On April 20, 2007, the Technical Committee of the International Organization of Securities Commissions (“IOSCO”) released a consultation report inviting views on key issues that IOSCO could address with respect to FOHFs for retail investors. The key regulatory issues for FOHFs identified by the report include: (1) information for FOHF managers and investors, (2) managers’ risk management systems, (3) nature and frequency of disclosure by the FOHF to investors, (4) selection of the underlying hedge funds, (5) performance targets and prospective financial information, (6) fees and expenses, (7) diversification and investment restrictions, (8) lock up periods and liquidity, (9) valuation, (10) leverage and (11) marketing.

The report identified the following key regulatory issues for managers of FOHFs: (a) management skills and due diligence with regard to the underlying hedge funds, (b) transparency for manager monitoring, (c) side letters and (d) delegation (outsourcing) of certain functions by the management company of the FOHF, including calculation of NAV or selection of underlying funds. Responses to the report are due July 20, 2007.

The IOSCO report entitled “An Experiment Within the Technical Committee Standing Committee on Investment Management (SC5) To Establish a Framework for Identifying Strategic Priorities” is available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD244.pdf.

According to the annual Survey of Mutual Fund Director Compensation and Governance Practices by Management Practice Inc. (“Survey”), mutual fund directors’ compensation increased an average of 15.5% in 2006, continuing a five year trend of increases. The Survey was drawn from almost 2,000 directors from over 300 fund families. The Survey notes that the need for specialized, knowledge-specific fund directors has driven overall compensation to record levels. Specifically, the cost of independent directors has increased because of “the premiums paid for Audit Committee Financial Experts, the depth of knowledge required of Compliance Committee Chairs and the securities expertise needed to serve as Chair of the Investment or Performance Committee.” According to the Survey, the annual median compensation of directors “in the largest families rose to $171,775 when measured based on assets and $161,625 when measured based on the number of funds governed.” The Survey also reported that “the average cost of all independent directors to safeguard $1 million in assets was $15.40 per year.”

In an April 24, 2007 letter to SEC Chairman Christopher Cox, six groups urged the SEC to provide guidance on the fee-based brokerage account rule recently overturned by the U.S. Court of Appeals for the District of Columbia Circuit. The six groups, consisting of the Consumer Federation of America, the Financial Planning Association, Fund Democracy, Inc., Investment Advisers Association, National Association of Personal Financial Advisors, and North American Securities Administrators Association, urged the SEC to: “(1) provide guidance to brokers on their obligations and information to investors about the implications of the court decision while a more permanent policy is being developed; and (2) reaffirm pro-investor aspects of the rule that were not overturned by the court ruling.” Specifically, the letter encouraged the SEC “to continue the position adopted in the vacated rule that discretionary management and financial planning services are not solely incidental to brokerage services,” and “to interpret the existing exemption such that non-discretionary advice bearing the core characteristics of investment advisory services is not deemed to be solely incidental to brokerage services.”

Note that the SEC may appeal the court decision until May 14.

The SEC’s semi-annual regulatory agenda (“Agenda”) published in the April 30, 2007 Federal Register provides a glimpse into the regulatory issues the SEC intends to address in the future. The Agenda does not provide a binding schedule.

Highlights of the actions the SEC and the Division of Investment Management intend to consider are listed below:

• Adopt proposed antifraud rules for advisers to certain pooled investment vehicles and rules that would revise the definition of accredited investor;
  
• Adopt proposed rule to allow certain types of funds or their investment advisers to enter into subadvisory agreements without obtaining shareholder approval;
  
• Adopt final amendments to Rule 22c-1 under the Investment Company Act of 1940 (“Investment Company Act”) providing that an order to purchase or redeem mutual fund shares would receive the current day’s price only if the fund, designated transfer agents, or a registered securities clearing agency receives the order by the time the fund establishes for calculating its net asset value;
  
• Adopt final amendments to Part 2 of Form ADV;
  
• Propose rules that update the books and records requirements for investment advisers;
  
• Propose rules that require investment advisers to create a report and maintain records regarding their direction of brokerage transactions and receipt of research and other services in connection with those transactions;
  
• Propose rules to codify prior exemptive relief granted for index-based exchange-traded funds;
  
• Propose rules to amend investment company registration statements to improve disclosure of portfolio transaction costs and to make comprehensive reforms of mutual fund disclosure requirements on Form N-1A;
  
• Propose rule amendments governing dividend payments and distributions by investment companies under Section 19 of the Investment Company Act; and
  
• Propose amendments to the cash solicitation rule under the Advisers Act.

The Agenda states that the SEC has not yet determined its next action regarding the investment company governance rule.

The SEC’s Division of Market Regulation issued an interpretive no-action letter on April 30, 2007 (the “Wachovia Letter”) modifying recent relief given to dual registrants who act as both broker-dealers and discretionary or fiduciary advisers to wrap fee program clients. The relief allows broker-dealers complying with conditions now familiar to the wrap fee industry to deliver to consenting clients periodic statements that contain the confirmation information stipulated by Rule 10b-10 under the Securities Exchange Act of 1934 in lieu of the trade-by-trade confirms otherwise required by Rule 10b-10. Notable developments in the applicable conditions to this relief, to the extent they differ from or clarify prior letters, include:

1. The Wachovia Letter (and similar 2006 relief also granted to Wachovia Securities, LLC) specifies that form of consent will be “prominent, clear and easily understandable.”

2. Consent may be demonstrated by initialing a separate signature line, rather than executing a full signature. As with other relief granted since the initial letter responding to the Money Management Institute (Aug. 23, 1999), the option of electronic consent is specifically permitted.

3. The Wachovia Letter permits the periodic statement to be sent quarterly, whereas prior relief contemplated that statements would be sent monthly. The Wachovia Letter provides that, where the broker-dealer charges wrap clients a mark-up, mark-down, commission or mutual fund sales load outside the wrap program fee, the broker-dealer will send trade-by-trade confirms.

4. Program Clients must be able to access all information required by Rule 10b-10 on the Broker-Dealer’s website no later than the next business day after trade date (T+1) or by phone or other specific request.

The no-action letter to Wachovia Securities LLC is available at http://www.sec.gov/
divisions/marketreg/mr-noaction/2007/wachovia043007-10b-10.pdf.

On March 19, 2004, the NASD submitted to the SEC, on behalf of the Task Force, a status report detailing the progress that has been made toward implementing the recommendations set forth in a July 2003 Task Force report (See Industry News Summary dated April 16, 2004 and for weeks 7/7/03 to 7/28/03). Among other things, the status report notes that the recommendation to develop common definitional terms among members of the working group of the Task Force was expected to be completed by the end of April 2004. On April 28, 2004, the ICI announced that a working group completed such common definitional standards to define breakpoint opportunities. The Task Force’s final list of common definitional standards includes both (1) recommended terms and (2) terms that the Task Force recommends that members not use in describing breakpoint opportunities.

The ICI urges mutual fund members that offer breakpoint discounts to review their prospectuses and statements of additional information and make any necessary revisions as soon as reasonably practicable to ensure that language used to define breakpoint eligibility conforms to the common definitional standards. The ICI also urges funds that produce communications relating to breakpoints for broker-dealers or their customers to use the approved terms in such materials as appropriate.

ICI Memorandum No. 17438 (April 28, 2004); NASD Status Report, Implementation of Recommendations of Joint NASD/Industry Task Force (March 19, 2004), available at www.nasdr.com/breakpoints_status.asp.

At the April 13, 2007 Mutual Fund Directors Forum’s Annual Policy Conference, a panel of mutual fund directors discussed the recent book entitled “Competitive Equity: A Better Way to Organize Mutual Funds” written by Peter Wallison, a senior fellow at the American Enterprise Institute, and Robert Litan, a senior fellow at the Brookings Institution. The book has fueled industry debate by recommending that funds’ boards of directors be dissolved. The book suggests that fees paid by funds are too high because funds’ boards set such fees; also that advisers to funds, instead of funds’ boards, should set the fees; and that “professional staffs” from institutions with fiduciary obligations to investors should replace fund boards.

One panelist agreed that, in fact, the fund business is not competitive at the investor level because investors usually are steered by their brokers to a fund favored by the broker. The panelist argued that the real competition is trying to get on a broker’s platform. Another panelist pointed out that the book recommends the United Kingdom’s fund model where fund advisers contract directly with investors and where the fees paid by funds are higher than those paid by U.S. funds.

Two economists from the SEC staff published a preliminary draft of a study stating they were unable to find evidence that naked short selling (failures to locate and borrow shares for delivery) was responsible for failures to deliver in the aftermarket for an initial public offering (“IPO”). The study, which focused on 295 IPOs over a period of 16 months, found that short sales and delivery failures are common in the IPO market and stock delivery failures might be related to underwriter activities that support the offer price.

The study can be found at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=981242.

The staff of the Division of Market Regulation (“Staff”), in a letter dated April 9, 2007, provided exemptive relief and no-action and interpretative advice in connection with secondary market transactions in shares of fixed income exchange-traded funds (“Shares”) and the creation and redemption of Shares. The Staff’s letter provided class relief for fixed income exchange-traded funds (“fixed income ETFs”) meeting certain conditions similar to the listing standards recently adopted by the American Stock Exchange by stating fixed income ETFs are no longer required to obtain separate relief under the rules listed below:

• Rule 101 of Regulation M: Fixed income ETFs meeting the requirements set forth in the letter are excepted under Rule 101, thus permitting persons who may be deemed to be participating in a distribution of Shares to bid for or purchase Shares during participation in the distribution.
• Rule 102 of Regulation M: Fixed income ETFs meeting the requirements set forth in the letter are excepted under Rule 102, thus permitting fixed income ETFs to redeem Shares during the continuous offering of the Shares.
• Rule 10a-1 under the Securities Exchange Act of 1934: An exception from Rule 10a-1 was granted to permit sales of Shares without regard to the “tick” requirements of Rule 10a-1.
• Rule 200(g) of Regulation SHO: Subject to specific conditions, the Staff would not recommend enforcement action under Rule 200(g) if a broker marks “short,” rather than “short exempt,” a short sale that is effected in Shares.
• Rule 10b-17 under the Securities Exchange Act of 1934: A fixed income ETF is exempted from the requirements of Rule 10b-17, which requires an issuer of a class of publicly traded securities to give notice of certain specific actions, with respect to transactions in Shares notwithstanding the fact that the Shares are issued and redeemed in Creation Unit aggregations (aggregations of multiple Shares).

The SEC Staff no-action letter is available at http://www.sec.gov/divisions/marketreg/mr-noaction/2007/fietfclassrelief040907-msr.pdf.

In an April 20, 2007 speech to the American Enterprise Institute and the Brookings Institute conference, Commissioner Paul S. Atkins spoke about the relationship of regulation to the competitiveness of U.S. capital markets and urged the goal of achieving a regulatory environment where the benefits of regulation are proportionate to costs. Referring to prior OEA studies on the costs and benefits of mutual funds having an independent chair that had only been recently released, Commissioner Atkins observed that while there may be some statistical correlation between having an independent chair and the level of fees charged by the mutual fund’s adviser, there is no strong correlation with overall return.

Commissioner Atkins also discussed the SEC’s new hedge fund investor rule proposal by stating that the underlying premise for the rule proposal is that investments in private investment funds are “too risky” for individuals other than the very rich. Commissioner Atkins stated that the proposal may very well prevent the “non-rich” from losing their money in private investment funds, but it also certainly will prevent the “non-rich” from participating in any upside profits and gains on these funds.

Lastly, Commissioner Atkins expressed his view that since the creation of the SEC’s Office of Compliance, Inspections, and Examination (“OCIE”) the level of interaction and communication between OCIE and the rest of the SEC’s staff has been less than optimal and suggested that the SEC should be using a "prudential model" of regulation in which OCIE can be instrumental in communicating “best practices” models and heading off potential problems.

Commissioner Atkins’ speech is available at http://www.sec.gov/news/speech/2007/spch042007psa.htm.

In an April 20, 2007 speech to the American Enterprise Institute and the Brookings Institute conference, Commissioner Paul S. Atkins spoke about the relationship of regulation to the competitiveness of U.S. capital markets and urged the goal of achieving a regulatory environment where the benefits of regulation are proportionate to costs. Referring to prior OEA studies on the costs and benefits of mutual funds having an independent chair that had only been recently released, Commissioner Atkins observed that while there may be some statistical correlation between having an independent chair and the level of fees charged by the mutual fund’s adviser, there is no strong correlation with overall return.

Commissioner Atkins also discussed the SEC’s new hedge fund investor rule proposal by stating that the underlying premise for the rule proposal is that investments in private investment funds are “too risky” for individuals other than the very rich. Commissioner Atkins stated that the proposal may very well prevent the “non-rich” from losing their money in private investment funds, but it also certainly will prevent the “non-rich” from participating in any upside profits and gains on these funds.

Lastly, Commissioner Atkins expressed his view that since the creation of the SEC’s Office of Compliance, Inspections, and Examination (“OCIE”) the level of interaction and communication between OCIE and the rest of the SEC’s staff has been less than optimal and suggested that the SEC should be using a "prudential model" of regulation in which OCIE can be instrumental in communicating “best practices” models and heading off potential problems.

Commissioner Atkins’ speech is available at http://www.sec.gov/news/speech/2007/spch042007psa.htm.

In an April 13, 2007 speech to the Mutual Fund Directors Forum’s Annual Policy Conference, SEC Chairman Christopher Cox discussed the SEC’s new enforcement settlement procedures. According to Chairman Cox, for certain cases in which a monetary penalty against a company might be involved and where the need for national consistency is greatest, the SEC is reviving what had been a long standing policy of the SEC for all cases for many years - that SEC approval be obtained before settlement discussions are commenced. But, Chairman Cox announced that there would be a difference: When cases are settled within the range of guidance, they will be eligible for summary approval through the SEC’s seriatim procedure. Cox believes these new procedures will produce stiffer penalties.

Chairman Cox’s speech also suggested that funds are using 12b-1 plans intended to pay for distribution for other reasons, such as a sales load in disguise and a method to pay administrative expenses. Chairman Cox also expressed his view that the considerable distance that 12b-1 fees have strayed from the rule’s paradigm is not only occasion for the SEC to take a hard look at current practices. It is also a reason for independent directors to take a fresh look at the way this use of investors’ funds has evolved. In addition, Chairman Cox reminded the independent directors that, in addition to “feeling intimately involved” with the decision to collect 12b-1 fees, they should also be required to periodically review all of the amounts that are spent in the name of the plan. In reviewing the propriety of any 12b-1 fee, independent directors must focus on whether the fees, as a percentage of total fund assets, has risen or fallen as the fund has grown.

Chairman Cox recommended that the SEC and the independent directors have to “tackle head-on the problem of brokers’ sales commissions masquerading as fund marketing costs.” According to Chairman Cox the independent directors’ decision whether to approve a 12b-1 plan and payments out of fund assets made pursuant to the plan, has to be no unless existing shareholders will benefit. Chairman Cox questioned the vitality of Rule 12b-1, stated that the original premises of the rule seem highly suspect in today’s world, and indicated it is an issue the SEC will address this year.

Chairman Cox also discussed the SEC’s plans for enhanced 401(k) plan disclosure, the continuing examination of the potential distorting effects of soft dollars, and the SEC’s intention to re-propose and finalize the mutual fund governance rule this year.

Chairman Cox’s speech is available at http://www.sec.gov/news/speech/2007/spch041207cc.htm.