United States: Ropes & Gray’s Investment Management Update: August-September 2012

The following summarizes recent legal developments of note affecting the mutual fund/investment management industry:

Bankruptcy Court Determines that Holders of Soft Dollar Credits Are Not Customers under SIPA

In a decision described as the first of its kind, the U.S. Bankruptcy Court of the Southern District of New York ruled that claims based on soft dollar credits issued by Lehman Brothers Inc. (LBI) to numerous investment advisers were not entitled to the special protections afforded to "customer claims" under the Securities Investor Protection Act (SIPA). As explained in Judge James Peck's opinion, the protections afforded by SIPA are available only to creditors who were "customers" of the insolvent broker-dealer and that term encompasses only persons who have securities held by the broker-dealer or who have deposited cash with the broker-dealer for the purpose of purchasing securities. Soft dollars "function something like frequent flyer miles: they are a specialized form of currency that may be redeemed solely as a means to pay for research services and other services provided by a broker-dealer to its customers." The court held that because the soft dollar credits are not securities, and (unlike cash) cannot be used to purchase securities, the holders of soft dollar credits are not "customers" for purposes of SIPA. Judge Peck characterized the claims asserted by the holders of soft dollar credits as simply claims for damages resulting from a breach of contract, i.e., LBI's failure to provide research services that the claimants would be entitled to pay for using soft dollars. Accordingly, the court held that the remedy afforded to holders of soft dollars is to pursue their rights as general unsecured creditors in LBI's bankruptcy case. The full text of the decision is available here.

New Consolidated Audit Trail Rule Requires FINRA and Securities Exchanges to Monitor and Analyze Trading Activity

In the wake of the "flash crash" of May 6, 2010 and in an effort to improve oversight of high-speed electronic market centers, including exchanges, electronic communication networks, alternative trading systems and dark pools, the SEC adopted Rule 613 under the Securities Exchange Act of 1934 mandating the creation of a market-wide consolidated order tracking system. These electronic market centers and FINRA must develop a plan to create, implement and maintain the consolidated audit trail to collect data tracking each order, cancellation, modification and trade execution for all exchange-listed equities and equity options across all U.S. markets. The new system would track every order placed by an individual account holder or an investment company or other pooled investment vehicle, as well as by any investment adviser with trading discretion over an individual or fund account. National securities exchanges and securities organizations must submit their consolidated audit trail plans to the SEC for approval and public comment by April 2013, and will begin reporting data to a central repository one year following SEC approval of the plan. The SEC release adopting new Rule 613 is available here.

Second Circuit Weighs in on Aiding and Abetting Standard of Proof

In Securities and Exchange Commission v. Apuzzo, the U.S. Court of Appeals for the Second Circuit clarified the elements the SEC must prove in order to succeed in a civil enforcement proceeding based on "aiding and abetting" a violation of securities laws. The defendant Joseph Apuzzo was the Chief Financial Officer of the Terex Corporation (Terex), a construction and mining equipment manufacturer. Terex allegedly engaged in certain sale and leaseback transactions with United Rentals, Inc. (URI), a large equipment rental company. The SEC alleged that Apuzzo aided and abetted the violations by URI of the federal securities laws by assisting URI in carrying out "sale-leaseback" transactions designed to allow URI to recognize revenue prematurely and to inflate the profit generated from URI's sales.

The issue before the Second Circuit was whether the district court had incorrectly held, in the context of an SEC civil enforcement case, that "substantial assistance" (an element of an aiding and abetting claim) could only be established by a showing that the aider and abettor was the "proximate cause" of the harm on which the primary violation was predicated. Prior to this decision, some district courts in the Second Circuit had been applying the proximate cause standard to both private suits and government enforcement cases. Conceding that "our case law has not always made this distinction with clarity," the Second Circuit held that the appropriate standard for determining whether an alleged aider and abettor has provided "substantial assistance" in an SEC civil enforcement action is the standard articulated by Judge Learned Hand in United States v. Peoni, in 1938. Under this standard, the SEC must prove that the defendant "in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as in something that he wishe[d] to bring about, [and] that he [sought] by his action to make it succeed." By affirming this standard, Apuzzo makes it easier for the SEC to prove aiding and abetting claims in the Second Circuit, since it will not be required to prove causation. In addition, the Dodd-Frank Act recently amended the section of the Securities Exchange Act of 1934 imposing liability on aiders and abettors so that it now includes "reckless" as well as "knowing" conduct. The full opinion is available here.

Southern District of New York Dismisses Leveraged ETF Class Action

On September 10, 2012, the Southern District of New York dismissed all of plaintiffs' claims in a consolidated securities lawsuit arising out the performance of ProShares' exchange-traded funds ("ETFs") during the 2008-2009 financial crisis. The ProShares ETFs in question pursued investment objectives designed to deliver either a multiple or an inverse multiple of the daily performance of a securities index. Starting in August 2009, numerous plaintiff groups brought class-action claims against 44 different ProShares ETFs, alleging that the registration statements in question failed to properly disclose the risk that the ETFs, when held for a period of time greater than one day, could lose substantial value quickly, especially in periods of high volatility of the underlying benchmark or index. The court dismissed the suits on the basis of its findings that ProShares had adequately disclosed the risk that plaintiffs claimed later materialized, namely that if investors held their ETFs for periods of time longer than one day, there was a risk that their value could diverge significantly from the expected daily result. Significantly, the court also agreed that certain recent decisions in SDNY and elsewhere which allowed similar claims to proceed against other ETF companies were not applicable because they involved key factual differences. Ropes & Gray partner Rob Skinner represented ProShares in this litigation. The full opinion is available here.

No-Action Letter Grants Advisers of College Savings 529 Plans Relief from Surprise Inspection Requirement

In a recent no-action letter requested by the Investment Company Institute (ICI), the SEC Staff stated that it would not recommend enforcement action against an investment adviser that treats a 529 plan trust as a "pooled investment vehicle" for purposes of Rule 206(4)-2 under the Investment Advisers Act (sometimes referred to as the "Custody Rule"). Under the Custody Rule, a "pooled investment vehicle" is not required to obtain a surprise examination by an independent public accountant provided various other requirements are met. As a result of this no-action letter, an adviser to registered investment companies (which are excepted from the Custody Rule) that is also acting as the program manager for a 529 plan will not be subject to the prospect of having a surprise examination conducted on the 529 plan portion of its business. A copy of the SEC's No-Action Letter is available here.

SEC Registration Fees to Increase on October 1st

The SEC announced that effective October 1, 2012, the fees payable in connection with Form 24F-2 (Annual Notice of Securities Sold Pursuant to Rule 24f-2) will increase from $114.60 per million dollars of net aggregate sales during a fiscal year to $136.40 per million dollars of net aggregate sales. Funds with fiscal years that ended after June 30, 2012, which are otherwise not required to file their Form 24F-2 by September 28, 2012, respectively, may wish to accelerate their filing and submit their Form 24F-2 and the related payment before 5:30 p.m. ET on Friday, September 28, 2012, in order to pay a lower fee at the current rate. A copy of the Commission's order and calculation methodology is available here.

Regulatory Priorities Corner

The following brief updates exemplify trends and areas of current focus of relevant regulatory authorities:

SEC Issues Financial Literacy Study. As required by the Dodd-Frank Act, the staff of the SEC's Office of Investor Education and Advocacy ("OIEA") released a study identifying the existing level of financial literacy among retail investors as well as methods and efforts to increase the financial literacy of investors. Some areas discussed that may develop into regulatory initiatives include (i) improving the timing, content, and format of disclosures; and (ii) improving the transparency of expenses and conflicts of interest. The study is available by clicking here.

SEC Sanctions Adviser for Failing to Disclose Revenue Sharing Arrangement. On September 6, 2012, the SEC fined two Portland, Oregon-based investment advisory firms, a total of $1.1 million for failing to disclose a revenue-sharing agreement and other potential conflicts of interest to clients. Although the alleged conduct of the adviser was egregious, the fines serve as a reminder that accurate disclosures of the conflicts of interest inherent in revenue sharing arrangements continue to be a focus for SEC enforcement. The SEC's Order can be found here.

Other Developments

Since the last issue of our IM Update we have also published the following separate Client Alerts of interest to the investment management industry:

The SEC Proposes Rules to Remove Prohibitions on General Solicitation and General Advertising in Certain Regulation D Offerings September 7, 2012

On August 29 the SEC, responding to a directive in the JOBS Act enacted on April 5, 2012, proposed new Rule 506(c) of Regulation D under the Securities Act. Proposed Rule 506(c) would allow private funds and other issuers to engage in "general solicitation" and "general advertising" in offerings made under Rule 506. This Alert describes proposed Rule 506(c), highlights items of interest in the SEC's proposing release, and identifies outstanding issues under the proposed rule and other federal statutes and rules applicable to offerings of private fund interests.

NFA Proposes Waiving Proficiency Exam Requirements in Connection with Certain Swaps Activities

August 28, 2012

Among its many provisions, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amended the definitions of Commodity Pool Operator (CPO) and Commodity Trading Advisor (CTA) to include firms managing funds or accounts that engage in "swaps." The Commodity Futures Trading Commission (CFTC) recently defined "swaps" very broadly. As a result of these developments, firms engaged in a broad range of swaps transactions that were not previously required to register as CPOs or CTAs must now register or find a registration exemption on which to rely. For a firm that is required to register, the firm's "Associated Persons" ordinarily must satisfy a proficiency examination requirement. This Alert discusses recent developments relating to this requirement.

SEC Whistleblower Office Issues First Award

August 22, 2012

This Alert discusses the SEC announcement that an anonymous tipster was eligible to receive the first award paid under its Dodd-Frank Act-mandated whistleblower program.

FAQs Regarding Private Equity Firms Launching Registered Funds August 20, 2012

Private equity firms have begun to launch registered funds (i.e., mutual funds), and many of our private equity clients have been asking us about the feasibility of offering their investment strategies through registered fund products. We have set forth in this client alert the questions that we frequently receive from private equity firms that are considering launching registered funds.

CFTC Staff Responds to Frequently Asked Questions on CTA and CPO Registration and Compliance August 16, 2012

On August 14, 2012, the CFTC Staff released guidance, in a question and answer format, which addresses frequently asked questions relating to (i) compliance obligations of CPOs and CTAs following rescission of the registration exemption under CFTC Rule 4.13(a)(4) previously relied on by many private funds, (ii) the inclusion of swaps in the trading threshold calculation under the registration exemption established by CFTC Rule 4.13(a)(3), and (iii) the amendments to the CFTC Rule 4.5 exclusion from registration for registered investment companies. This Alert discusses the highlights of the CFTC's new guidance.

Update: SEC and CFTC Adopt Final Swap Definitional Rules, Triggering Compliance Dates for Multiple Dodd-Frank Act Rules August 13, 2012

The SEC and the CFTC adopted regulations defining the terms "swap" and "security-based swap." This marks a critical milestone in the Dodd-Frank Act regulatory timeline, as the compliance dates for many other rules under the Dodd-Frank Act are dependent on the effective date of these swap definitional rules, which is 60 days following the date of publication in the Federal Register, i.e., October 12, 2012. A summary of certain of these rules which will have the greatest impact on buy-side users of derivatives, and their respective compliance dates, is included in this Alert.

CFTC Proposes to Require Mandatory Clearing of Certain Interest Rate Swaps and Credit Default Index Swaps July 25, 2012

On July 24, 2012, the CFTC issued proposed rules that would require certain interest rate swaps and credit default index swaps to be cleared. This is the first proposed mandatory clearing determination by the CFTC pursuant to the Dodd-Frank Act. The CFTC also adopted final rules that create a phased-in implementation schedule for compliance with mandatory clearing determinations under the Dodd-Frank Act. This Alert discusses the types of derivatives that would be subject to the clearing requirement and the implementation schedule.

www.ropesgray.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions