to certain investors who purchased Class A mutual fund shares.

♦ According to data that Vest submitted to the NASD, Vest is estimated to have failed to give certain customers breakpoint discounts totaling more than $725,000 during 2001 and 2002.

♦ The Order also finds that Vest failed to make adequate disclosure to customers in connection with its sales of large amounts ($100,000 or greater) of Class B shares. In recommending that certain customers purchase these shares, Vest failed to adequately disclose that an equivalent investment in Class A shares could yield a higher return as a result of breakpoint discounts and reduced ongoing expenses.


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2.23.04 SEC EXTENDS COMPLIANCE DATES REGARDING “INTERNAL CONTROL OVER FINANCIAL REPORTING” http://www.reedsmith.com/library/publicationView.cfm?itemid=66119&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/final/33-8392.htm (Copy of release announcing postponement)

♦ The SEC postponed the compliance date by which investment companies must include in their annual reports a report of management on the company's internal control over financial reporting.

♦ Investment companies originally were required to maintain internal control over financial reporting with respect to fiscal years ending on or after June 15, 2004, and to make officer certifications to that effect in annual reports on Form N-CSR for fiscal years ending on or after that date.

♦ The SEC extended this compliance date to November 15, 2004.

2.24.04 COLUMBIA FUNDS CHARGED WITH MARKET TIMING http://www.sec.gov/litigation/litreleases/lr18590.htm (Copy of litigation release)

♦ The SEC filed a civil fraud action in federal court in Boston alleging that Columbia Management Advisors, Inc. and Columbia Funds Distributor Inc. allowed certain preferred mutual fund customers to engage in short-term and excessive trading, while at the same time representing publicly that it prohibited such trading.

♦ The SEC's complaint alleges that, from at least 1998 through 2003, Columbia Distributor secretly entered into arrangements with at least nine investors allowing them to engage in short-term trading in at least seven funds, including international funds and a fund aimed at young investors.

♦ The complaint alleges that, in some of the arrangements, defendants accepted so-called "sticky assets" - long- term investments that were to remain in place in return for allowing the investors to actively trade in the funds.

♦ The complaint also alleges that the nine investors who entered the arrangements engaged in frequent short-term or excessive trading in at least sixteen different Columbia funds.

♦ It further alleges that executives of Columbia Distributor entered into the arrangements, and that Columbia Advisors knew and approved of eight of the arrangements and allowed them to continue despite knowing such short-term trading was detrimental to long-term shareholders in the funds.

2.24.04 PROPOSED RULE WOULD PROHIBIT USE OF BROKERAGE COMMISSIONS TO FINANCE SALE OF MUTUAL FUND SHARES http://www.reedsmith.com/library/publicationView.cfm?itemid=66556&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/proposed/ic-26356.htm (Copy of release proposing the rule)

♦ The SEC proposed amendments to Rule 12b-1 under the 1940 Act that would prohibit funds from paying for distribution of their shares with brokerage commissions.

♦ The proposed amendments also would require funds that use a selling broker-dealer to execute portfolio securities transactions to adopt, and the fund's board of directors to approve, certain policies and procedures.

2.25.04

SEC PROPOSES MANDATORY 2 PERCENT MUTUAL FUND REDEMPTION FEE

♦ The SEC proposed a new rule that would require all mutual funds to impose a 2 percent fee on redemption proceeds of shares redeemed within five days of their


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http://www.sec.gov/news/press/2004-23.htm (Copy of release announcing proposed rule)

purchase. (Comments on the proposal were due by May 10, 2004.)

♦ Under the proposed rule, the fund would retain the proceeds from the redemption fees.

♦ The rule is designed to require short-term shareholders to reimburse the fund for the direct and indirect costs that the fund pays to redeem these investors’ shares.

♦ In the past, these costs generally have been borne by the fund and its long-term shareholders.

♦ The rule would not apply to money market funds, exchange-traded funds, or mutual funds that encourage active trading and disclose to investors in the prospectus that such trading will likely impose costs on the fund.

2.25.04 HOUSE COMMITTEE APPROVES VARIOUS AMENDMENTS TO THE 1940 ACT http://financialservices.house.gov/legis.asp?formmode=item&number=277 (More information about the bill)

♦ The Financial Services Committee of the House approved H.R. 2179, which if enacted would add several amendments to the 1940 Act, including: • Prohibiting any 12b-1 fee after a mutual fund has

been closed to new investors, other than to cover certain shareholder servicing activities;

• Requiring investment advisers and distributors, when entering into or renewing a contract with a mutual fund, to inform the board of directors of any of their conflicting business practices; and

• Requiring the board of directors of an investment company to select a lead independent director.

2.27.04 SEC ADOPTS NEW RULES REGARDING FUND SHAREHOLDER REPORTS AND QUARTERLY PORTFOLIO DISCLOSURE http://www.reedsmith.com/upload/SEC%20Update%202004-08.pdf (Copy of Reed Smith bulletin) http://www.sec.gov/rules/final/33-8393.htm (Copy of release announcing proposed rule)

♦ The SEC adopted the following rule and form amendments relating to shareholder reports and portfolio disclosure, effective May 10, 2004: • Open-end management investment companies are

required to disclose fund expenses borne by shareholders during the reporting period in their annual and semi-annual reports to shareholders;

• Registered investment companies are permitted to include a summary portfolio schedule in their reports to shareholder, provided that the complete portfolio schedule is filed with the SEC on Form N-CSR semi-annually and provided to shareholders on request, at no charge;

• Money market funds are exempt from including a portfolio schedule in their reports to shareholders, provided that this information is filed with the SEC on Form N-CSR and is provided to shareholders upon request, free of charge;

• Reports to shareholders are required to include a tabular or graphic presentation: of the fund’s portfolio holdings by “identifiable categories”;

• A fund will be required to file its complete portfolio schedule as of the end of its first and third fiscal quarters with the SEC on the new Form N-Q, which will then be filed under the Investment Company Act and the Exchange Act, and certified by the fund’s principal executive and financial officers; and

• Mutual funds will be required to include the “Management’s Discussion of Fund Performance” in its annual report to shareholders.

• All fund reports to shareholders for periods ending


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on or after July 9, 2004 must comply with the amendments. In addition, funds must file quarterly reports on Form N-Q with respect to any fiscal quarter ending on or after July 9, 2004.

3.3.04 DOL PROVIDES GUIDANCE ON ERISA FIDUCIARY DUTIES IN RESPONSE TO MUTUAL FUND ABUSES http://www.reedsmith.com/library/publicationView.cfm?itemid=66565&catid=14 (Copy of Reed Smith bulletin) http://www.dol.gov/ebsa/newsroom/sp021704.html (Copy of statement)

♦ The U.S. Department of Labor (“DOL”) has issued guidance on the responsibilities of ERISA plan fiduciaries in light of the alleged late trading and market timing abuses involving mutual funds.

♦ The statement emphasizes that the fiduciaries’ conduct should be guided by the ERISA requirement that they discharge their duties prudently, requiring them to obtain information on the nature of the alleged abuses, their potential economic impact on the plan, the steps being taken to limit future abuses, and any remedial action.

♦ They should not limit their reviews to funds already identified by the regulators as affected by the abuses, because other funds may be affected as well.

♦ The guidance also addresses what steps fiduciaries can take to deal with market timing.

♦ Imposing trading limitations can affect whether the plan qualifies for the relief for plan fiduciaries from responsibility for participant investment decisions under ERISA section 404(c).

♦ DOL concluded that two approaches to limiting market timing - imposing reasonable redemption fees and imposing reasonable limits on investment changes within a specified period - do not run afoul of the section 404(c) requirements. However, such limitations must be allowed under the terms of the plan and clearly disclosed to the plan participants.

♦ DOL also took the opportunity to announce that it is conducting reviews of mutual funds, similarly pooled investment funds, and service providers to such funds, for ERISA violations.

3.10.04 SEC FINES BANC OF AMERICA SECURITIES LLC (“BAS”) $10 MILLION FOR REPEATED DOCUMENT PRODUCTION FAILURES http://www.sec.gov/litigation/admin/34-49386.htm (Copy of release) http://www.nasdr.com/news/pr2002/release_02_062.html (Copy of release)

♦ On March 10, 2004, the SEC announced that during an investigation, it was determined that BAS engaged in improper trading of securities prior to the firm’s issuance of research concerning such securities.

♦ During the investigation, BAS repeatedly failed to promptly furnish documents that were requested by the SEC, thus violating the recordkeeping and access requirements under Sections 17(a) and 17(b) of the Securities Exchange Act and Rule 17a-4(j) thereunder.

♦ As part of the settlement, BAS agreed to censure and a $10 million civil penalty. BAS also consented, without admitting or denying the SEC’s findings, to cease and desist from committing or causing violations of the recordkeeping and access requirements.

♦ In a related case (December 3, 2002), the SEC, the New York Stock Exchange, and the NASD announced joint actions against five broker-dealers for violations of recordkeeping requirements concerning e-mail communications.

♦ Each of the firms - Deutsche Bank Securities Inc.; Goldman, Sachs & Co.; Morgan Stanley & Co. Incorporated; Salomon Smith Barney Inc.; and U.S.


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Bancorp Piper Jaffray Inc. - consented to the imposition of fines totaling $8.25 million (approximately $1.65 million per firm), along with a requirement to review their procedures to ensure compliance with recordkeeping statutes and rules.

3.10.04 SEC OFFICIALS TESTIFY ABOUT MUTUAL FUNDS BEFORE THE SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS http://www.reedsmith.com/library/publicationView.cfm?itemid=67259&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/news/testimony/ts031004lar.htm (Copy of Ms. Richard's testimony)

♦ Lori A. Richards, Director of the OCIE, testified about changes OCIE is making to its examination oversight of investment advisers, and commented on document-retention policies.

♦ Ms. Richards specifically discussed changes in examination oversight with respect to market timing, and more broadly with respect to overall examination oversight.

♦ Ms. Richards also testified that in the past, routine examinations did not include a random review of employees’ internal e-mail communications (unless relevant to the examination). Now, to aid in detecting any misconduct that might not otherwise be reflected in the books and records, routine examinations include a review of a sample of fund executives’ internal e-mail communications.

♦ Ms. Richards opined that a document-retention policy that provides for no more than the routine deletion of e-mails after a certain period of time should be considered a prima facie books-and-records violation since investment advisers could in no way demonstrate that required records were not part of the deleted e-mails.

♦ Ms. Richards indicated that the SEC is deploying software that will enable them to review masses of e-mail traffic.

3.11.04

SEC PROPOSES ADDITIONAL PORTFOLIO MANAGER DISCLOSURE http://www.sec.gov/rules/proposed/33-8396.htm (Copy of release announcing proposed rule)

♦ The SEC proposed additional disclosure requirements relating to portfolio managers of mutual funds and closed-end funds.

♦ The SEC’s proposals would: • Require a mutual fund to identify in its prospectus

each member of a committee, team, or other group of persons that is jointly and primarily responsible for day-to-day management of the portfolio;

• Eliminate the current provision in Form N-1A that excludes a fund that has as its investment objective replication of the performance of an index from the requirement to identify and provide disclosure regarding its portfolio managers;

• Require a mutual fund to provide information in its Statement of Additional Information (“SAI”) regarding other accounts managed by any of its portfolio managers, including a description of conflicts of interest that may arise in connection with simultaneously managing the fund and the other accounts;

• Require a mutual fund to disclose in its SAI the structure of, and the method used to determine, compensation of each portfolio manager;

• Require a mutual fund to disclose in its SAI each portfolio manager’s ownership of securities in the fund and other accounts, including investment


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companies, managed by the portfolio manager, the fund’s investment adviser, or any person controlling, controlled by, or under common control with an investment adviser or principal underwriter of the fund;

• Require enhanced prospectus back cover page disclosure regarding the availability of additional information about the fund; and

• Require a closed-end fund to provide disclosure regarding its portfolio managers in its reports on Form N-CSR.

♦ Comments on the proposal were due by May 21, 2004.

3.12.04 SEC PROVIDES GUIDANCE ON ADVISER COMMUNICATION http://www.reedsmith.com/library/publicationView.cfm?itemid=66801&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/divisions/investment/noaction.htm#advertisingic (Scroll to “List of No-Action Letters by Subject Category/Advertising-Investment Company/Investment Counsel Association of America, Inc., March 1, 2004” for copy of no action letter)

♦ In a no-action letter issued on March 1, 2004, the SEC staff clarified that an adviser may respond in writing to unsolicited requests by clients, prospective clients and consultants for specific information about the adviser’s past specific recommendations.

♦ The letter explained that that the written response would not be considered an “advertisement” under Rule 206(4)-1 under the Advisers Act.

3.17.04 SEC AND CFTC SIGN MEMORANDUM OF UNDERSTANDING http://www.sec.gov/news/press/2004-36.htm (Copy of release)

♦ The SEC and CFTC signed a Memorandum of Understanding (“MOU”) regarding the oversight of security futures product trading and the sharing of security futures product information.

♦ With respect to security futures products, the MOU provides that the SEC and CFTC will notify each other of any planned examinations, advise the other of reasons for an intended examination, provide each other with examination-related information, and conduct examinations jointly, if feasible.

♦ The SEC and CFTC will also notify each other of significant issues arising from these markets and share trading data and related information for security futures product activity.

4.5.04 OCIE REPORT ON FUND AND ADVISER EXAMS http://www.sec.gov/news/extra/apx-ts031004lar.pdf (Copy of exam report)

♦ The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) released “Examinations of Investment Companies and Investment Advisers-March 2004” (“Report”) at the request of Richard C. Shelby, Chairman of the Senate Banking, Housing and Urban Affairs Committee.

♦ The Report discusses the SEC’s examination program for funds and investment advisers in general, and reviews certain recent “enhancements” to the program.

♦ The Report also identifies the following 12 major areas that may be reviewed during fund and adviser examinations: 1) portfolio management; 2) brokerage arrangements and best execution; 3) allocations of trades; 4) personal trading; 5) pricing of clients’


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portfolios and calculation of net asset value; 6) information processing and protection (books and records, disclosures, filings); 7) performance advertising, marketing, and fund distribution activities; 8) safety of client and fund assets; 9) fund shareholder order processing; 10) anti-money laundering; 11) corporate governance; and 12) money market funds.

4.13.04 SEC ADOPTS MARKET TIMING AND OTHER DISCLOSURE RULES http://www.reedsmith.com/library/publicationView.cfm?itemid=68498&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/final/33-8408.htm (Copy of adopting release)

♦ The SEC adopted amendments to Forms N-1A, N-3, N-4, and N-6 under the Securities Act of 1933 and the Investment Company Act of 1940. The amendments: 1) require open-end management investment

companies and variable insurance products to disclose in their prospectuses information about the risks of, and policies and procedures with respect to, the frequent purchase and redemption of investment company shares;

2) clarify that open-end management investment companies and insurance company managed separate accounts that offer variable annuities are required to explain in their prospectuses both the circumstances under which they will use fair value pricing and the effects of using fair value pricing; and

3) require open-end management investment companies and insurance-company-managed separate accounts that offer variable annuities to disclose in their prospectuses their policies with respect to disclosure of portfolio holdings information.

The amendments became effective May 28, 2004, and the compliance date was December 5, 2004.

4.30.04

SEC PROPOSES TO EXEMPT THRIFTS FROM THE ADVISERS ACT http://www.reedsmith.com/library/publicationView.cfm?itemid=69652 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/proposed/34-49639.htm (Copy of proposing release)

♦ The SEC proposed a new rule under the Investment Advisers Act of 1940 Act that would except thrifts from having to register as investment advisers under the Advisers Act when they provide investment advice as part of certain trust department fiduciary services.

♦ Under the proposed rule, a thrift institution would be deemed not to be an investment adviser if its investment advisory services are provided solely in its capacity as trustee, executor, administrator, or guardian for customer accounts created and maintained for a fiduciary purpose, or to its collective trust funds excepted from the Investment Company Act of 1940.

♦ Thrifts that provide advisory services beyond the new exceptions would be required to continue to be registered with the SEC, but could apply the Advisers Act only to accounts that fall outside the exceptions.

♦ The SEC also proposed an amendment to Form ADV, the registration form for investment advisers, and a new rule under the Securities Exchange Act of 1934 that would exempt thrift-sponsored collective trust funds from registration and reporting requirements under the Exchange Act.

♦ Comments on the proposals were due July 9, 2004. 5.7.04 PROPOSED NEW RULES FOR ASSET-BACKED

SECURITIES

♦ On May 3, 2004, the SEC promulgated new proposed rules that would affect the asset-backed securities


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http://www.sec.gov/rules/proposed/33-8419.htm (Copy of proposed rule)

market and asset managers. ♦ The proposed reforms are designed to: 1) update and

clarify current registration requirements for asset-backed securities offerings; 2) consolidate and codify existing interpretive positions that allow modified Exchange Act reporting; 3) provide tailored disclosure guidance and requirements for filings under the federal securities laws involving asset-backed securities; and 4) streamline and codify existing interpretive positions that permit the use of written communications in a registered offering of asset-backed securities in addition to the statutory registration statement prospectus.

♦ Comments on the proposal were due July 12, 2004. 5.10.04 IRS RATIONALIZES REPO DIVERSIFICATION TEST

http://www.reedsmith.com/library/publicationView.cfm?itemid=70257&catid=14 (Copy of Reed Smith bulletin) http://www.irs.gov/irb/2004-22_IRB/ar12.html (Copy of Internal Revenue bulletin)

♦ The IRS issued a new “revenue procedure” that, under certain conditions, allows an investment company to “look through” its position in a repurchase agreement (“repo”) that is collateralized by Government securities. The effect is that the fund is permitted to treat the repo as a “Government security” for purposes of qualifying as a regulated investment company under the asset diversification test of section 851(b)(3) of the Internal Revenue Code.

♦ The IRS position is effective for repos held by an RIC on or after August 15, 2001, which coincides with the effective date of ICA Rule 5b-3.

♦ The position taken in the revenue procedure does not extend to the characterization of repos for purposes of the diversification requirements for insurance company separate accounts (under Code section 817).

5.12.04 NASD ANNOUNCES NEW MUTUAL FUND TASK FORCE http://www.reedsmith.com/library/publicationView.cfm?itemid=70258&catid=14 (Copy of Reed Smith bulletin) www.nasdr.com/news/pr2004/release_04_032.html (Copy of release)

♦ NASD Chairman Robert Glauber announced the formation of a Mutual Fund Task Force, whose mission is “to identify and recommend ways to bring greater transparency to mutual fund costs and distribution arrangements.”

♦ The task force will work to respond to SEC rule proposals and requests for comment on ways to improve disclosure of mutual fund costs and issues regarding mutual fund distribution arrangements.

♦ The task force was expected to begin work by the end of June.

♦ The work of the task force will proceed in two phases: 1) consideration of mutual fund portfolio transaction costs (“directed brokerage” arrangements, “soft dollars,” and disclosure); 2) focus on “distribution arrangements” (12b-1 fees and “revenue sharing”).

5.14.04 INTERAGENCY STATEMENT ON SOUND PRACTICES CONCERNING COMPLEX STRUCTURED FINANCE TRANSACTIONS http://www.reedsmith.com/library/publicationView.cfm?itemid=70260&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/policy/34-49695.htm (Copy of policy statement)

♦ On May 14, 2004, five federal agencies requested public comment on a statement regarding risk management procedures to help financial institutions manage the full range of risks associated with complex structured finance transactions, including the risk that the transactions do not comply with the applicable law (the “Statement”).

♦ The two major themes to the Statement are: 1) financial institutions are expected to bring a multi-disciplinary, comprehensive approach to management of the credit market, and of operational, legal and


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reputational risks associated with these transactions; and 2) financial institutions are expected to fully understand their customers’ business objectives for entering into a complex structured finance transaction.

♦ Comments regarding the Statement were due June 18, 2004.

5.20.04 SEC DIRECTOR NOT CONVINCED ABOUT MUTUAL FUND INDUSTRY’S DESIRE TO REFORM http://www.sec.gov/news/speech/spch052004pfr.htm (Copy of the speech)

♦ Paul Roye, the Director of the SEC’s Division of Investment Management, speaking at the Investment Company Institute’s General Membership meeting in Washington, D.C., raised concerns about the mutual fund’s industry desire to reform.

♦ In response to one of the most significant scandals in the history of mutual funds, the SEC has proposed and adopted numerous rules.

♦ In a few cases, the industry has opposed some of the SEC rule proposals, including a 4 p.m. trading deadline.

♦ Mr. Roye noted that a number of mutual fund complexes had filed comment letters opposing this and other rules. In his view, opposition by the industry was unexpected and may suggest that the industry may not be committed to truly reforming itself.

5.20.04

ADVISER COMPLIANCE OFFICER BARRED FROM THE INDUSTRY http://www.sec.gov/litigation/admin/34-49741.htm (Copy of administrative order)

♦ The SEC barred Thomas A. Hooker, Jr., a former compliance officer of Strong Capital Management, Inc. (“SCM”), from association with any investment adviser, and prohibited him from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter, for reasons noted below.

♦ In the same proceeding, the SEC found that Richard S. Strong, president and founder of SCM and the Strong Funds, violated his fiduciary duties to the Strong Funds and their shareholders, by frequently trading shares of the Strong Funds. According to the release, in 2000, Hooker noted Strong's frequent trading in a compliance review. Hooker informed his supervisor, who was also the Strong entities' in-house counsel and Chief Compliance Officer, of Strong's trading. At that time, Strong agreed that he would stop frequently trading the Strong Funds. The in-house counsel directed Hooker to monitor Strong's trading activity to ensure that he had stopped frequent trading.

♦ Strong continued to engage in frequent trading through 2003. The SEC found that Hooker failed to follow up to ensure that Strong's trading activity had in fact stopped. There were no compliance measures implemented to monitor or prohibit his frequent trading activity, such as a review of his mutual fund trades to determine whether they were inconsistent with the prospectuses for the Strong Funds he traded.

5.26.04 SEC ADOPTS RULES ON BREAKPOINT DISCLOSURE AND ADVISER ETHICS CODES, PROPOSES TRANSFER AGENT RULE http://www.sec.gov/news/press/2004-71.htm (Copy of Press Release)

♦ The SEC voted on May 26, 2004 to adopt a new rule, as well as amendments to rules and forms dealing with investment adviser codes of ethics. New rule 204A-1 under the Investment Advisers Act requires SEC-registered advisers to adopt codes of ethics, along with


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http://www.reedsmith.com/library/publicationView.cfm?itemid=74041&catid=14 (Copy of Reed Smith bulletin on Adviser Code of Ethics)

related amendments to the recordkeeping provisions of Advisers Act rule 204-2. The SEC also adopted amendments to Part II of Form ADV, to require advisers to describe their codes of ethics to clients and, upon request, to furnish clients with a copy of the code of ethics. Lastly, the SEC adopted “conforming” amendments to the code of ethics’ requirements of Investment Company Act rule 17j-1.

♦ The SEC also voted to adopt form amendments regarding disclosure requirements for mutual funds concerning discounts on front-end sales loads. See story below for more details.

♦ The SEC also voted to propose for comment a new rule regarding transfer agent operations.

5.27.04 SEC GUIDANCE ON PROXY VOTING AND USE OF INDEPENDENT THIRD PARTIES http://www.reedsmith.com/library/publicationView.cfm?itemid=72689&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/divisions/investment/noaction/egan052704.htm (copy of interpretive letter)

♦ In January 2003, the SEC adopted new Investment Advisers Act Rule 206(4)-6, which requires registered investment advisers to adopt and implement policies and procedures that are designed to ensure that their clients’ proxies are properly voted, material conflicts are avoided, and fiduciary obligations are otherwise fulfilled.

♦ In the Release adopting Rule 206(4)-6, the SEC indicated that an investment adviser could demonstrate that its vote of its clients’ proxies was not a product of a conflict of interest if the adviser voted the proxies in accordance with a pre-determined policy based on the recommendations of an independent third party.

♦ The SEC recently elaborated on the adviser’s related responsibilities in an interpretive letter to Egan-Jones Proxy services, May 27, 2004.

♦ In the letter, the SEC advised that an adviser that retains a third party to make recommendations regarding how-to-vote client proxies should “take reasonable steps to verify that the third party is in fact independent” of the adviser, “based on all of the relevant facts and circumstances.”

♦ The adviser must be able to conclude that the third party is also independent of the issuer of the securities in question.

♦ An adviser should establish and implement procedures to identify and address conflicts that can arise on an ongoing basis related to the third party.

♦ Even if a proxy voting firm would in fact be independent, the letter cautions that an adviser would not cleanse itself of its conflict of interest by hiring that third party to make proxy voting recommendations if the adviser already knows that the third party’s recommendations will be consistent with the adviser’s own interest.

6.4.04

SEC CHARGES A BOCA RATON BROKER-DEALER/INVESTMENT ADVISER WITH FRAUD http://www.sec.gov/litigation/litreleases/lr18738.htm (Copy of litigation release)

♦ The SEC filed a civil securities fraud action against Geek Securities Inc., Geek Advisors, Inc., Kautily “Tony” Sharma, president and owner of Geek Securities and Geek Advisors and Neal R. Wadhwa, a Geek Securities registered representative (the “defendants”).

♦ The defendants allegedly engaged in pervasive market timing and late trading on behalf of their institutional


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clients. ♦ With respect to the market-timing scheme, the SEC

alleges that, between at least September 2001 and November 2003, mutual fund companies blocked Geek Securities and Geek Advisors clients from trading in their mutual funds because of their market-timing activities.

♦ The SEC’s complaint also alleges that, between at least September 2001 and November 2003, Geek Securities and Geek Advisors, through Sharma and Wadhwa, participated in a systematic scheme to late trade mutual fund shares on behalf of some of its clients.

♦ The SEC’s complaint alleges that the defendants violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 there under. The complaint also alleges that Geek Securities violated Section 15(c)(1) of the Exchange Act and that Sharma and Wadhwa aided and abetted Geek Securities’ violation of Section 15(c)(1) of the Exchange Act.

♦ The SEC is seeking injunctive relief, disgorgement, and civil money penalties.

6.7.04 SEC ADOPTS ENHANCED “BREAKPOINT” DISCLOSURES FOR FUNDS http://www.reedsmith.com/library/publicationView.cfm?itemid=72004&catid=14 (Copy of Reed Smith bulletin) http://www.sec.gov/rules/final/33-8427.htm (Copy of final rule)

♦ The SEC adopted requirements for enhanced “breakpoint” disclosure in mutual fund prospectuses.

♦ The amendments (to mutual fund registration Form N-1A) require funds to describe briefly in the prospectus: 1) any arrangements that result in breakpoints in sales loads; 2) the methods used to value accounts in order to determine whether a shareholder has met sales load breakpoints; and 3) whether the fund makes available on or through its website information regarding its sales loads and breakpoints.

♦ The new disclosure requirements are virtually identical to those the SEC proposed in December 2003.

♦ The effective date of the amendment was July 23, 2004.

♦ All initial registration statements, and all post-effective amendments that are either annual updates to effective registration statements or that add a new series, filed on Form N-1A on or after September 1, 2004, must include the disclosure required by the amendments.

6.10.04 MSRB PROPOSES NEW 529 PLAN ADVERTISING AND DISCLOSURE REQUIREMENTS

http://www.reedsmith.com/library/publicationView.cfm?itemid=72688&catid=14 (Copy of Reed Smith bulletin)

MSRB Notice 2004-16 (June 10, 2004) (Copy of Notice)

♦ The Municipal Securities Rulemaking Board (“MSRB”) proposed draft amendments to its advertising rule (MSRB rule G-21) that would impose on advertisements for "municipal fund securities" (e.g., interests in certain college savings plans - aka "529 Plans") requirements very similar to those that SEC rule 482 imposes on mutual fund advertisements.

♦ The MSRB also proposed for comment draft "interpretive guidance" under its basic "fair practice" rule (rule G-17) that would broaden the existing point-of-sale disclosure obligation relating to out-of-state investments in 529 Plans to include disclosures regarding the potential loss of other state benefits, in addition to tax benefits (such as scholarships, grants, etc.) that may be offered to individuals who invest in their home state Plans.


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6.15.04 NASD ADVERTISING HEAD SAYS DELAY IN STAFF REVIEWS BECAUSE OF NEW SEC RULE http://www.sec.gov/rules/final/33-8294.htm (Copy of final rule)

♦ Tom Pappas, director of advertising regulation at NASD, said that his staff’s regulatory reviews of broker-dealers’ mutual fund advertising materials (prior to their use) has been taking two or three months as a result of the implementation of a new SEC rule designed to prevent misleading performance advertising.

♦ A typical review period up until recently has been two or three weeks.

6.15.04 MRSB PROPOSED NEW RESTRICTIONS ON “GIFTS, GRATUITIES AND NON-CASH COMPENSATION” http://www.reedsmith.com/library/publicationView.cfm?itemid=72688&catid=14 (Copy of Reed Smith bulletin)

♦ The Municipal Securities Rulemaking Board (“MSRB”) issued a Notice seeking comment on proposed amendments to MSRB Rule G-20, relating to gifts and gratuities given by brokers, dealers, or municipal securities dealers (collectively “dealers”).

♦ The draft amendment would modify the “normal business dealings” exception to the Rule’s $100 gift limitation.

♦ The MSRB is proposing to add a new section to Rule G-20 that would generally prohibit non-cash compensation arrangements in connection with the distribution of new issue municipal securities and sales of municipal fund securities, subject to certain limited exceptions. The MSRB intends that the proposed new provisions would make its treatment of non-cash compensation consistent with NASD rules.

♦ Drafting new sections that would prohibit dealers from directly or indirectly making payments of any non-cash compensation in connection with the sale of shares of college savings plans and other municipal fund securities would define the term “non-cash compensation.”

♦ The MSRB is also proposing certain exceptions from the general prohibition that would permit a dealer or associated persons to accept or make certain payments of non-cash compensation, subject to narrowly defined conditions.

♦ Rule G-8 (recordkeeping) would be amended to require dealers to maintain a record of all non-cash compensation.

♦ Comments on the proposals were due by July 30, 2004.

6.21.04 OCC ADVISORY LETTER ON BANKS AND ELECTRONIC RECORDS RETENTION http://www.occ.treas.gov/ftp/advisory/2004-9.txt (Copy of advisory letter)

♦ The Office of the Comptroller of the Currency (“OCC”) issued an advisory letter highlighting issues regarding bank electronic record systems in light of the E-SIGN Act.

♦ The letter provides a basic framework that bank management can use to assess and address key issues posed by electronic recordkeeping systems.

♦ The letter addresses functional and regulatory considerations, specifically maintenance of adequate record retention systems.

♦ Relating to an adequate record retention system, the letter discusses records needed for: litigation, internal and external audits and controls, and bank supervision, as well as records needed to comply with laws and regulations.

♦ Finally, the letter details implementation


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considerations, including security, internal controls, back-up and recovery, record destruction and disposal, retention periods and content, and change management.

6.21.04 FPA REQUESTS SEC TO WITHDRAW ADVISER ACT BROKER EXEMPTION RULE PROPOSAL http://www.fpanet.org/member/press/releases/062104_SEC.cfm (Copy of press release)

♦ The Financial Planning Association (“FPA”) filed comments with the SEC urging the agency to repeal a five-year old rule proposal by the SEC that would exempt broker-dealers from having to register as investment advisers under the Investment Advisers Act of 1940 under certain conditions.

♦ Specifically, a broker-dealer providing investment advice to its brokerage customers would not be required to treat those customers as advisory clients solely because of the form of the broker-dealer's compensation if it satisfied the following three conditions: 1) the broker-dealer must not exercise investment discretion over the account from which it receives special compensation; 2) any investment advice is incidental to the brokerage service provided to each account; and 3) advertisements for and contracts or agreements governing the account must contain a prominent statement that it is a brokerage account.

♦ The comment letter emphasizes the problems the rule poses to consumers, noting “the registered representative - unlike a registered investment adviser - has no blanket fiduciary duty to place the client’s interests first.”

6.23.04 SEC ADOPTS RULES REQUIRING CONTRACT APPROVAL DISCLOSURE RULE

♦ The SEC adopted rule and form amendments to expand the disclosure currently provided by open-and closed-end funds regarding how boards evaluate and approve, and recommend shareholder approval of, investment advisory contracts.

♦ The revised contract approval disclosures will have to be included in proxy statements that seek shareholder votes on advisory contracts, and in fund shareholder reports.

♦ The SEC is also deleting the current requirement that disclosure be included in fund Statements of Additional Information (“SAI”), but is adding a requirement that fund prospectuses include an alert to the effect that the relevant shareholder report contains the contract approval disclosure.

♦ All proxy statements filed on or after October 31, 2004, will be required to comply with the amendments

♦ All fund reports to shareholders with respect to periods ending on or after March 31, 2005, will be required to comply with the amendments.

♦ All initial registration statements and all annual registration statement updates, filed on or after the transmission to shareholders of a report containing the required disclosure, must include the prospectus disclosure stating that a discussion regarding the board’s basis for approving any investment advisory contract is available in the fund’s shareholder reports.

♦ The effective date for the amendments that remove the current SAI disclosure requirement with respect to the board’s approval of any existing investment advisory


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contract is January 31, 2005. Prior to that date, a fund may omit disclosure in its SAI with respect to any board approval of an advisory contract if it has previously provided the required disclosure with respect to that board approval in a shareholder report.

6.24.04

SEC STAFF TO PUBLICLY RELEASE DISCLOSURE COMMENT LETTERS AND RESPONSES http://www.sec.gov/news/press/2004-89.htm (Copy of press release)

♦ The SEC announced that it would begin releasing comment letters and filer responses relating to disclosure filings reviewed by its Division of Corporation Finance and the Division of Investment Management.

♦ The SEC believes the letters should be useful to mutual fund and other issuer filers because they set forth staff positions on particular filings.

♦ Comment letters and response letters relating to disclosure filings made after August 1, 2004, that are selected for review, will be released not less than 45 days after the staff has completed a filing review.

6.24.04

SEC OBTAINS EMERGENCY RELIEF AGAINST FRAUDULENT WEB SITE http://www.sec.gov/litigation/litreleases/lr18761.htm (Copy of litigation release)

♦ The SEC announced that on June 21, it obtained a temporary restraining order and asset freeze to halt fraudulent activity by a web site, FairPax.com, that impersonated a New Hampshire mutual fund complex and promised investors returns of 657 percent per year.

♦ According to the SEC's complaint, the fraudulent FairPax.com, FairPax, Inc., and the unidentified individuals operating the web site misappropriated descriptions of the purported mutual funds offered from a registered New Hampshire-based mutual fund, Pax World Funds. The SEC’s complaint further alleges that the purported socially responsible high yield mutual fund FairPax offered is fraudulent and has not been registered with the SEC, as required.

♦ The SEC's complaint alleges that FairPax violated anti-fraud provisions of the federal securities laws. The SEC also alleged that FairPax violated the registration provisions of the securities laws.

♦ The SEC seeks an order permanently enjoining the defendants from violating these provisions, and requiring that the defendants disgorge funds received from investors and pay a civil monetary penalty.

7.2.04 NEW SEC RULE WILL REQUIRE ADVISERS TO HAVE A CODE OF ETHICS

http://www.reedsmith.com/library/publicationView.cfm?itemid=74041&catid=14 (copy of Reed Smith bulletin) http://www.sec.gov/rules/final/ia-2256.htm (copy of rule) http://www.sec.gov/about/forms/formn-1a.pdf

(copy of revised Form N-1A)

♦ The SEC adopted new Rule 204A-1 under the Investment Advisers Act of 1940 (“Advisers Act”) that requires SEC-registered investment advisers to adopt codes of ethics, along with related amendments to the recordkeeping provisions of Advisers Act Rule 204-2.

♦ The SEC also adopted amendments to Part II of Form ADV, to require advisers to describe their codes of ethics to clients and, upon request, to furnish clients with a copy of the code of ethics.

♦ Lastly, the SEC adopted “conforming” amendments to the code of ethics requirements of Investment Company Act of 1940 (“1940 Act”) Rule 17j-1.

♦ The key provision of the new rule is the requirement that advisers' employees report their personal securities holdings and transactions, including those in affiliated mutual funds.

♦ Most investment advisers have had codes of ethics governing personal trading for years. And, advisers to


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mutual funds under the 1940 Act were already required to have a code of ethics.

♦ Among other requirements, the new rule requires an adviser's code of ethics to set forth a standard of business conduct that the adviser requires of all supervised persons, and to require that supervised persons comply with the “Federal Securities Laws.” This is a new requirement that has not appeared in most codes of ethics.

♦ The SEC’s final rule did not require advisers to have pre-clearance procedures (except certain very limited circumstances) or black-out employee trades during certain periods. In the release adopting the rule, the SEC noted, however, that many advisers have these types of procedures.

♦ Although the new requirements were “effective” as of August 31, 2004, advisers have until February 1, 2005 to comply.

7.14.04 SEC PROPOSES RULE TO REQUIRE REGISTRATION OF HEDGE FUND ADVISERS

http://www.sec.gov/rules/proposed/ia-2266.htm (copy of the proposing release)

♦ The SEC voted 3-2 to propose Rule 203(b)(3)-2 that would require hedge fund advisers to register with the Commission under the Advisers Act.

♦ The proposed new rule would require advisers to "private funds" to register with the Commission by requiring the advisers to "look through" the funds and to count the number of investors (rather than the fund) when determining whether the advisers are eligible for the Adviser Act's exemption for advisers with 14 or fewer clients.

♦ The rule would require advisers to count limited partners and shareholders of certain unregistered investment funds as “clients.”

♦ A “private fund” would be one that would be an investment company but for the exceptions in Sections 3(c)(1) or 3(c)(7) of the 1940 Act; permits owners to redeem ownership interests within two years of purchase; and is offered based on the investment advisory skills, ability or expertise of the investment adviser.

♦ The proposed rule would contain special provisions for advisers located outside the United States designed to limit the extraterritorial application of the Advisers Act to offshore advisers to offshore funds that have U.S. investors.

♦ Comments on the proposal were due September 14, 2004.

7.20.04 ICAA ISSUES "BEST PRACTICES REPORT"

http://www.icaa.org/public/advisercoe.pdf (copy of the report)

♦ The Investment Counsel Association of America (“ICAA”) issued a report entitled “Best Practices for Investment Adviser Codes of Ethics” (“Report”).

♦ The Report was issued in response to the adoption by the SEC on July 2, 2004 of a new rule under the Advisers Act (Rule 204A-1) that requires each registered investment adviser to adopt and implement a code of ethics that addresses at least the matters specified in that rule.

♦ The Report represents an effort to expand and update the Guidelines on Personal Investing that ICAA issued in February 1995. The Report is “intended to provide


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guidelines and suggest best practices for an adviser seeking to update, revise of construct its own code of ethics appropriate to the nature and size of its particular advisory business and the types of clients it services. The Best Practices also addresses all of the provisions required by the SEC’s new rule.”

7.20.04 FPA FILES PETITION CHALLENGING ADVISER EXEMPTION FOR BROKER-DEALERS

http://www.fpanet.org/member/press/releases/072004_lawsuit.cfm (copy of the release)

♦ The Financial Planning Association (“FPA”) filed a petition in the U.S. Court of Appeals in Washington, D.C., challenging a proposed rule by the SEC to expand the exemption for broker-dealers otherwise subject to the fiduciary and disclosure standards of the Advisers Act.

♦ The SEC on November 4, 1999, proposed a rule exempting fee-based brokerage programs from the fiduciary and disclosure standards of the Advisers Act. In the petition, the FPA argues that the SEC violated the intent of the federal Administrative Procedures Act by not completing its rulemaking process in timely fashion, and for misinterpreting its authority under the Advisers Act in crafting a new exemption.

7.23.04 SEC STAFF AFFIRMS ABILITY TO RELY ON SUMMARIES OF SERVICE PROVIDERS’ POLICIES AND PROCEDURES UNDER RULE 38A-1

♦ The Investment Company Institute (“ICI”) released a memo reviewing its informal discussions with SEC staff on the issue of whether 1940 Act Rule 38a-1 requires a fund’s Chief Compliance Officer (“CCO”) to obtain and review all of the policies and procedures of a fund’s “service providers” (including subadvisers), or whether the CCO may rely instead on summaries of those materials that are prepared by the service provider or a third party.

♦ According to the ICI, the SEC staff believes that as part of the CCO’s “diligent evaluation” of the fund’s service providers, the CCO “must have a reasonable belief that the information (s)he relies upon concerning their policies and procedures is sufficient to enable the fund’s board to determine that such policies and procedures are reasonably designed to prevent violation of the federal securities laws.”

7.27.04 SEC ADOPTS NEW FUND GOVERNANCE REQUIREMENTS

http://www.sec.gov/rules/final/ic-26520.htm (copy of the report)

♦ The SEC issued a Release announcing adoption of rule amendments that will condition the availability of 10 widely used SEC exemptive rules on implementation of five new fund governance requirements, relating to the composition and operation of the fund’s Board of Directors/Trustees (“Board”).

♦ The requirements as adopted are generally similar to what the SEC proposed.

♦ Included in the new requirements are the provisions mandating that at least 75 percent of the fund’s Board must not be “interested persons” of the fund (they must be independent directors), and that an independent director serve as chairman of the fund’s Board.

♦ The SEC also amended its investment company recordkeeping rule 31a-2 to require funds to retain any documents or other written information considered by the fund’s Board in connection with approving the terms of, or renewing, any agreement between the fund and an investment adviser.

♦ The amendments to the exemptive rules became


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“effective” on September 7, 2004. After January 15, 2006: i) funds may not rely on any of the exemptive rules unless they comply with all of the amended “Fund Governance Standards;” and (ii) funds must begin to comply with the recordkeeping requirements of amended Rule 31a-2.

♦ After the effective date, but before the compliance date, a fund that relies on any of the exemptive rules must continue to meet the fund governance requirements the SEC adopted in 2001 (concerning a majority of independent directors, independent director self-selection and self-nomination, and independent legal counsel).

7.28.04 SEC REPROPOSES NASD RULE REGARDING CEO CERTIFICATION AND DESIGNATING A CCO

http://a257.g.akamaitech.net/7/257/2422/06jun20041800/edocket.access.gpo.gov/2004/pdf/04-17649.pdf (copy of the release)

♦ The SEC issued a Release seeking comment on the NASD’s proposal to create new NASD Rule 3013, and accompanying Interpretive Material 3013.

♦ The new rule would require each member to designate a principal to serve as chief compliance officer and further require the member’s chief executive officer (or equivalent officer) to certify annually to having in place a process to establish, maintain, review, modify, and test policies and procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules, and the federal securities laws.

♦ Comments on the proposal were due by August 24, 2004.

7.29.04 MUTUAL FUND DIRECTORS FORUM ISSUES “BEST PRACTICES” REPORT

http://66.216.74.187/PDFs/best_pra.pdf (copy of the report)

♦ The Mutual Fund Directors Forum (“Forum”) issued a report entitled "Best Practices for Mutual Fund Directors (“Directors Report”).

♦ The Directors Report, which was issued in response to a request from the SEC, contains written practical guidance and best practices for independent directors in areas in which director oversight and decision-making is needed for the protection of fund shareholders.

♦ The Forum is a nonprofit membership organization for independent directors of U.S. registered investment companies.

8.12.04 IRS PROPOSES GUIDANCE ON “E” AND “F” REORGANIZATIONS

http://a257.g.akamaitech.net/7/257/2422/06jun20041800/edocket.access.gpo.gov/2004/pdf/04-18476.pdf (copy of the proposed regulations)

♦ The IRS recently published for comment proposed regulations that provide guidance regarding the requirements for a transaction to qualify as a reorganization under section 368(a)(1)(E) or (F) of the Internal Revenue Code.

♦ The main purposes of the proposals are to specify that a “continuity of the business enterprise” and a “continuity of interest” are not required for a transaction to qualify as a reorganization under section 368(a)(1)(E) or (F); and to set out requirements for qualification under section 368(a)(1)(F).

♦ Comments on the proposals were due by November 10, 2004.

8.13.04 SEC STAFF INFORMALLY ADVISES ICI THAT NO FURTHER CHANGES ARE ANTICIPATED TO THE FUND COMPLIANCE RULE

♦ When the SEC adopted the 1940 Act compliance rule (Rule 38a-1), it sought comment on various new provisions designed to better ensure the CCO’s independence from fund management.

♦ The ICI released a memo indicating that it has been advised informally by the SEC staff that the Commission does not intend to revise the rule in


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response to comments received on the new provisions. As such, the following new provisions are expected to remain in the rule without change: • Requiring the fund’s board to approve the CCO's

compensation; • Providing the board sole power to remove the CCO

from his position; • Requiring the CCO to report directly to the board

and meet with the independent directors in executive session at least annually; and

• Prohibiting persons from coercing or fraudulently influencing the CCO in the course of his responsibilities.

♦ The ICI did not indicate whether the SEC would provide any guidance on aspects of the provisions that were the subject of concerns in many comment letters, or when a formal Release from the SEC may be expected.

8.20.04 NASD PROPOSES SALES CHARGE AND EXPENSE DISCLOSURE IN FUND ADS

http://a257.g.akamaitech.net/7/257/2422/06jun20041800/edocket.access.gpo.gov/2004/pdf/E4-1950.pdf (copy of the proposal)

♦ The SEC issued a Release seeking comment on a proposal by the NASD to require mutual fund performance ads to include disclosure about the fund’s sales charges and expenses, and to prescribe how the disclosure should appear.

♦ NASD is proposing to amend Conduct Rules 2210 and 2211 to require certain mutual fund “communications with the public” that provide performance data to disclose the fund’s fees, its expense ratio, and standardized performance.

♦ The requirements would not apply to “institutional sales material” or to public appearances.

♦ Comments on the proposal were due by September 17, 2004.

8.23.04 MUTUAL FUNDS MUST NOW MAKE MORE DISCLOSURE ABOUT THEIR PORTFOLIO MANAGERS http://www.sec.gov/rules/final/33-8458.htm (copy of the adopting release)

♦ The SEC amended Forms N-1A, N-2, N-3, and N-CSR (the registration forms for mutual funds, closed-end funds, and insurance company managed separate accounts that issue variable annuity contracts) to require those funds to identify in their prospectuses each member of a committee, team, or other group of persons associated with the fund or its investment adviser that is jointly and primarily responsible for the day-to-day management of the fund's portfolio.

♦ In addition, the SEC now requires a fund to provide disclosure in its Statement of Additional Information (“SAI”) regarding other accounts for which the fund's portfolio manager is primarily responsible for the day-to-day portfolio management, including a description of material conflicts of interest that may arise in connection with simultaneously managing the fund and the other accounts.

♦ The SEC adopted amendments that require a fund to disclose in its SAI the structure of, and the method used to determine, the compensation of its portfolio managers. In addition, a fund will have to disclose the securities ownership in the fund of each portfolio manager.

♦ All initial registration statements on Forms N-1A, N-2, and N-3, and all post-effective amendments that are


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annual updates to effective registration statements on these forms, filed on or after February 28, 2005, must include the disclosure required by the amendments.

♦ Every annual report by a closed-end fund of Form N-CSR filed for a fiscal year ending on or after December 31, 2005, and every semi-annual report by a closed-end fund of Form N-CSR filed after the first such annual report, must include the disclosure required by the amendments.

8.23.04 SEC REOPENS RULE-MAKING COMMENT PERIOD FOR ADVISER EXEMPTION FOR BROKER-DEALERS

http://www.sec.gov/rules/proposed/34-50213.htm (copy of the SEC release)

♦ The SEC reopened the period for public comment on a rule proposal under the Advisers Act that would address the application of the Advisers Act to brokers offering certain full service brokerage services for an asset-based fee instead of traditional commissions, mark-ups, and mark-downs, and that would address electronic trading for reduced brokerage commissions.

♦ The SEC on November 4, 1999, proposed a rule exempting fee-based brokerage programs from the fiduciary and disclosure standards of the Advisers Act. The FPA, among others, raised a number of issues regarding the proposal.

♦ In response, the SEC has reopened the rule-making period to seek comment on the following issues: • Do current fee-based programs more closely align

interests of investors with those of brokerage firms and their registered representatives than do traditional commission-based services?

• If the SEC determines not to adopt this rule as proposed, what would be the practical impact on broker-dealers?

• Should the SEC require broker-dealers who would seek to rely on the rule nevertheless to register if they market fee-based accounts based on the quality of investment advice provided? Should brokers be precluded from using certain terms like "investment advice" and "financial planning" in advertising these services, or is prominent disclosure that an account is a brokerage account sufficient to alert an investor to the nature of the account?

♦ The SEC extended the comment period until September 22, 2004, and intended to reach a final decision on the proposal by December 31, 2004.

8.26.04 SEC HITS VAN WAGONER AND FUND DIRECTOR OVER PRIVATE PLACEMENTS

http://www.sec.gov/litigation/admin/ia-2281.htm (copy of first proceeding) http://www.sec.gov/litigation/admin/ic-26581.htm (copy of second proceeding)

♦ The SEC settled fraud charges against Van Wagoner Capital Management, Inc. (“VWCM”), the investment adviser to the Van Wagoner Funds, Inc (the “Funds”), and Garrett Van Wagoner (the president of VWCM) relating to their misstatement of the valuations of certain private equity securities held by the Funds, and failure to observe the Funds’ investment restrictions that limited “illiquid” investments to 15% percent of the net assets.

♦ The settlement includes an $800,000 penalty from Van Wagoner and VWCM, a seven-year prohibition on Van Wagoner serving as an officer or director of a mutual fund, a seven-year restriction on certain of Van Wagoner’s activities with the investment adviser, and certain other remedial measures.


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♦ In a separate proceeding, the SEC announced actions against and settlements with a former independent director of the Funds, Robert Colman, who purchased private equity securities in transactions at the same time as the Funds.

♦ The SEC found this to be an impermissible “joint transaction.”

9.1.04 RULE 15c3-3 RESERVE REQUIREMENTS FOR MARGIN RELATED TO SECURITY FUTURES PRODUCTS

http://www.sec.gov/rules/final/34-50295.htm (copy of final rule)

♦ The SEC adopted amendments to the formula for determination of customer reserve requirements of broker-dealers under the Exchange Act to address issues related to customer margin for security futures products.

♦ The amendments permit a broker-dealer to include margin related to security futures products written, purchased, or sold in customer securities accounts required and on deposit with a registered clearing agency or a derivatives clearing organization as a debit item in calculating its customer reserve requirement under specified conditions.

♦ The amendments are intended to help ensure that a broker-dealer is not required to fund its customer reserve requirements with proprietary assets.

♦ In addition, the SEC is adopting a rule amendment delegating authority to the Director of the Division of Market Regulation to provide relief, under certain circumstances, from the conditions under which margin related to customer security futures products margin may be included as a debit item.

9.2.04 U.S. CHAMBER OF COMMERCE FILES SUIT CHALLENGING SEC 75%/INDEPENDENT CHAIR MUTUAL FUND DIRECTOR RULE

http://www.sec.gov/rules/final/ccusastay090904.htm (copy of a letter providing more information about the suit)

♦ The U.S. Chamber of Commerce (“Chamber”) filed a lawsuit challenging the requirements in the SEC’s new fund governance rules that investment companies have a board composed of at least 75% independent directors and an independent chairman.

♦ The Chamber’s complaint claims that the SEC exceeded its statutory authority, failed to adequately justify its exercise of its rulemaking authority, and engaged in rulemaking that is arbitrary and capricious.

♦ The complaint asks that the independent chair and 75% independent director conditions be declared unlawful and set aside, and that the Commission be enjoined from giving effect to the conditions.

9.2.04 FUNDS PROHIBITED FROM PAYING FOR BROKERAGE BY DISTRIBUTING SHARES THROUGH EXECUTING BROKER

http://www.sec.gov/rules/final/ic-26591.htm (copy of final rule) http://www.nasdr.com/pdf-text/rf04_27.pdf (copy of proposal)

♦ The SEC issued a Release adopting amendments to the 1940 Act rule 12b-1 to prohibit mutual funds from paying for the distribution of their shares with brokerage commissions generated from trading in fund portfolio securities.

♦ The SEC refers to this practice as “directed brokerage.”

♦ Funds that wish to continue to direct portfolio brokerage to broker-dealers that also sell fund shares must implement policies and procedures designed to prevent brokerage placement decisions from being influenced by a broker’s promotion or sales of fund shares.

♦ Similarly, on February 10, 2004, the NASD filed with the SEC a proposed change to NASD Conduct Rule 2830(k), which governs members’ execution of


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investment company portfolio transactions. ♦ NASD is proposing to eliminate a current provision of

this rule that allows a member to sell shares of a fund that has a disclosed policy of considering sales of fund shares as a factor in selecting brokers to execute fund portfolio transactions.

♦ Before the NASD proposal can become final, the SEC must publish it for public comment and approve the change, neither of which it has done.

♦ The SEC Release adopting the amendments to rule 12b-1 notes only that the NASD proposal “currently is under review” by the Commission.

♦ The amendments to Rule 12b-1 were effective on October 14, 2004. The compliance date was December 13, 2004.

9.10.04 SEC ADOPTS NASD RULE REGARDING CEO CERTIFICATION AND DESIGNATING A CCO http://a257.g.akamaitech.net/7/257/2422/06jun20041800/edocket.access.gpo.gov/2004/pdf/E4-2227.pdf (copy of the release) http://www.nasdr.com/news/pr2004/release_04_061.html (copy of the press release)

♦ The new NASD requirements were adopted without change from the version that was published for comment on July 28, 2004.

♦ On September 23, 2004, the NASD issued a Press Release that announces the SEC's approval, and states NASD’s intention to issue a Notice to Members on the new requirements “no later than November 9.” According to the Press Release, the effective date of the rule will be 30 days following publication of that Notice to Members. Firms must designate a CCO by the effective date, and CEOs of regulated firms must execute their first certifications within one year of that effective date.

10.25.04 MSRB PROPOSES TO CREATE THE “REAL-TIME TRANSACTION PRICE SERVICE” FOR MUNIS http://www.msrb.org/msrb1/archive/2004/RTRSFee.htm (copy of notice)

♦ The Municipal Securities Rulemaking Board (“MSRB”) filed with the Securities and Exchange Commission (“SEC”) a proposal to create the Real-Time Transaction Price Service (“Real-Time Service”) and establish a $5,000 annual subscription fee.

♦ The Real-Time Service will disseminate municipal securities transaction prices in “real-time” as part of the MSRB’s Real-Time Transaction Reporting System (“RTRS”).

♦ The proposal will become effective upon approval by the SEC, and is expected to become operative in January 2005 as part of the RTRS.

♦ As background, on August 31, 2004, the SEC approved the MSRB’s proposal for implementation of a real-time transaction reporting and price-dissemination system, which will require dealers to submit their transaction reports within 15 minutes of time of trade. The system will automatically check the reports for errors, ensure that they are valid trade reports, format the reports, and make them available for immediate electronic transmittal to each subscriber.

10.26.04

SEC ADOPTS RULE REQUIRING HEDGE FUND ADVISERS TO REGISTER http://www.sec.gov/news/press/2004-150.htm (copy of press release announcing the new rule)

♦ In a 3-2 vote, the Commissioners of the SEC adopted new Rule 203(b)(3)-2 under the Investment Advisers Act of 1940 (“Advisers Act”), which will require hedge fund advisers to register with the SEC by February 1, 2006.

♦ Hedge fund advisers will no longer be able to rely on an exemption from adviser registration designed for advisers providing advice only to 15 or fewer clients.


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♦ Registration under the new rule is intended to assist the SEC with: • collecting information about the operations of hedge

fund advisers; • conducting examinations of hedge fund advisers; • requiring all hedge fund advisers to adopt basic

compliance controls to prevent violation of the federal securities laws;

• improving disclosures made to prospective and current hedge fund investors; and

• preventing felons or individuals with other serious disciplinary records from managing hedge funds.

10.29.04 NASD PROPOSES BAN ON USE OF FUND BROKERAGE COMMISSIONS FOR DISTRIBUTION

http://www.sec.gov/rules/sro/nasd/34-50611.pdf (copy of release) http://www.reedsmith.com/upload/SEC%20Update%202004-32.pdf (copy of Reed Smith bulletin)

♦ The SEC issued a Notice seeking public comment on a proposal by the NASD to amend NASD Conduct Rule 2830(k), which governs members’ execution of investment company portfolio transactions.

♦ The NASD proposed to eliminate a current provision of this rule that allows a member to sell shares of a fund that has a disclosed policy of considering sales of fund shares as a factor in selecting brokers to execute fund portfolio transactions, and to add a new provision to the rule to effectively prohibit this type of “directed brokerage.”

♦ This NASD rule proposal corresponds with the SEC’s recent amendment of Rule 12b-1 (under the Investment Company Act of 1940 (“1940 Act”)) to prohibit open-end management investment companies from paying for the distribution of their shares with brokerage commissions. The compliance date for the amendment to Rule 12b-1 was December 13, 2004.

♦ The SEC must approve the change before the NASD proposal can become final.

♦ SEC comments on the proposal were due by November 30, 2004.

10.29.04 COMPLIANCE DATE FOR CODE OF ETHICS RULE EXTENDED TO FEBRUARY 1, 2005

♦ On October 29, 2004, the Investment Company Institute (“ICI”) issued a memorandum to its members stating that the SEC has extended the compliance date of Rule 204A-1 under the Advisers Act, which requires each registered investment adviser to adopt a code of ethics.

♦ As a result of the ICI communicating to the SEC the difficulties investment advisers were experiencing in complying with the January 7 compliance date, the compliance date has been extended from January 7, 2005 to February 1, 2005.

11.1.04 REGULATION B IMPLEMENTATION POSTPONED http://www.sec.gov/news/press/2004-151.htm (copy of the press release announcing the postponement)

♦ The SEC extended until March 31, 2005, the compliance dates for banks with respect to certain broker registration requirements contained in the Gramm-Leach-Bliley Act (“GLBA”). Banks have indicated that they will need time to implement systems to ensure compliance with the new statutory requirements regarding the definition of “broker.”

♦ The GLBA repealed a full exception that had allowed banks to engage in securities activities without registering as a broker or dealer and replaced the full exception with new functional exceptions. The new functional exceptions were to become effective May


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12, 2001. On May 11, 2001, the SEC adopted interim rules that, among other things, gave banks time to come into full compliance with the more narrowly tailored exceptions from broker-dealer registration. To further accommodate the banking industry's continuing compliance concerns, the SEC delayed the effective date of the bank “broker” rules through a series of orders that ultimately extended the temporary exemption from the definition of “broker” to Nov. 12, 2004. The SEC has since extended the exemption from the definition of “broker” until March 31, 2005, pending its consideration of comments received on its Regulation B proposal. This will give the Commission time to fully consider comments received on Regulation B and to take any final action on the proposal as necessary, including consideration of any modification necessary to the proposed compliance date.

11.1.04 SEC APPROVES NEW NASD CEO CERTIFICATION

AND CCO DESIGNATION REQUIREMENTS

http://www.nasd.com/stellent/groups/rules_regs/documents/notice_to_members/nasdw_011955.pdf (copy of the rule language and interpretive material) http://www.reedsmith.com/upload/SEC%20Update%202004-33.pdf

(copy of Reed Smith bulletin)

♦ The NASD issued Notice to Members 04-79 to announce the SEC’s approval of new NASD Rule 3013 and accompanying interpretive materials.

♦ The new rule requires members to: 1) designate a chief compliance officer (“CCO”); and 2) have the chief executive officer (or equivalent officer) (“CEO”) certify annually that the member has in place processes to establish, maintain, review, test, and modify written compliance policies and written supervisory procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules, and federal securities laws and regulations.

♦ Members were required to designate and identify to NASD on Schedule A of Form BD a principal to serve as CCO by December 1, 2004. The CEO certification must be executed within one year of December 1, 2004 and annually thereafter.

♦ The new NASD requirements were adopted without change from the version that was published for comment in July 2004.

11.3.04 SEC ISSUES CONCEPT RELEASE TO OVERHAUL DISCLOSURE RULES UNDER THE 1933 ACT http://www.sec.gov/rules/proposed/33-8501.htm (copy of the proposing release)

♦ The SEC proposed rules that will modify and advance significantly the registration, communications, and offering processes under the Securities Act of 1933.

♦ The proposals, if adopted, would eliminate unnecessary and outmoded restrictions on offerings. In addition, the proposals would provide more timely investment information to investors without mandating delays in the offering process that the SEC believes would be inconsistent with the needs of issuers for timely access to capital.

♦ The proposals also would continue the SEC's long-term efforts toward integrating disclosure and processes under the Securities Act and the Securities Exchange Act of 1934 (“1934 Act”).

♦ The proposals would accomplish these goals by addressing communications related to registered securities offerings, delivery of information to investors, and procedural restrictions in the offering


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and capital formation processes. 11.10.04

SEC STAFF EASES BURDEN FOR CLOSED-END FUNDS UNDER COMPLIANCE RULE http://www.sec.gov/divisions/investment/noaction/ici111004.htm (copy of the no-action letter)

♦ Rule 38a-1 under the 1940 Act, or the “compliance programs rule,” requires a board of directors of a registered investment company, including a closed-end fund, to review and approve the compliance policies and procedures of each service provider, including each principal underwriter of the fund.

♦ In a “no-action” letter addressed to the ICI, the SEC staff stated that it would not recommend enforcement action against a closed-end fund if its board of directors does not review and approve a principal underwriter’s compliance policies and procedures if that principal underwriter does not undertake regularly to serve or act as a principal underwriter for the fund.

♦ In its request for relief, the ICI asserted that application of Rule 38a-1 to a principal underwriter of a closed-end fund is unnecessary because a principal underwriter and a closed-end fund do not have an ongoing relationship.

♦ The SEC staff agreed and, in reaching its conclusion, observed that in all other instances the rule requires an investment company to oversee the compliance of service providers that provide ongoing services to the investment company, including: advisers, administrators, transfer agents, and, with respect to an open-end fund, the principal underwriter.

11.11.04

THE USE OF NEGATIVE RESPONSE LETTERS TO CHANGE THE BROKER-DEALER OF RECORD ON A MUTUAL FUND OR VARIABLE INSURANCE PRODUCT ACCOUNT HELD DIRECTLY AT THE ISSUER http://www.nasd.com/stellent/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_012109&ssSourceNodeld=6 (copy of interpretive letter) http://www.nasd.com/stellent/groups/rules_regs/documents/notice_to_members/nasdw_011634.pdf (copy of Notice to Members 04-72) http://www.reedsmith.com/upload/SEC%20Update%202004-31.pdf (copy of Reed Smith bulletin)

♦ According to the National Association of Securities Dealers’ (“NASD”) Interpretive Letter issued November 8, 2004, a member firm that is currently the “broker of record” for a mutual fund or variable insurance product account held directly at the issuer may, under certain circumstances, use negative response letters to change the “broker of record” to another broker-dealer under certain circumstances.

♦ The NASD has been considering the use of negative consents in this context for several years, and has issued several notices and interpretive letters in this regard. In September 2002, the NASD issued a Notice to Members (02-57) concerning the use of negative response letters for the “bulk transfer of customer accounts.” The staff expressed its view that a customer should affirmatively consent to the transfer of his or her account to another firm because, when a firm initiates the transfer of a customer’s account via a negative response letter, there is no assurance that the customer has had sufficient time or information with which to decide whether to object to the transfer. Furthermore, transfers of customer accounts by a member using negative response letters may, under certain circumstances, conflict with a member’s obligation to observe high standards of commercial honor and equitable principles of trade under NASD Rule 2110.

♦ The staff responded to inquiries regarding the potential application of Notice to Members (02-57) to changes in the “broker of record” by issuing Notice to Members (04-72) on October 5, 2004, which reaffirmed that the guidance provided in Notice to Members (02-57)


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regarding permissible use of negative response letters did not apply to changes in “brokers of record” for mutual fund and variable insurance product accounts where the account is held directly with the issuer.

♦ The NASD then modified its guidance on this question in an October 20, 2004 interpretive letter, recognizing the appropriateness of the use of negative response letters to change the “broker of record” in directly held mutual fund and variable insurance product accounts in situations involving the acquisition or merger of a member firm where the acquiring or surviving entity is the legal successor-in-interest to the member firm. However, based on membership questions, the NASD staff determined that additional guidance was necessary.

♦ The November 8 letter sets out the NASD staff’s current view that the use of negative response letters to make changes to a customer’s account (including changing the “broker of record”) should be used only when a “compelling reason” exists that overrides potential risks to investors.

♦ The letter gives examples of circumstances under which a member may use negative response letters to change the “broker of record” on directly held mutual fund and variable insurance product accounts that will become effectively abandoned because the member currently named as the “broker of record” does not intend to service those accounts on a going-forward basis.

♦ The staff also stated its expectation that a member relying on this guidance must provide account holders with adequate time and information to decide whether to object to the transfer, and reminded members to provide the information and disclosures outlined in Notice to Members (02-57).

11.11.04 REPORT OF THE MUTUAL FUND TASK FORCE – SOFT DOLLARS AND PORTFOLIO TRANSACTION COSTS

http://www.nasd.com/stellent/groups/rules_regs/documents/rules_regs/nasdw_012356.pdf (copy of report) http://www.reedsmith.com/upload/SEC%20Update%202004-36.pdf (copy of Reed Smith bulletin)

♦ The NASD Mutual Fund Task Force (“Task Force”) issued a report on “Soft Dollars and Portfolio Transaction Costs” (“Report”) which sets forth the Task Force’s observations and recommendations concerning “soft dollar” services and portfolio transaction costs.

♦ The NASD formed the Task Force in May 2004 “to consider ways to improve the transparency of mutual fund portfolio transaction costs and distribution arrangements.”

♦ The Task Force has recommended that the SEC: • narrow its interpretation of the scope of research

services for purposes of the safe harbor set forth in Section 28(e) under the Securities Exchange Act of 1934;

• require enhanced disclosure to fund Boards and shareholders about portfolio transaction costs and soft dollar products and services received;

• mandate enhanced disclosure in fund prospectuses; • consider soft dollar issues raised by other managed

advisory accounts; and • apply disclosure requirements to all types of


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“Commissions” (or “commission equivalents”). 12.2.04 SEC POSTS RELEASE REQUIRING HEDGE FUND

ADVISERS TO REGISTER

http://www.sec.gov/rules/final/ia-2333.pdf (copy of the release adopting the rule) http://www.reedsmith.com/upload/SEC%20Update%202004-37.pdf (copy of Reed Smith bulletin)

♦ The SEC posted the release adopting Rule 206(4)-2, which requires hedge fund investment advisers to register with the SEC by February 1, 2006 under certain circumstances.

♦ Rule 203(b)(3)-2 requires investment advisers to count each owner of a “private fund” towards the threshold of 14 clients for purposes of determining the availability of the private adviser exemption of Section 203(b)(3) of the Advisers Act.

♦ As a result, an adviser to a “private fund,” which is defined in Rule 203(b)(3)-1, can no longer rely on the private adviser exemption of the adviser, during the course of the preceding 12 months, if it has advised private funds that had more than 14 investors.

12.2.04 SEC ADOPTS REQUIREMENTS FOR PROPER DISPOSAL OF “CONSUMER REPORT INFORMATION”

http://www.sec.gov/rules/final/34-50781.htm (copy of release) http://www.reedsmith.com/upload/SEC%20Update%202004-38.pdf (copy of Reed Smith bulletin)

♦ The SEC added a new provision (sometimes referred to as the “disposal rule”) to “Regulation S-P – Privacy of Consumer Financial Information” to require every SEC-registered broker-dealer, investment company, investment adviser and transfer agent (“covered entities”) that maintains or otherwise possesses “consumer report information” for a business purpose to properly dispose of the information by taking reasonable measures to protect against unauthorized access to or use of the information in connection with its disposal.”

♦ The SEC also amended existing provisions of Regulation S-P that relate to the safeguarding of “customer information” (which requirements are sometimes referred to as the “safeguard rule”) to specifically require that the policies and procedures required under the safeguard rule be in writing.

♦ The compliance date is July 1, 2005. However, covered entities have until July 1, 2006 to bring existing contracts with service providers for services involving the disposal or destruction of consumer report information into compliance with the new requirements.

12.15.02 PCAOB TO TAKE A GREATER ROLE IN SETTING AUDITOR INDEPENDENCE STANDARDS

http://www.pcaobus.org/News_and_Events/News/2004-12-14.asp (copy of press release)

♦ The Public Company Accounting Oversight Board (“PCAOB”) proposed certain ethics and independence rules to promote the ethics and independence of registered public accounting firms that audit and review financial statements of U.S. public companies, including investment companies.

♦ The proposed rules: • treat a public accounting firm as not independent if

the firm, or an affiliate of the firm, provides any service or product to an audit client for a contingent fee or a commission, or receives from an audit client, directly or indirectly, a contingent fee or commission;

• treat a public accounting firm as not independent if the firm, or affiliate of the firm, provides assistance in planning, or provides tax advice on, certain types of potentially abusive tax transactions to an audit client, or provides any tax services to certain senior officers of an audit client;


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• require public accounting firms to provide certain information to the audit committee of an audit client in connection with seeking pre-approval to provide non-prohibited tax services to the audit client; and

• require public accounting firms to be independent of their audit clients throughout the audit and professional engagement period.

• Most accounting firms already are subject to similar auditor independent rules, including Rule 2-01 of Regulation S-X of the Securities Act of 1933.

12.16.04 COMMITTEE FORMED TO EXAMINE IMPACT OF SARBANES-OXLEY ACT ON SMALLER PUBLIC COMPANIES

http://www.sec.gov/news/press/2004-174.htm (copy of the press release announcing the formation of the committee)

♦ The SEC established an advisory committee to assist it in examining the impact of the Sarbanes-Oxley Act and other aspects of the federal securities laws on smaller public companies. The advisory committee will be known as the Securities and Exchange Commission Advisory Committee on Smaller Public Companies.

♦ The committee will focus on: • frameworks for internal control over financial

reporting applicable to smaller public companies, methods for management’s assessment of such internal control, and standards for auditing such internal control;

• corporate disclosure and reporting requirements and federally imposed corporate governance requirements for smaller public companies, including differing regulatory requirements based on market capitalization, or other measurements of size or market characteristics;

• accounting standards and financial reporting requirements applicable to smaller public companies; and

• the process, requirements and exemptions relating to offerings of securities by smaller companies, particularly public offerings.

♦ The committee will consider whether the costs imposed by the current securities regulatory system for smaller public companies are proportionate to the benefits, identifying methods of minimizing costs and maximizing benefits, and facilitating capital formation by smaller companies. The Chairman also stated the SEC expects the committee to provide recommendations as to where and how the SEC should draw lines to scale regulatory treatment for companies based on size.

12.16.04 SEC PROPOSES NEW TRADING RULES RELATED TO MARKET INFORMATION http://www.sec.gov/rules/proposed/34-50870.pdf (copy of the rule release)

♦ The SEC reproposed rules under Regulation NMS governing the dissemination of market information. The rules are designed to improve the regulatory structure of the U.S. equity markets.

♦ The SEC proposed the following four sets of rules: Trade-Through Rule. This rule would require trading centers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by other trading centers, subject to an applicable exception. To be protected, a quotation must be immediately and automatically accessible.


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Access Rule. This rule would require fair and non-discriminatory access to quotations, establish a limit on access fees to harmonize the pricing of quotations across different trading centers, and require each national securities exchange and national securities association to adopt and enforce rules that prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross automated quotations. Sub-Penny Rule. This rule would prohibit market participants from accepting, ranking, or displaying orders, quotations, or indications of interest in a pricing increment smaller than a penny, except for orders, quotations, or indications of interest that are priced at less than $1.00 per share. Market Data Rules. These rules would update the requirements for consolidating, distributing, and displaying market information, as well as amendments to the joint industry plans for disseminating market information that would modify the formulas for allocating plan revenues and broaden participation in plan governance.

12.20.04 NASD ADOPTS BAN ON USE OF FUND BROKERAGE COMMISSIONS FOR DISTRIBUTION http://www.sec.gov/rules/sro/nasd/34-50883.pdf (copy of release) http://www.nasd.com/web/groups/rules_regs/documents/notice_to_members/nasdw_013000.pdf (copy of Notice to Members 05-04) http://www.reedsmith.com/upload/SEC%20Update%202005-03.pdf (copy of Reed Smith bulletin)

♦ The SEC issued a Release approving a proposal by the NASD to amend NASD Conduct Rule 2830(k), which governs members’ execution of investment company portfolio transactions.

♦ The NASD is eliminating a current provision of this Rule that allows a member to sell shares of a fund that has a disclosed policy of considering sales of fund shares as a factor in selecting brokers to execute fund portfolio transactions, and is adding a new provision to the rule to effectively prohibit this type of “directed brokerage” activity.

♦ On January 14, 2005, the NASD posted Notice to Members (05-04), announcing the SEC approval of the changes. Notice to Members (05-04) includes the final text of the amendments to Rule 2830(k), and states that the rule changes become effective February 14, 2005.

♦ The NASD's action corresponds with the SEC’s recent amendment of Rule 12b-1 under the 1940 Act to prohibit open-end management investment companies from paying for share distribution with brokerage commissions.

♦ The deadline for compliance with amended Rule 12b-1 was December 13, 2004.

12.21.04 CFTC AMENDS LARGE TRADING POSITION RULES

http://www.sec.gov/litigation/litreleases/lr18984.htm (copy of the release adopting the rule)

♦ The CFTC amended its large trader reporting rules, which require futures commission merchants, clearing members, foreign brokers, and traders to report certain position and identifying information to the CFTC when the positions of traders equal or exceed CFTC set contract reporting levels.

♦ The final rules, among other things, raise contract reporting levels.

12.23.04 IDC ISSUES “STATEMENT OF POLICY CONCERNING SOFT DOLLARS”

♦ The Independent Directors Council (“IDC”), which is associated with the ICI, sent its newly issued “Statement of Policy Concerning Soft Dollars” to the SEC.


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http://www.reedsmith.com/upload/SEC%20Update%202004-39.pdf (copy of Reed Smith bulletin)

♦ In summary, the IDC is urging the SEC to: • narrow the scope of the “safe harbor” for research

set out in section 28(e) of the 1934 Act; • impose greater disclosure requirements concerning

the payment of soft dollars; and • require the “unbundling” of research and execution

costs. ♦ The IDC notes that the recommendation for increased

disclosure in the November 11, 2004 Report of the NASD Task Force on Soft Dollars and Portfolio Transaction Costs is too limited; rather, IDC favors increased disclosure with respect to “proprietary” as well as “third party” research.

Documents

Reed Smith LLP George F.Magera Investment Adviser News ... · Highlights included new rules regarding investment adviser codes of ... The compliance dates for many of these rules