Legal Alert: ALI-ABA’s SEC/NASD Compliance Conference

The American Law Institute – American Bar Association ("ALI-ABA"), in cooperation with the Financial Services Institute, recently held a conference on SEC/NASD Compliance. The conference featured senior SEC and NASD officials and leading legal and compliance practitioners who discussed a range of compliance issues facing investment advisers, investment companies and broker-dealers. The conference provided an overview of recent regulatory changes, as well as practical advice for investment advisers, investment companies and broker-dealers in designing and implementing their compliance programs. The conference was chaired by Clifford E. Kirsch, who joined Sutherland Asbill & Brennan LLP earlier this month as a partner in the firm’s New York office. Among the panel participants was Brian L. Rubin, a partner in Sutherland’s Washington DC office. This Alert summarizes some substantive highlights from the panels and conference materials.

This panel provided practical advice concerning how firms should develop, implement and test their compliance programs. In addition, the panelists discussed compliance’s role to monitor and to conduct surveillance vis-à-vis business’ role to manage and direct the firm’s business.

• Developing, Implementing and Testing Compliance Programs. One of the panelists offered an overview of how to develop and implement a compliance program:

1. Establish a written vision of a " reasonable compliance system design." Firms should communicate this vision to business units and employees, and retain a copy of the vision as part of the compliance manual.
2. Organize the effort. Firms should identify and communicate with key stakeholders (e.g., the chief compliance officer and the heads of business units responsible for implementing parts of the compliance program).
3. Document the development of the compliance program. Firms should document their evaluation of past compliance programs, their identification of compliance issues, and the other steps discussed in more detail below.
4. Define the compliance requirements. Firms should identify all laws and regulations that are applicable to each of their lines of business.
5. Map the compliance requirements to relevant departments and policies and procedures. For each compliance requirement, firms should identify existing policies and procedures and the business units responsible for those policies and procedures.
6. Prioritize the compliance requirements. Firms should develop criteria to assess the potential compliance risks; based on those criteria, firms should prioritize the compliance requirements.
7. Evaluate existing compliance program and draft, review and approve new policies and procedures. Firms should adopt new and/or revised policies and procedures where needed. In addition, this process should be documented.
8. Launch and implement the compliance program. Firms should train staff regarding compliance responsibilities and, in general, foster a "culture of compliance" within the organization. In addition, firms should communicate with individuals who are responsible for the implementation or monitoring of policies and procedures to ensure that those individuals understand their responsibilities.
9. Monitor the compliance program. Firms should monitor their compliance programs through, among other things, testing and an escalation process.

1. Testing. The panelists discussed several different testing strategies, including creating a risk matrix and using a "heat map." One panelist suggested that compliance departments review, on an ad hoc basis, CRD reports at least on a quarterly basis to gain an understanding of issues that are triggering complaints.
2. Escalation process. Firms should have a clearly defined escalation process to ensure that appropriate compliance or legal personnel are notified of any issues or potential violations as they arise.

• Defining the Role of Compliance. Mr. Kirsch opened the discussion by stressing that compliance personnel and business personnel need to operate under a common understanding of their respective roles and responsibilities. Mr. Kirsch noted that some larger organizations have found it worthwhile to delineate these roles in writing and distribute them throughout the organization, while others have found it useful to reinforce these concepts at internal meetings and training sessions. One industry member suggested that the structure and design of a compliance program is often dependent on firm size. For example, some small firms do not have the luxury of keeping compliance and business roles separate.

1. Communications between Compliance and the Business Units. The panel looked at ways in which compliance personnel can effectively interact with business personnel. One panelist talked about the importance of firms documenting interactions between compliance and the business units. Another speaker suggested that firms should form committees to force frequent and organized communication between compliance and business units.
2. Role of a Mutual Fund’s Board of Directors. One of the industry members noted that in the mutual fund context it is important for compliance personnel and the mutual fund’s board of directors to engage in free-flowing discussions and for compliance to use the board of directors to help resolve conflicts of interest and other problems that arise.

This panel was comprised of former SEC and NASD enforcement officials as well as one current senior executive with NASD. Sutherland’s Brian Rubin, who was formerly a senior enforcement counsel with the SEC as well as NASD’s Deputy Chief Counsel of Enforcement, introduced the panel, which included Roger Sherman (Senior Vice President of NASD Enforcement) and Arthur Gabinet (a Principal of Securities Regulation with The Vanguard Group and former District Administrator for the SEC’s Philadelphia District Office). Mr. Rubin noted that because "the cover up can be worse than the crime," the panel would focus on the process of responding to regulatory inquiries, instead of substantive regulatory issues.

• Responding to Regulatory Inquiries. The panelists discussed the following steps firms should take upon receipt of a regulatory inquiry:

1. Identify critical personnel to respond, including a point person. In terms of staffing, Mr. Sherman stated that firms should designate a person in charge of responding to the request. Mr. Sherman cautioned firms against using a "committee" approach, and stated that if a firm opts to use such an approach, the lines of responsibility for responding to the request must be clearly delineated.
2. Establish communications with the regulator by making a courtesy call to the staff attorney or examiner identified in the inquiry letter. During that call, the firm can take the opportunity to ask for clarification regarding aspects of the request, discuss any potential production issues with the staff, request an extension, or notify the staff about any similar regulatory inquiries from other regulators.
3. Convene with internal personnel to determine next steps. The next steps include, among other things, (a) formulating a game plan for responding to the inquiry; (b) deciding whether to conduct an internal investigation; (c) deciding whether to retain outside counsel; and (d) determining whether any privilege issues exist as to the requested information and, if so, whether to invoke or waive the privilege.
4. Engage in an ongoing dialogue with the staff during the production process. Firms should keep the staff apprised of production status and any issues that arise during production. Mr. Rubin asked the other panel members whether they believed that ongoing dialogue would be sufficient to appease the staff so that they would not get annoyed (or bring an action) about delayed production. In response, it was stated that having an ongoing communication with the staff will not excuse the delay. Specifically, a mere phone call to the staff every two weeks indicating that the firm is "working on a response" will not suffice and could lead the regulator to delve into the firm’s system and procedures and possibly initiate a separate examination.
5. Provide a complete, accurate and timely response. Firms should provide candid disclosure concerning any shortcomings in their responses. In addition, firms should seek extensions to enable complete and accurate responses, where needed.
6. Amend the response, if necessary. Firms should amend any responses that they later learn are inaccurate. One issue is whether a firm should immediately contact the regulator once a potential inaccuracy is discovered, or whether the firm should conduct an internal investigation first to understand the nature and scope of the inaccuracy. Which approach to take depends on the facts and circumstances of each case; however, regulators will likely be irritated if the firm takes too long to disclose the inaccuracy.

• Potential Production Pitfalls. The panelists highlighted several production pitfalls that firms should avoid:

1. Providing a "hurried" response. Mr. Sherman encouraged firms to speak with the staff concerning production issues and request extensions to allow a "reasoned," as opposed to a "hurried," response. Mr. Sherman noted that the staff has a "fair amount of empathy" for extension requests; however, he cautioned firms not to wait until the last minute to make such requests. As an example of what not to do, Mr. Sherman cited one NASD complaint. In that complaint, NASD charged a member firm with violating Rule 8210 by knowingly producing inaccurate and incomplete data. The complaint alleged that the firm discovered three days before the firm’s response was due, that the data was inaccurate. Instead of requesting an extension, the firm produced the data and did not notify NASD about the alleged inaccuracy.
2. Failing to designate a point person. Failing to designate a point person and/or clearly delineate the responsibilities for responding to a request can result in "one big dropped ball," according to Mr. Sherman.
3. Failing to monitor outside counsel. Mr. Sherman noted that firms will be held liable for the actions of outside counsel, even where the firm argues that it was unaware of the outside counsel’s actions.
4. Failing to make reasonable inquiry. Firms must conduct reasonable due diligence before responding to a regulatory request. What due diligence is reasonable depends on, among other things, the nature of the issue and the size of the firm. For example, it was noted that if a firm is responding to a market timing inquiry in the post-Spitzer context, a mass email asking representatives whether they are aware of market timing issues may not suffice. Instead, it was suggested that the firm develop a plan to examine the trading at its various offices.
5. Failing to establish and maintain written policies and procedures for responding to regulatory inquiries. NASD recently charged a firm for violating Conduct Rules 3010(a) and (b) and 2110 by failing to have adequate systems and written procedures designed to ensure that adequate due diligence was conducted in response to regulatory inquiries. Mr. Rubin questioned the fairness of that charge because there was little, if any, guidance at the time of the alleged violation suggesting that such written procedures were required. Mr. Rubin took an informal poll of the audience participants, which revealed that only a handful of firms represented at the conference currently had written policies and procedures for responding to regulatory inquiries and that none of those firms had such policies and procedures prior to the enforcement action.

• Inadvertent Production of Privileged Documents. Mr. Sherman indicated that NASD will return inadvertently produced privileged documents, but noted that if the documents have already been reviewed by a member of the staff, their contents obviously cannot be "expunged" from the staff member’s memory. Among the course material is an article on inadvertent production of privilege documents co-authored by Mr. Rubin. It can be found through Sutherland’s website at http://www.sablaw.com/professionals/bio.aspx?id=8649&view=pubs.

• Waiving Attorney-Client and Work Product Material. Mr. Rubin noted that there is increasing pressure on firms to waive privileged documents, particularly in the context of SEC investigations. One of the panelists offered that the Seaboard Report has been misunderstood and that waiving the privilege should not be viewed as the sine qua non of cooperation. There is a continuum of cooperation and varying degrees of credit that can be awarded for different forms of cooperation. Mr. Sherman stated that firms can generally provide NASD the information it needs without waiving the privilege.

• Self-Reporting. In the previous panel, it was noted that in deciding whether and how to self-report potential violations identified through their compliance programs, firms should carefully consider a variety of factors, including (a) their disclosure obligations, (b) which regulator(s) to report to, including whether to report to, for example, a local NASD district office or NASD’s headquarters, and (c) to whom within the regulating entity to report the potential violations. One of the panelists picked up on this discussion and emphasized that "confessing" generally does not "absolve" a firm from wrongdoing. If there is "blood on the floor" (a phrase that the panelist said is used by the SEC staff to refer to investor harm), then even if a firm self-reports and does its best to clean up "the blood," the firm will not be absolved of the wrongdoing.

The conference speaker on this issue was George Walz, a Vice President with NASD’s Member Regulation Department. He spoke regarding various educational, training and compliance tools provided by NASD for its members (and in some cases, for the public).

• Educational and Training Tools. Mr. Walz listed the following educational and training tools available to member firms:

1. NASD Conferences. NASD offers conferences covering a variety of topics, such as branch office management and supervision and small firm compliance and supervision. A complete list of NASD conferences is available at http://www.nasd.com/conferences.
2. NASD Classroom Learning Courses and Video Webcasts. NASD also offers classroom learning courses (www.nasd.com/classroomlearning) and video webcasts (www.nasd.com/onlinelearning), which explore topics in more depth than the conferences.

• Compliance Tools. Mr. Walz also discussed the following electronic databases available for use by member firms:

1. Mutual Fund Breakpoint Search Tool. This tool allows the public to look up breakpoint schedules and rules for mutual funds with front-end sales charges. It is available at .
2. NASD Report Center. This tool provides a large variety of reports on member firms’ activities drawn from data reported to NASD. Mr. Walz highlighted the Webcast Usage Report, which can be used to track registered representatives’ participation in online training and thus can be used in the firm element portion of a firm’s continuing education plan. NASD Report Center is available to member firms at www.nasd.com/reportcenter.
3. Equifax Persona Plus. This tool provides certain personal background information to member firms regarding applicants, which can aid firms in screening potential applicants. The reports are available at www.nasd.com/crdequifaxreport; various fees apply.

The speaker on this issue was John H. Walsh, the Chief Counsel and Associate Director of the SEC’s Office of Compliance Inspections and Examinations ("OCIE"). He spoke about what to expect in 2006 from SEC examinations. In addition, Mr. Walsh discussed certain recent initiatives and regulatory changes, including the SEC’s recently announced outreach program for chief compliance officers of investment advisers and two procedural changes with respect to the examination process. Mr. Walsh also noted that OCIE is making fewer referrals to the Division of Enforcement and is seeking alternative means of addressing deficiencies uncovered by examinations.

• Types of Examinations to Expect in 2006. OCIE will utilize a range of oversight options, from informal telephone calls to chief compliance officers at one end of the spectrum, to working closely with the Division of Enforcement in examinations for cause, at the other. OCIE will also continue to employ risk-based "sweeps" of industry firms. Mr. Walsh noted several benefits from "sweep" examinations, including quicker responses to new risks and effective peer comparisons among firms. As new risks are emerging less frequently than in previous years, Mr. Walsh stated that the number of "sweep" examinations are declining.

• Subject Areas of Focus for Examinations in 2006. Mr. Walsh identified the following subject areas of focus for examinations in 2006:

1. Identity theft. Mr. Walsh emphasized that robust policies and procedures are necessary to protect investors from identify theft, and that firms must have controls both to prevent unauthorized access to private information and to prevent exploitation of that information if accessed. Mr. Walsh noted that the SEC is currently conducting a sweep to examine this issue.
2. Sales practices and suitability for seniors. Mr. Walsh indicated that OCIE is focusing on fraud against seniors, who recently have appeared to be more willing to undertake increased investment risks. Examinations will focus on free lunch seminars, which often involve high pressure sales tactics. In particular, OCIE will assess whether firms are aware of these seminars, whether they are supervised, and whether there are suitability controls in place for transactions executed as a result of these seminars.
3. Conflicts of interest. Mr. Walsh stated that OCIE will focus on conflicts of interest particular to the sector of the industry they are examining. For broker-dealers, OCIE will focus on conflicts of interest between proprietary trading and customer trading. For investment advisers, OCIE will focus on conflicts of interest on the allocation side. For mutual funds, OCIE will focus on whether funds are finding alternative ways to purchase "shelf space" now that directed brokerage has been effectively eliminated.
4. Anti-money laundering. Mr. Walsh emphasized that firms should actively document their customer identification program policies and procedures, noting that self regulatory organizations, such as NASD, are finding increasing numbers of deficiencies in this area. While the regulators initially took a conservative approach towards enforcing the anti-money laundering rules, they are now beginning to take a more aggressive approach. In this regard, Mr. Walsh cited a recent enforcement action where the SEC found that a broker-dealer violated Section 17(a) of the Securities Exchange Act of 1934 and Rule 17a-8 thereunder by failing to document accurately its customer identification procedures. A copy of the order instituting administrative proceedings, making findings and imposing a cease-and-desist order in that case is available at http://www.sec.gov/litigation/admin/2006/34-53847.pdf.

• Industry Outreach. Mr. Walsh discussed the SEC’s outreach program for chief compliance officers of investment advisers. He noted that, as part of the program, theoretical case studies will be presented, giving chief compliance officers an opportunity to explore issues and their solutions.

• Procedural Changes. Mr. Walsh highlighted two changes concerning examination procedures:

1. 120-Day Policy. OCIE will contact firms within 120 days of completing an onsite examination to provide a status update and will continue to update examination subjects at 120-day intervals. This extends the prior 90-day rule where OCIE attempted to close examinations within 90 days of the onsite visit, which had proven unworkable given the advent of sweep examinations.
2. Notice of Impending Sweep Examinations. Under a new policy, OCIE must give the Commission prior notice of any impending sweep examinations.

• Declining Referrals. Mr. Walsh stated that after several years of "rolling scandals," during which the OCIE made a significant number of referrals to the Division of Enforcement, referral rates are finally declining and approaching a more "normal" level. For example, referral rates related to broker-dealers peaked at 27%, but have recently fallen to 22%. Similarly, referral rates related to mutual funds have declined from 17% to 11%.

The panelists for this session were Mr. Kirsch, David Bellaire, the General Counsel of the Financial Services Institute, and Stephanie Brown, the General Counsel and Managing Director of LPL Financial Services. They discussed several topics of particular importance to the independent broker-dealer community, including new SEC Rule 202(a)(11)-1, the supervision of outside business activities, email retention and surveillance, equity-indexed annuities and issues relating to the new NASD "branch office" definition and Form BR filing requirements.

• New Rule 202(a)(11)-1. SEC’s Rule 202(a)(11)-1, adopted on April 12, 2005, addresses the dichotomy between brokers and investment advisers and attempts to delineate when a broker "crosses the line" into providing investment advice such that the requirements of the Investment Advisers Act of 1940 ("Advisers Act") are triggered. Under the new rule, a broker-dealer will be subject to the Advisers Act if the broker-dealer provides advice in connection with financial planning services and the broker-dealer either (a) holds itself out to the public as providing financial planning services, (b) delivers a financial plan to a customer, or (c) represents to the customer that the advice is being provided in connection with financial planning services. The boundaries drawn by the new rule are less than clear. For example, it is unclear what constitutes the delivery of a financial plan. One of the panelists noted that one of the difficult issues facing broker-dealers, in light of the new rule, is determining whether a registered representative can provide to his customers information from certain financial planning software.

• Outside Business Activities. One of the panelists identified the following steps to conducting a "high quality" examination aimed at detecting outside business activities:

1. Ensure adequate preparation. The panelist stressed the importance of preparation: "quality of the preparation determines the quality of examination." Preparation for an examination involves, among other things, reviewing advertisements, exception reports and trading activities. In addition, the examiners should meet before the examination to develop a game plan.
2. Ensure proper supervision. Examinations should be supervised by an experienced examiner and an experienced compliance person.
3. Prioritize outside business activities. Examiners should be encouraged to pay particular attention to outside business activities and other violations that could have a serious impact on the firm.
4. Review emails. Reviewing emails is an "important part of the auditing process."
5. Ensure post-examination debriefing and follow up. Examiners should be debriefed once the examination is completed. The examiners’ working papers should be reviewed to determine if follow up is needed. Firms should constantly analyze their examination process to determine areas for improvement.

• Email Retention and Surveillance. One of the panelists noted that email retention and surveillance presents unique issues for independent broker-dealers because branches have a degree of autonomy, including autonomy over their computer systems. In addition, the broker-dealer must retain emails generated through their representatives’ "doing business as" ("DBA") names. The panelist suggested that firms establish an external email host site for DBA emails, then have those emails downloaded from the host site to the firm’s system.

• Equity-Indexed Annuities. The classification and regulation of equity-indexed annuities continues to be controversial. The issue is of particular importance to independent broker-dealers because many of their representatives engage in autonomous fixed insurance business, including the sale of fixed and equity-indexed annuities directly to customers. The panelists discussed the reaction of independent broker-dealers to NASD Notice to Members 05-50 (available at ), which provides that broker-dealers have certain supervisory responsibilities concerning equity-indexed annuities, even when the equity-indexed annuity is not a security. The panelists discussed the two positions adopted by independent broker-dealers in response to Notice to Members 05-50, and the implications of Notice to Members 05-50 for other insurance products.

1. Taking sales of equity-indexed annuities "in-house." Many firms now require that all equity-index annuities sold by their representatives be executed "in-house" (i.e., through the firm), so that the transactions are supervised through the firm’s usual processes. A panelist noted that one benefit of taking sales of equity-indexed annuities "in house" is that the sales will run through normal commission schedules.
2. Treating sales of equity-indexed annuities as outside business activities. Other firms maintain that sales of equity-indexed annuities are outside business activities under Rule 3030 and not subject to firm supervision. A panelist expressed particular concern regarding a group of firms that are marketing themselves to representatives as permitting sales of equity-indexed annuities without restriction. Mr. Kirsch stressed the need for firms to train representatives to come to the firm for an assessment of whether a product is a security and not to rely on his or her own assessment or third-party assessments.
3. Implications of Notice to Members 05-50 to other types of insurance products. The panelists also discussed whether NASD’s position on equity-indexed annuities could extend to other products (e.g., other fixed insurance products). One of the panelists noted that some firms are evaluating whether to extend firm supervision to other fixed insurance products. It was also noted that equity-indexed annuities are unique because NASD’s concern arose from the dramatic increase in equity-indexed annuity sales and the significant amounts of money moving from variable annuities to equity-indexed annuities, trends not seen with other fixed insurance products.

• Form BR Issues. Under revised Rule 3010, "branch office" is defined to include any location where one or more persons conducts the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of any security, or any location held out as such. For all "branch offices," member firms are required to complete a registration form, "Form BR." On that form, the firm must disclose all DBA names and websites used by the branch. Given that independent broker-dealer representatives often operate out of small, independent offices and often use DBA names, the registration obligations are proving "burdensome and labor intensive" for independent broker-dealers, according to one of the panelists. Also, there is significant concern about costs and resources involved in maintaining branch office registrations, including adding new branch offices and updating information on Form BRs as circumstances change. With respect to updating information, a panelist noted that one firm has set up a creative process to ensure that representatives update the firm as to changes in their registration information – its system is such that representatives can access their quarterly commission statements online only if they first review and update their registration information.

This panel discussed a variety of compliance hot topics in the securities industry, including new SEC Rule 22c-2 and the proposed amendments thereto, identity theft, anti-money laundering obligations of investment advisers, rules and regulations concerning gifts and gratuities applicable to investment advisers, and recent SEC guidance concerning soft dollars.

• New Rule 22c-2. New Rule 22c-2 under the Investment Company Act of 1940, adopted in March 2005, requires boards of directors of covered mutual funds to make a determination prior to the effective date of the rule (currently October 16, 2006, but it is likely to be extended) whether to charge shareholders a redemption fee for certain short-term investments. The boards must decide whether the fee is "necessary or appropriate" to recoup costs attributable to short-term redemptions or to otherwise reduce any dilution of the funds’ value.

1. SEC’s proposed amendments. In February 2006, the SEC proposed amendments to Rule 22c-1. Those amendments include: (1) limits on the types of intermediaries with which the issuers must negotiate information sharing agreements; (2) further guidance on the application of the rule to a chain of intermediaries; and (3) clarification that if an issuer does not obtain an agreement with an intermediary, it must thereafter prohibit the intermediary from purchasing the fund’s shares.
2. Industry guidance. In the wake of new Rule 22c-2, several industry associations have published documents to aid firms in implementing the new rule. For example, the Investment Company Institute and the Securities Industry Association have jointly proposed a uniform model contractual clause to implement a redemption fee. It is available at www.sia.com/securities/pdf/ModelContractClausesForRule22c-2.pdf . In addition, the Society of Professional Administrators and Record Keepers has developed model contractual language for retirement plan administrators. It is available at http://www.rgwuelfing.com/SPARK_INST_22c-2_Lang_Data_Stds_02212006.pdf.
3. Implications for variable product issuers. Rule 22c-1 will apply to mutual funds’ underlying variable insurance products. It is the SEC’s position, as articulated in the February 2006 release proposing amendments to Rule 22c-2, that imposing a redemption fee will not cause insurance companies to breach their contracts by imposing excessive charges and fees on policyholders because the redemption fee will be imposed by the funds underlying the insurance company separate account, not by the insurance companies themselves. In addition, the SEC did create an exception to the redemption fee for full or partial variable insurance contract withdrawals. This exemption enables investors to exercise their "free look" rights without paying a redemption fee. Additional information concerning this issue can be found in the March 2005 adopting release for Rule 22c-2 (available at http://www.sec.gov/rules/final/ic-26782.pdf) and the February 2006 release proposing amendments to Rule 22c-2 (available at http://www.sec.gov/rules/proposed/ic-27255.pdf).

• Identity Theft. One of the panelists highlighted the growing threat of identity theft as an issue of likely regulatory focus this year. Specifically, the panelist noted two threats: (1) stolen laptops, and (2) computer viruses. He noted that financial service companies may be required to disclose stolen laptops or computer viruses to their customers if they have reason to believe the intent of theft or computer virus was to acquire personal information.

• Anti-Money Laundering. As of right now, there are no anti-money laundering rules applicable to non-bank affiliated investment advisers or non-registered investment companies. The SEC has proposed rules that would apply to all investment advisers but has not adopted them yet. Despite the fact that the SEC has not adopted the proposed rules, the panelists discussed reports that during investment adviser examinations the SEC is requesting that investment advisers describe their anti-money laundering programs. One of the panelists suggested that investment advisers should perform anti-money laundering risk assessments.

• Gifts and Gratuities. While NASD’s Rule 3060 and related guidance clearly state the obligations of broker-dealers in accepting or offering gifts or gratuities, a panelist noted that the regulations applicable to investment advisers are far less clear. Nonetheless, it is generally recommended that advisers adopt relevant policies and procedures. The panelist suggested that investment advisers maintain a gift log, similar to what broker-dealers are required to do. He stated that investment advisers have adopted a variety of minimum thresholds for the log, ranging generally from $100 to $500 per gift.

• Soft Dollars. Section 28(e) of the Securities Exchange Act of 1934 allows certain individuals who hold investment discretion over an account to use soft dollars to purchase certain brokerage and research services. In 2005, the SEC proposed new guidance that sets forth the following three-step analysis of whether a product or service is "research" under Section 28(e):

1. Identify whether the product or service is eligible under Section 28(e). Based on the text of the rule, the SEC stated that research must involve "reasoning or knowledge." This may potentially include items such as ordinary research reports or education seminars, but exclude other items such as telephones, computer terminals, or travel to seminars.
2. Evaluate if the assistance is lawful or appropriate. This analysis examines how the research is used. One panelist suggested that this analysis is essentially a common sense analysis.
3. Determine whether the cost assessed for the research is appropriate for what the adviser received. One panelist indicated that more guidance is needed from the SEC to determine whether a cost is appropriate.

© 2006 Sutherland Asbill & Brennan LLP. All Rights Reserved.

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