On October 25, the SEC and CFTC approved a 30-day extension of the public comment periods for proposed rules relating to the implementation of provisions of the Commodity Futures Modernization Act of 2000 (the "Act"). The Act lifted a long-time ban on the trading of single-stock and narrow-based stock index futures. The proposed joint rules would govern the collection of customer margin for securities futures and the applicability of CFTC and SEC rules on customer protection, recordkeeping, reporting and bankruptcy rules to accounts that hold security futures products. (See Industry News Summary for the week of 9/24/01 to 10/01/01). Comments on the proposed rules are now due by December 5, 2001. SEC Today, October 29, 2001.

NASDR recently included guidance regarding the presentation of performance of exchange-traded funds (ETFs) in its quarterly compliance report for member firms. ETFs are investment companies registered under the Investment Company Act of 1940 that offer shares which trade in the secondary market, including national securities exchanges. Typically, an ETF invests in a portfolio of securities that closely tracks a specific index. Investors may purchase and redeem shares from the ETF only in large quantities called "creation units", which are priced at the ETF's net asset value. Because ETFs are listed on exchanges, individual ETF shares can be bought and sold throughout the trading day at the current market price and an investor may sell ETF shares short or purchase them on margin.

The NASDR noted that performance communications used prior to prospectus delivery for ETFs structured as open-end management investment companies must comply with the standardized performance requirements set forth in rule 482 under the Securities Act of 1933. Rule 482 requires performance communications to include one-year, five-year, and ten-year average annualized total returns computed in accordance with a standard formula. Under rule 482, these standardized returns must be current to the most recently ended calendar quarter prior to submission of the communication for publication.

The formula for computing standardized returns is based on the fund's NAV as of the ending date of the performance period. NASDR noted that due to market action, ETF shares trading on an exchange may be available for purchase at a premium or discount to NAV. Consequently, NASDR cautioned that communications which quote only NAV-based performance for an ETF may fail to provide the reader with a sound basis for evaluating the facts with respect to an investment in the ETF. NASDR noted that NASD Conduct Rule 2210(d)(1)(A) prohibits the omission of material information necessary to make a communication fair and not misleading.

Accordingly, NASDR has taken the position that in addition to quoting standardized performance based on NAV, performance communications for ETFs must also include equally prominent disclosure of returns based on the closing market price of the shares for the same time periods as standardized returns. Such data must be accompanied by disclosure of the basis for each set of figures (e.g., "these total returns are based on the closing market price of the ETF on [date]"). NASDR noted that NASDR staff discussed its position with the SEC staff, which concluded that this position is not inconsistent with the SEC's exemptive orders issued to ETFs that permit their operation. In recent exemptive orders issued to ETFs, the SEC has required the prospectuses and annual reports of ETFs to show cumulative total return and average annual total return based on both NAV and market price. NASD Regulatory and Compliance Alert, Fall 2001.

On July 24, 2001, the SEC published a concept release seeking comment on the impact on fair and orderly markets and investor protection of trading and potentially quoting securities in an increment of less than a penny. In the concept release, the SEC noted that as of April 9, 2001, all U.S. equity markets have been quoting stocks in pennies. The SEC further noted that in the past, some Nasdaq market makers and electronic communication networks ("ECNs") traded stocks in smaller price increments than the public quote. In the new decimal environment, this practice has continued with some trades occurring in Nasdaq securities priced in subpennies. The SEC seeks comment on the effects of subpenny prices on market transparency and the operation and effectiveness of SEC and self-regulatory organization rules that are dependent on trading or quoting price differentials.

The original comment period for the concept release ended September 24, 2001. In the wake of the September 11, 2001 events, the SEC extended the deadline for submitting public comments to November 23, 2001. SEC Release No. 44-44845, September 26, 2001.

On October 25, 2001, the SEC adopted final amendments to rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 (the "1934 Act"). These rules govern the recordkeeping requirements for broker-dealers. The amendments clarify and expand recordkeeping requirements including those for purchase and sale documents, customer records, associated person records, customer complaints, communications with the public and supervisory procedures. The amended rules require broker-dealers to comply with the following requirements, among other provisions:

• create a record containing certain minimum information as to each customer for which the broker-dealer is required to make a suitability determination and to furnish that information to the customer on a periodic basis,
• create and maintain certain records for each office of the broker-dealer and these records must either be maintained at that office or delivered to that office promptly upon request, and
• include additional information on each order ticket, including the identity of the associated person, if any, responsible for the account and any other person who entered or accepted the order on behalf of the customer.

On October 25, 2001, the CFTC promulgated new Rules 41.21 through 41.25 under 17 CFR Part 41. The new rules specify listing standards and conditions for the trading of security futures products. New Rule 41.21 specifies that security futures products based on a single security may only be based on an underlying security which is registered pursuant to Section 12 of the Securities Exchange of 1934 (the “1934 Act”) and must be common stock or other equity securities as the CFTC and the SEC deem appropriate. The new rules further provide that the securities must conform to any listing standards the designated contract market files with the SEC. The CFTC noted that a depositary share, including ADRs, may underlie a security future and be a component of a narrow-based security index provided that (1) the security underlying the depositary share is registered pursuant to Section 12 of the 1934 Act and (2) the depositary share is registered under the Securities Act of 1933.

The new rules also establish requirements relating to the reporting of data, speculative position limits and special provisions relating to contract design for cash settlement and physical delivery of security futures products. For instance, new Rule 41.25(a)(3) specifies that a determination of the level of the position limit and whether a position limit is required depends upon the trading activity and capitalization of the security or securities underlying the security futures product. 17 CFR Part 41, October 25, 2001.

On October 23, 2001, the SEC issued a Report of Investigation and Statement explaining its decision not to take enforcement action against a company it had investigated for financial statement irregularities. In its report, the SEC outlined its framework for evaluating cooperation by a company in determining whether and how to charge violations of the federal securities laws.

In its report, the SEC identified four broad measures of a company's cooperation:

• Self-policing prior to the discovery of the misconduct, including establishing effective compliance procedures and an appropriate tone at the top;
• Self-reporting of misconduct when it is discovered, including conducting a thorough review of the nature, extent, origins and consequences of the misconduct, and
• promptly, completely, and effectively disclosing the misconduct to the public, to regulators, and to self-regulators;
• Remediation, including dismissing or appropriately disciplining wrongdoers, modifying and improving internal controls and procedures to prevent recurrence of the misconduct, and appropriately compensating those adversely affected; and
• Cooperation with law enforcement authorities, including providing SEC staff with all information relevant to the underlying violations and the company's remedial efforts.

The SEC noted that credit for cooperative behavior may range from an SEC decision electing not to take enforcement action to bringing reduced charges, seeking lighter sanctions, or including mitigating language in documents the SEC uses to announce and resolve enforcement actions.

Stephen M. Cutler, the recently named Director of Enforcement, noted that by crediting those who seek out, self-report, and rectify illegal conduct, the SEC hopes to advance its goal of 'real-time enforcement.' In addition, Mr. Cutler noted that by setting forth a framework for exercising its prosecutorial discretion, the SEC encourages companies to address unlawful conduct swiftly and meaningfully and to cooperate with law enforcement authorities. SEC Press Release 2001-117, October 23, 2001.

SEC permits investment of securities lending collateral through joint accounts. The SEC's Division of Investment Management recently wrote that it would not recommend enforcement action if the cash collateral that an investment company and certain of its affiliated persons receive in connection with their participation in a securities lending program is invested in certain short-term investments through one or more joint accounts. A custodian bank that administers a securities lending program sought relief in connection with its proposal to deposit into one or more joint accounts the cash collateral of investment companies that are advised or subadvised by the same investment adviser, or an entity controlling, controlled by, or under common control with, the investment adviser.

The SEC conditioned its relief on the bank's representations that:

• It would not be an affiliated person within the meaning of the Investment Company Act of 1940 (the "1940 Act") of any of the investment companies that participate in a joint account,
• It would invest the cash collateral in short-term investments that constitute "eligible securities" as defined in rule 2a-7 under the 1940 Act,
• All purchases and sales of short-term investments by the bank on behalf of the participants would comply with investment guidelines that are set by each participant and its investment adviser,
• The investment adviser of each investment company participating in a joint account would have sole responsibility for determining whether an investment company could participate in a joint account, subject to standards and procedures that would be established by the board of directors of the investment company,
• The investment adviser would be responsible for overseeing the bank's administration of the joint accounts, including the accounting and control procedures and ensuring the fair treatment of the joint account participants,
• The participants would invest through a joint account only to the extent that, regardless of the joint accounts, they would desire to invest in short-term investments that are consistent with their respective investment objectives, policies and restrictions,
• A participant's decision to use a joint account would be based on the same factors as its decision to make any other short-term investment, and
• It would operate the joint accounts in accordance with the conditions found in a series of exemptive orders granted by the SEC as described below.

Rule 17d-1 under the 1940 Act provides that no affiliated person of a registered investment company and no affiliated person of an affiliated person may participate as a principal in any joint enterprise, joint arrangement or profit-sharing plan without first obtaining an exemptive order from the SEC. The Division has issued a number of conditional orders which permit funds and other participants to use joint accounts for the investment of cash collateral and uninvested cash balances, representing proceeds from sales of portfolio securities and/or cash awaiting investment (collectively, "cash balances"). These orders are generally subject to a number of conditions governing the establishment, form and function of the joint account, investment of joint account assets and the administration and oversight of the joint accounts. Chase Manhattan Bank no-action letter (July 24, 2001).

GAO releases report on anti-money laundering efforts in the brokerage and mutual fund industries. The GAO recently released a report on its survey of anti-money laundering efforts in the securities industry. The report describes:

1. government and industry views on the potential for money laundering in the securities industry,
2. current legal and regulatory requirements relating to anti-money laundering in the securities industry and the actions regulators have taken to oversee these requirements,
3. the efforts undertaken by broker-dealers and mutual funds to detect and prevent money laundering, and
4. international anti-money laundering efforts relating to securities activities and the effectiveness of these efforts.

The report noted that the number of documented cases where broker-dealer or mutual fund accounts have been used to launder money is limited. However, the GAO also noted that law enforcement agencies expressed concern that criminals may increasingly use the securities industry to launder money. The agencies explained that the securities industry would more likely be used in the later stages of money laundering to obscure the origin of illegal proceeds rather than in the initial stage when cash is first placed into the financial system.

In its report, the GAO remarked that most broker-dealers or firms that process customer payments for mutual fund groups are subject to all U.S. anti-money laundering requirements, including reporting and recordkeeping requirements relating to currency and other transactions arising under the Bank Secrecy Act. However, unlike banks and depository institutions, broker-dealers and processing firms are not required to report suspicious activities that could be evidence of money laundering. Among the report's findings are the following:

• More than 90% of the broker-dealers or mutual fund firms surveyed never accept cash which reduces the firms' vulnerability to the initial stage of money laundering when illicit funds are first placed into the financial system.
• Many direct-marketed mutual fund groups and some broker-dealers accept monetary instruments such as traveler's checks or money orders which could be used by money launderers as part of attempts to structure deposits to avoid currency reporting requirements.
• Other than currency related restrictions, most firms have not implemented other types of voluntary anti-money laundering measures, including written policies and procedures to identify and report suspicious activities. The GAO found that 17% of the broker-dealers and 40% of the direct-marketed mutual fund groups surveyed implemented voluntary anti-money laundering measures.

The GAO noted that the Treasury Department is currently developing a rule requiring broker-dealers to report suspicious activities related to money laundering and anticipates that such a rule will be issued for public comment by the end of 2001. GAO Report on Anti-Money Laundering: Efforts in the Securities Industry, October 2001.

On October 18, 2001, the SEC requested that all securities-related entities, including brokers, dealers, investment advisers, investment companies and transfer agents, whether or not registered with the SEC, to cooperate voluntarily with law enforcement authorities in their ongoing investigations of the September 11, 2001 terrorist attacks. Specifically, the SEC has requested that these securities-related entities designate a senior level individual to be the firm's liaison with law enforcement. The SEC has asked that each firm send the designated individual's name, title, telephone number and e-mail address to the SEC at [email protected] no later than Friday, October 26, 2001.

The SEC will contact the designated individual with a confidential list of individuals and entities about whom law enforcement agencies have requested information. Securities-related firms are asked to check their records to determine whether any of the individuals or entities on the list have had any transactions or relationships with the firm in the U.S. or elsewhere. Similar requests have been issued to banks and futures commission merchants.

This request is separate from the request issued September 26 (see Industry News Summary for the week of 09/24/01 through 10/01/01) concerning compliance with President Bush's executive order freezing United States assets of and blocking transactions with identified individuals and organizations. SEC Release No. 2001-115, October 18, 2001.

SEC director reviews SEC examination program. Lori Richards, the SEC's Director of the Office of Compliance Inspections and Examinations ("OCIE"), delivered an address to conference participants regarding the SEC's examination program. Ms. Richards reiterated previous remarks that the compliance function within a firm should be "strong, well-resourced and respected."

Ms. Richards described three possible outcomes of an examination where the OCIE staff has findings. First, she noted that it is common when OCIE discovers problems during an examination, to issue a deficiency letter. She further noted that deficiency letters reflect OCIE staff findings and do not have the force or severity of a SEC order. Ms. Richards explained that the SEC issues deficiency letters to provide a firm with the opportunity to quickly fix problems. Alternatively, OCIE may provide a deficiency letter and simultaneously refer the matter to enforcement or to a self-regulatory organization. Finally, the staff may issue a deficiency letter and also issue a public report. Ms. Richards stressed that due to confidentiality concerns, the staff rarely issues public reports but will do so when it feels that an area may need improvement and deserves special attention. However, Ms. Richards noted that the staff removes a firm's identity in the public report.

Ms. Richards advised firms to:

• keep current on legal and regulatory developments,
• scrutinize and harmonize policies and procedures of affiliated firms when they have merged with other firms,
• invest in technology that prevents violations and detects aberrations, and
• consider using surprise audits as a compliance tool.

On October 15, 2001, the SEC announced the opening of the new Northeast Regional Office at 233 Broadway, New York, NY. The SEC's previous Northeast Regional Office at 7 World Trade Center was destroyed on September 11, 2001.

On October 9, 2001, Laura Unger announced that she would leave the SEC at the end of 2001. Upon her departure, the SEC will have only two commissioners: new chairman of the SEC Harvey Pitt and Commissioner Isaac Hunt.

The U.S. Court of Appeals for the Ninth Circuit rejected claims against the independent trustees of a fund which stemmed from the trustees' decision to replace the investment adviser (the "original adviser") to the fund. The fund was organized by an individual (the "sponsor") who also controlled the original adviser and sat as one of two interested trustees on the fund's board. The sponsor had requested that the trustees approve a merger of the fund into another investment company he had sponsored and renew the investment advisory agreement with the original adviser. If the fund merged into the other investment company, the trustees would be terminated. The three independent trustees, believing that they had not been provided with sufficient information as required to consider the proposals, instead voted not to renew the investment advisory agreement and voted to remove the interested trustees from the fund's board.

The independent trustees then selected another investment adviser (the "proposed adviser") as the new investment adviser to the fund. The fund's shareholders, however, did not approve an advisory agreement with the proposed adviser. The independent trustees then signed a release relieving the sponsor of any liability, renewed the investment advisory agreement with the original adviser and resigned.

The sponsor subsequently sued the independent trustees, their counsel and the proposed adviser, alleging various breaches of the Investment Company Act of 1940 (the "1940 Act") and state law. The district court dismissed several claims in pre-trial rulings but permitted the claims against the independent trustees for breach of fiduciary duty and waste to proceed to trial. After a 14 day trial in 1999, the district court entered judgment for the trustees. Upon appeal by the sponsor, the appeals court upheld the district court's dismissal of claims against the counsel to the independent trustees and the proposed adviser and the court's judgment for the trustees. The appeals court's rulings included the following:

• Counsel to the independent trustees owed a duty only to the independent trustees, not to the fund's shareholders;
• The proposed adviser also owed no fiduciary duty to the fund because it did not actually perform any advisory services before being rejected by the fund's shareholders;
• The 1940 Act's statutory presumption that a natural person is not a controlled person can only be overcome by a determination to the contrary made by the SEC; and
• The 1940 Act does not require prior shareholder approval before an investment adviser may be replaced. Rule 15a-4 under the 1940 Act permits interim investment advisory agreements without shareholder approval following the termination of a previous investment advisory agreement.

The ICAA filed a comment letter on behalf of its member investment advisory firms regarding the impact of implementation of next business day settlement of securities transactions in U.S. securities markets ("T+1"). Implementation of T+1 is scheduled to occur in June 2004. In particular, the ICAA wrote to bring to the SEC's attention the following areas of concern for investment advisers:

Competition and regulation of trade matching utilities. The ICAA expressed its concern that a "substantial portion" of investment advisers will be reliant on outsourcing of trade comparison and matching functions to third-party vendors as a result of the move to T+1. Currently, only the Depository Trust Clearing Corporation ("DTCC") and Thompson Financial, Inc. ("Thompson") have created a trade matching utility for the T+1 environment. DTCC and Thompson created Omgeo, a for-profit, global joint venture which would perform various trade matching and electronic confirmation functions critical to the implementation of T+1. The ICAA warned the SEC that unless other trade matching utilities enter the market place, Omgeo would have the effect of monopoly power on the marketplace which may have "significant and continuing impact on costs" to investment advisers in implementing T+1.

Privacy of client information. The ICAA noted that certain investment adviser client information that currently resides in DTCC's Standing Instruction Database will be made available to Omgeo. The database contains customer information including names, addresses, taxpayer identification numbers, custodial account numbers and custodian addresses. The ICAA warned that Omgeo and any future similar trade processing utility is currently not subject to any present statutory or regulatory restraint on the commercial sale of the client information to third parties. The ICAA further noted that clearing agencies, such as Omgeo, do not fall within the definition of "financial institution" within the coverage of the privacy provisions of the Gramm-Leach-Bliley Act of 1999 and are not included within the SEC's Regulation S-P. The ICAA urged the SEC to "take appropriate action" to safeguard important and confidential client information provided by investment advisers to trade matching utilities.

Economic impact to investment advisers. The ICAA commented on the costs that implementation of T+1 would have on investment advisers. In particular, the ICAA noted that a recent study by the Securities Industry Association ("SIA") on the estimated cost to securities industry participants "dramatically undercounted" the number of smaller investment advisers that would be impacted by changes necessitated by a transition to T+1. The ICAA pointed out that the SIA study categorized "small" investment advisers to be those with $50 billion or under in assets under management and that only 175 firms fell in this category. The ICAA stated that, in reality, the overwhelming majority of federally registered advisers manage less than $50 billion (6,569 out of 6,649 advisers that had registered on the Investment Adviser Registration Depository as of May 1, 2001) and that the study does not properly address the anticipated costs to smaller advisers (i.e., those with $1 billion or less in assets under management). The ICAA urged the SEC to weigh carefully the costs and benefits of mandating T+1 for investment advisers.

Impact of mandatory participation in trade matching systems. The ICAA requested that the SEC consider whether it is appropriate to mandate through rulemaking the participation by smaller investment advisers in automated trade matching and electronic confirmation systems. The ICAA noted that such costs may outweigh any perceived benefit of operational efficiency. The ICAA noted that some advisers with limited client, broker-dealer and custodian relationships could "continue to operate efficiently" in a T+1 environment by continuing to rely on their existing communication links. ICAA letter to SEC Chairman Pitt, October 9, 2001.

The ICI recently released a study of the regulatory issues regarding closed-end funds. The paper:

• provides an overview of the operation of a closed-end fund and its principal differences from an open-end fund, including a description of the structural characteristics of closed-end funds, the history of closed-end funds and the regulatory framework in which they operate;
• examines issues regarding the prices at which shares of closed-end funds trade on the secondary market, including the impact on investors of discounts and premiums and the possible strategies closed-end funds may employ to address discounts;
• discusses the ability of closed-end funds to raise additional capital through leverage and rights offerings and the ability of closed-end funds to repurchase their shares in the open market and through tender offers;
• reviews innovations in the closed-end fund industry, including the development of "interval funds" that enable closed-end funds to continuously offer shares to the public and make periodic offers to repurchase shares, new distribution systems and dividend reinvestment plans; and
• provides a brief overview of defensive measures for closed-end funds in the area of shareholder proposals and proxy issues.

NASD is seeking comment on the establishment of criteria and procedures to permit it to delete certain information related to customer disputes from the CRD. Information regarding NASD members is generally deleted from the CRD system pursuant only to a specific statutory requirement or a court order. Generally, the NASD believes that this practice is appropriate but requests comment as to whether additional safeguards should be instituted when the information to be deleted involves customer dispute information, including customer complaints or arbitration claims. The NASD is seeking comment on whether it should limit deletion of customer dispute information from the CRD to cases where a fact finder (e.g., a court) has determined that:

• the subject matter of a claim or info., the associated person named in the proceeding did not work for the firm or was named in error);
• the claim in question is without legal merit; or
• the information contained in the CRD system is determined to be defamatory in nature.

The SEC's Division of Investment Management (the Division) recently wrote to several variable insurance trade associations to clarify its views regarding certain exchanges of variable annuity contracts. The Division elaborated on its previous warnings that it would scrutinize recent increases in variable annuity exchanges, especially exchanges into bonus annuities where the insurer adds an up-front commission to the contract value.

Section 11 of the Investment Company Act of 1940 (the 1940 Act) generally prohibits an insurance company and other affiliated insurers from making an offer to its variable annuity contract owners to exchange their existing contracts for other variable annuity contracts issued by the insurer and its affiliates, unless the SEC has issued an order approving the terms of the offer or the offer complies with rule 11a-2 under the 1940 Act. Rule 11a-2 permits an exchange offer, subject to requirements designed to address concerns about the imposition of additional sales charges. Specifically, rule 11a-2 requires that (1) no surrender charge be deducted at the time of the exchange and (2) if both the old and new contracts are subject to surrender charges, then, in computing the surrender charge for the new contract, the insurer must credit the period during which the contract owner held the old contract.

Section 11 does, however, provide a limited exception for offers by a principal underwriter to an individual investor in the course of a retail business conducted by the principal underwriter (the retail exception). The staff clarified that it interprets the retail exception to apply to communications between an individual broker and his or her individual customer. Thus, the retail exception would apply when an individual broker recommends an exchange to a particular customer. The Division clarified that the retail exception would not apply to an exchange offer to a group or class of contract owners. The Division also stated that the retail exception does not apply to any exchange offer by an insurance company separate account.

In analyzing whether an exchange offer falls within the retail exception permitted by section 11, the staff advises insurance companies to consider the following factors:

• whether the insurer has a plan or intention to promote exchanges from existing contracts into other contracts;
• whether, and how, the insurer dedicates staff and other resources to "asset retention" programs designed to discourage investors from surrendering;
• whether the insurer has initiated any direct communication with a contract owner regarding a new contract or the availability of an exchange offer from an old contract into a new contract and the nature of any such communication;
• whether the insurer provides a list of contract owners to a broker-dealer that includes contract owners who have not previously been customers of the broker-dealer receiving the list, the purpose for which the list is provided and the use that is made of the list;
• the nature of any written or oral communications from the insurer to brokers about a new contract or about exchanges from an existing contract into a new contract;
• the presence or absence, and the amount and any changes in the amount, of compensation paid to brokers who exchange a contract owner from an existing contract to a different contract;
• the amount of broker compensation in relation to the services that a broker performs in connection with an exchange;
• whether exchanges are offered on terms designed to encourage exchange activity, such as waiver of the surrender charge on an exchanged contract;
• whether the insurer or principal underwriter has sent any electronic or written communication about a new contract, or the availability of an exchange offer from an existing contract into a new contract, to all existing contract owners or a group of existing contract owners and the nature of any such communication; and
• the existence and nature of any marketing by an insurer or principal underwriter of a new contract or the availability of an exchange offer from an existing contract into a new contract that is designed, or likely, to reach all existing contract owners or a group of existing contract owners.

If you advise a money market fund, it is not too soon to begin documenting (1) whether certain securities present minimal credit risk to the fund, especially considering the effect of downgrades on issuer cash flows, and (2) whether the market quotations for the securities already reflect anticipated downgrades and are widening the deviation between the fund's amortized cost value and market-based value.

(See, e.g., Wall Street Journal, October 5, 2001: Moody's Says It May Downgrade Ratings of Several Telecom Firms).

The SEC has announced that it will seek comments on proposed amendments to rule 17f-4 under the Investment Company Act of 1940 (the 1940 Act). Rule 17f-4 governs an investment company's use of securities depositories for U.S. securities holdings. Rule 17f-4 does not govern the custody of an investment company's foreign securities holdings.

The proposed amendments to the rule, which have not yet been released, would relax certain conditions and expand its availability to unit investment trusts. The amended rule would permit transfer agents to custody investment company shares and relieve investment company boards of directors of the responsibility of approving depository arrangements. Instead, an investment company board would retain the responsibility of monitoring the arrangement but may delegate the approval of the arrangement to officers of the investment company. SEC Today, October 4, 2001.

SEC confirms that a 401(k) plan may be considered a "qualified purchaser and "single purchaser" regarding its investment in section 3(c)(7) funds . The staff of the Division of Investment Management wrote that it would not recommend SEC action against section 3(c)(7) funds which treated certain retirement plans as "qualified purchasers" for purposes of section 3(c)(7). The staff granted the interpretive relief to a defined contribution plan that provides retirement benefits for the participating employees and beneficiaries ("plan participants") of a company. The plan participants may allocate their account value as they elect among six investment options that are managed and invested by the plan trustees. An investment committee consisting of five plan trustees makes the investment decisions for the investment options. The plan trustees make the initial decision to invest plan assets in a section 3(c)(1) fund and all subsequent decisions regarding the amount and duration of the investment. The plan participants' investment discretion is limited to allocating their accounts among the investment options. The SEC noted that the plan trustees have managed the plan according to the conditions contained in previous SEC no-action relief to ensure that a section 3(c)(1) fund may treat the plan as a single beneficial owner for purposes of section 3(c)(1) of the 1940 Act. Section 3(c)(1) of the 1940 Act generally excludes from the definition of "investment company" any issuer whose securities are owned by not more than 100 persons.

The plan trustees now propose to invest a portion of the funds in section 3(c)(7) funds. Section 3(c)(7) of the 1940 Act generally excludes from the definition of "investment company" any issuer whose securities are owned exclusively by "qualified purchasers." Qualified purchasers generally are individuals with at least $5 million in investments and companies with at least $25 million in investments.

In granting the interpretive relief, the staff particularly noted that the company represented that (1) the plan will own and invest on a discretionary basis not less than $25 million in investments and was not formed for the specific purpose of acquiring the securities offered by any section 3(c)(7) fund and (2) the plan is a section 401(k) plan, subject to the provisions of the Employee Retirement Income Security Act of 1974 ("ERISA") and the plan trustees, who are fiduciaries subject to the fiduciary provisions of ERISA, make all of the investment decisions for the plan.

The staff also noted that the company indicated that the investment options are not used to facilitate the individual investment decisions of plan participants to invest in any section 3(c)(7) fund, including representations that:

• other than the plan trustees acting in their capacity as plan fiduciaries, a plan participant's investment discretion will be limited to allocating his or her account among a number of investment options, each of which has an identified generic investment objective;
• the decision to invest the assets of an investment option in a section 3(c)(7) fund, (both initially and subsequent to the initial investment) and to withdraw the assets from the section 3(c)(7) fund, and the amount of assets invested, will be made solely by one or more plan fiduciaries, without direction from or consultation with any plan participant other than the plan trustees acting in their capacity as plan fiduciaries, and
• immediately following each purchase of any section 3(c)(7) fund's securities by an investment option, at least 50% of the assets of the option will consist of securities or property other than securities of the section 3(c)(7) fund.

Previously, the staff has taken the position that a participant-directed plan that offers its plan participants generic investment options that, in turn, may be invested in a section 3(c)(1) fund, could be treated as a single beneficial owner of the section 3(c)(1) fund's securities when, among other things, (1) the decision as to whether and how much to invest in a section 3(c)(1) fund would be made solely by a plan fiduciary, and (2) no representation would be made to plan participants that any specific portion of the relevant generic investment option would be invested in any particular section 3(c)(1) fund. The company additionally represented that it would follow the conditions of the prior relief to ensure that the plan would qualify as a single beneficial owner of the section 3(c)(7) fund. H.E. Butt Grocery Co. no-action letter, May 18, 2001.

On October 3, 2001, the House Committee on Education and the Workforce approved the "Retirement Security Advice Act of 2001" (H.R. 2269), a bill designed to give employees greater access to professional investment advice. The bill would allow employers to provide their employees who participate in retirement plans with access to professional investment advice as long as advisers fully disclose their fees and any potential conflicts of interest. Currently, the Employee Retirement Income Security Act of 1974 ("ERISA") creates barriers that severely limit the ability of many employers and investment intermediaries from providing individualized investment advice to employees who participate in retirement plans.

Under current law, an individual that provides investment advice for a fee or other compensation to a plan participant or beneficiary with respect to their retirement account balance is considered a plan fiduciary. ERISA prohibits a fiduciary from dealing with the assets of the plan in a manner that would raise potential conflicts of interest. Consequently, investment advisers who advise funds which are investment options available under a retirement plan are prohibited from advising plan participants to invest in those options.

H.R. 2269 would allow employers to contract with a professional investment adviser to provide investment advice to the plan participants and beneficiaries. The bill requires that investment advice may only be provided by “fiduciary advisers,” or qualified entities that are already regulated under other federal and state laws. These qualified entities would include registered investment advisers, insurance companies and banks.

The bill would permit the fiduciary adviser to provide investment advice on investment options to plan participants and beneficiaries. The fiduciary adviser could provide advice on investment options, including funds the fiduciary adviser provides investment advice to for a fee, as long as certain requirements are satisfied. For instance, either before or at the time the fiduciary adviser provides investment advice, the fiduciary adviser must provide the plan participant or beneficiary in writing (which may include e-mail) a clear description of:

1. All fees or other compensation the fiduciary adviser or any affiliate will receive in connection with any acquisition or sale of any securities or property resulting from the investment advice.
2. Any material interest the fiduciary adviser may have in securities or property for which investment advice is provided.
3. Any limitation on the scope of investment advice to be provided by the fiduciary adviser concerning any sale or acquisition of security or property.
4. The types of services offered by the fiduciary adviser in connection with providing investment advice.

The bill clarifies that employers are not required to contract with an investment adviser. If the employer chooses to contract with an investment adviser, the employer is not responsible for the individual advice given by the adviser to the plan participants and beneficiaries. Under the bill, the employer is, however, responsible for the prudent selection and periodic review of the fiduciary adviser. CCH Mutual Funds Guide, No. 803, October 17, 2001.

AIMR has approved changes to its performance presentation standards (AIMR-PPS) to make them more consistent with AIMR's comparable global performance presentation standards. The redrafted standards will replace the existing AIMR-PPS standards on January 1, 2002. Any firm which claims compliance with AIMR-PPS must reflect the changes in their investment reporting by December 31, 2001. AIMR stated that it approved the changes to enable investment management firms to use performance reports in non-U.S. countries without having to recalculate the performance figures to comply with different standards.

AIMR additionally stated that the majority of changes affect the presentation of performance rather than the calculation of the underlying numbers. The changes include:

• the addition of new advertising guidelines which permit firms to claim AIMR-PPS compliance without a presentation of the calculations in the advertisement itself;
• a requirement to disclose the total assets of the firm; and
• a requirement that key disclosures such as number of portfolios, amount of assets in the composite and percentage of the firm's total assets in the composite be tied to the last date of the reporting period.

AIMR has also announced that it has changed the procedure for verifying a firm's compliance with AIMR-PPS. Previously, the standards permitted two levels of verification: firm-wide ("Level I") and composite-specific ("Level II"). AIMR has now aligned the verification process more closely with global standards and eliminated the "Level II verification." Firms will still be able to conduct performance examination audits of composite results, but these will no longer be considered a formal AIMR-PPS verification exercise as of January 1, 2003. AIMR Press Release, June 5, 2001.

On July 31, 2001, the SEC approved NASD Rule 0116 which specifies the NASD rules and interpretive materials that apply to transactions and business activities involving exempted securities, other than municipal securities. NASDR has incorporated by reference the definition of "exempted security" as found in the Securities Exchange Act of 1934. In addition, the new rule codifies an NASD staff position that Rule 2820(g), which governs the payment of non-cash compensation, applies to certain group variable contracts that are exempted securities. The revised rule clarifies that NASDR's Conduct Rules prohibit most forms of non-cash compensation for the sale of variable contract securities. The rule is effective on October 28, 2001. NASD Notice to Members 01-63, October 2001.