Bank of New York Settles Lost Shareholder Case
4.24.2006 The Bank of New York ("BNY"), a bank and registered transfer agent headquartered in New York, settled SEC allegations by consenting to the entry of a final judgment imposing a $250,000 civil penalty. The SEC had alleged that BNY violated Section 17A(d) of the Securities Exchange Act of 1934 and Rule 17Ad-17 thereunder by failing to exercise reasonable care, as a transfer agent, to ascertain the correct addresses of lost securityholders. Transfer agents are required to use reasonable care in searching for securityholders who are deemed "lost" after correspondence sent to them is returned as undeliverable. Rule 17Ad-17 requires a search using at least two electronic databases at specified intervals.
The SEC complaint also alleged that, from January 1998 to September 2004, BNY failed to classify certain securityholders as lost despite the return of undeliverable correspondence. As a result, BNY omitted approximately 14,159 securityholders from the required searches, and ultimately escheated approximately $11.5 million in assets belonging to those securityholders to various states, as unclaimed property. In addition, coding errors affecting BNY's system used for compiling lists of lost securityholders caused BNY to omit other eligible securityholders from searches. These securityholders were forced to pay third parties $743,112 in unnecessary fees to recover their lost assets.
Please click http://www.sec.gov/litigation/litreleases/2006/lr19664.htm to access a copy of the release.
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OCIE Official Speaks at Compliance Conference
4.18.2006 John Walsh, Associate Director and Chief Counsel of OCIE, spoke about the annual compliance reviews at the NRS 21st Annual Spring Compliance in Palm Springs, California.
He first spoke about the annual compliance review of investment advisers. He noted that firms should conduct a "risk assessment" by creating an "inventory" of risks and then "mapping" those risks to their compliance policies and procedures. OCIE reviews have seen many firms using checklists. However, Walsh cautioned that in some cases there is no apparent connection between the checklist and the firm's compliance policies and procedures. In some cases, OCIE has found no written policies and procedures at an adviser. Walsh noted that this most commonly occurs at multiple registered entities within a complex, where some adviser entities were just overlooked.
With respect to mutual funds, he stated that some fund managers have overwhelmed their Boards with vast amounts of information, such as multiple binders of documents with very small print. The rule does not require this, and if he was a director, he would resent it.
Walsh spoke about the lack of testing in compliance programs. He listed the following examples of testing that would be useful in a compliance program:
- Tests that compare brokerage allocations to sales of fund shares; if you detect fluctuations in allocations that seem to reflect fluctuations in fund sales; you may have a 12b-1(h) compliance issue;
- Tests that take a long-term look at personal trading; if you only monitor day-by-day, trade-by-trade, you may not identify problematic trading; especially by the skilled trader who knows how to work around the margins of your control system;
- Tests that compare aggregate IPO allocations over time; if you only look at the allocations one-by-one, you may miss the clients who never show up, or the ones who take a small portion of each IPO, but over time end up with a lot more; and
- Tests that compare the performance of similarly managed accounts over time; if you have side-by-side accounts with different compensation structures, this test could be extremely useful.
Walsh also spoke about chief compliance officers and broker-dealer complaince programs.
Please click http://www.sec.gov/news/speech/2006/spch041806jhw.htm to access a copy of the speech.
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Employee Screening Reports Now Available Through the NASD
4.13.2006 The NASD through Equifax now offer NASD member firms the ability to request, through Web CRD system, an Equifax Employment Screening Report known as an Equifax PERSONA PLUSTM report. This report provides identification information and the financial history of an individual from Equifax's database of more than 200 million records. PERSONA PLUS reports requested from Equifax via Web CRD will be available to firm participants for $3.00 per report. The PERSONA PLUS Report service through Web CRD offers a new approach for conducting background checks of applicants as well as existing employees.
Please click http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_016283&ssSourceNodeId=5 for more information about this report.
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SEC Will Replace Many Paper Notices with Electronic Notices
4.13.2006 The SEC’s Divisions of Corporation Finance and Investment Management will begin to use the EDGAR system to issue notifications of effectiveness for Securities Act registration statements and post-effective amendments, other than those that become effective automatically by law. These notifications will be posted to the EDGAR system the morning after a filing is determined to be effective. The Divisions will no longer prepare and mail paper effectiveness orders associated with these filings. Registrants will continue to be notified promptly by telephone that their registration statements or post-effective amendments are effective.
After May 22, 2006, the SEC's website - www.sec.gov - will also present a list of filings declared effective on the previous business day. The effectiveness notices will be distributed as an EDGAR form type called "EFFECT." Consequently, for the first time, an interested person can search for a company's filings and be able to see when the staff declared a particular Securities Act registration statement effective.
Orders relating to applications for registration as a transfer agent or as a municipal securities dealer, prepared by the SEC's Office of Filings and Information Services, also will be supplemented by electronic notifications distributed through EDGAR on the morning after those applications are granted.
Please click http://www.sec.gov/news/press/2006/2006-61.htm for the press release announcing the new policy.
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ICI Submits Comment Letter on Proposed Redemption Rule
4.10.2006 The Investment Company Institute (ICI) submitted a comment letter to the SEC on Rule 22c-2 under the Investment Company Act of 1940. After expressing support for the rule, the ICI "strongly recommend" that the compliance date be extended at least six months. The ICI also recommended a technical revision to the rule's definition of "financial intermediary" to ensure that it includes persons that submit orders directly to the fund on behalf of a financial intermediary.
On February 28, 2006 the SEC had proposed amendments to the rule prior to the rule's initial effective date. In that action, the SEC sought comment on whether additional time is needed beyond the October 16, 2006 compliance date to comply with the proposed amendments.
With respect to the technical amendment, the ICI expressed the need for the following new paragraph (c)(1)(iv) that would be added to the definition of "financial intermediary:" "Any person that submits orders to purchase or redeem shares directly to the fund, its principal underwriter or transfer agent, or to a registered clearing agency on behalf of any of the foregoing persons."
Please click http://www.ici.org/new/06_sec_22c2_com.html#TopOfPage to access the comment letter.
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SEC Names New Director of Division of Investment Management
4.10.2006 SEC Chairman Christopher Cox announced that Merrill Lynch lawyer Andrew "Buddy" Donohue will join the Securities and Exchange Commission as its next Director of the Division of Investment Management. Mr. Donohue, 55, is Global General Counsel for Merrill Lynch Investment Managers. In that position, he oversees the firm's legal and regulatory compliance functions for over $500 billion in assets including mutual funds, fixed income funds, hedge funds, private equities, managed futures, and exchange funds.
Prior to his service at Merrill Lynch Investment Managers, Mr. Donohue spent more than a decade as Executive Vice President, General Counsel, Director, and member of the Executive Committee for Oppenheimer Funds, one of the nation's leading retail mutual fund management companies, with managed assets of over $150 billion.
Please click http://www.sec.gov/news/press/2006/2006-52.htm for a copy of the SEC release.
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Court of Appeal Sends Fund Governance Rule Back to the SEC
4.10.2006 The U.S. Court of Appeals for the D.C. Circuit remanded the fund governance rule back to the SEC. This action effectively stays the rule for 90 days while the SEC reassesses the costs the rule would impose on fund companies.
The challenged provisions would require most mutual funds to have a board of directors with at least 75% independent directors and an independent chairman. The court previously ruled, on June 21, 2005, that the SEC failed to consider the cost of compliance and failed to give adequate consideration to an alternative proposal.
The court ruled on this second appeal that the SEC improperly relied on materials outside the record in arriving at its cost estimates. The court also noted that many mutual funds have already come into compliance with the fund governance rules and expressed uncertainty whether immediately vacating the challenged provisions might risk substantial disruption to the mutual fund industry. Accordingly, it vacated the challenged requirements, but said it is withholding the issuance of its mandate for 90 days.
The court said that this approach will afford the SEC an opportunity to reopen the record for comment on the costs of implementing the two provisions. It ordered the SEC to file with the court within ninety days a status report, unless the SEC has prevailed on a motion to modify, accelerate, or postpone the mandate, and upon further order the mandate will issue.
Please click http://pacer.cadc.uscourts.gov/docs/common/opinions/200604/05-1240a.pdf to access the court decision.
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Adviser Trade Group Seek Standardized Deficiency Letters
4.10.2006 The Investment Adviser Association (IAA) sent a letter to the SEC requesting the issuance of standardized deficiency letters. Deficiency letters are sent by OCIE, the inspection arm of the SEC, to investment advisers after the completion of an OCIE exam.
The IAA pointed out that deficiency letters often conclude that certain examination findings amount to a violation of the Investment Advisers Act of 1940 or a breach of fiduciary duty. Letters also frequently opine that certain matters represent “serious internal control issues,” “serious risks,” “material control issues,” and “material deficiencies.”
It cautioned that OCIE staff sometimes reaches findings or conclusions that are subjective and on which reasonable minds could differ. In the absence of illegal or fraudulent conduct, OCIE staff, in the IAA’s view, should not substitute its judgment for that of the investment advisers’ officers and fund directors who have made reasonable business judgment decisions.
Therefore, the IAA argued that the best way to enhance the consistency and clarity of deficiency letters was to remove the subjectivity from the conclusions regarding violations and materiality and adhere to the facts and the law. Accordingly, it proposed that deficiency letters address: (i) applicable law; (ii) the conduct at issue; and (iii) why the conduct is “deficient” with respect to the law or why additional policies, procedures, or disclosures are required.
The letter also made a number of other recommendations related to the deficiency letter process.
Please click http://www.icaa.org/public/letters/comment032906.pdf to access a copy of the letter.
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CFTC and SEC Propose Framework for Trading Futures on Debt Security Index Contracts
4.6.2006 The Commodity Futures Trading Commission (CFTC) and SEC jointly proposed rules that will permit trading of futures on debt indexes. The proposal advances the goal of the President’s Working Group on Financial Markets to create a new class of tradable derivatives contracts.
The SEC and CFTC expect that new products will be created under the proposal that can provide additional ways to diversify and manage risk. The regulators also expect the new definition for broad-based debt indexes will benefit both markets and market participants by making available a wider array of financial products for trading.
Futures contracts on debt indices that are allowed under the proposed rules would trade on futures exchanges subject to regulation by the CFTC. Security futures on debt securities could be traded on futures exchanges and securities exchanges subject to regulation by the CFTC and SEC.
The joint rulemaking is necessary because, under current regulations, trading futures on debt indices is essentially forbidden. The federal law that governs the subject, however, specifically gives joint rulemaking authority to the two agencies to permit the trading of futures on indexes composed of debt securities.
The proposed rules provide that a future on a debt security index not subject to SEC regulation must be broad-based. This requirement is designed to insure that the securities making up the index are not readily susceptible to manipulation. (The opportunity for manipulation could exist if an index covered too few securities, or a significant number of illiquid securities.) The rules will clarify the definition of a “narrow-based security index,” providing criteria that are specifically relevant to debt securities.
Please click http://www.cftc.gov/opa/adv06/opawa14-06.htm to access a copy of the release announcing the proposal.
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NASD Charges New York Broker With Facilitating Late Trading and Market Timing
4.6.2006 The NASD announced that it filed a complaint against A.B. Watley Direct, Inc. (ABW Direct) of New York, and its former registered representatives, Robert Conway and Kenneth Ng, charging them with facilitating late trading and improper market timing of mutual funds on behalf of hedge fund clients.
The NASD also charged ABW Direct’s President, Robert Malin, and Executive Vice President, Linus Nwaigwe, with supervisory lapses. Conway and Ng were brokers registered with both ABW Direct and A.B. Watley, Inc. (ABW Inc.). ABW Inc is an affiliated entity that was formerly a registered broker-dealer, but was expelled by NASD in 2004 for failure to pay fines levied in prior disciplinary actions. Both ABW Direct and ABW Inc. are subsidiaries of A.B. Watley Group, Inc. (ABW Group), a publicly traded company.
In its complaint, the NASD charged that from approximately July 2002 until September 2003, Conway and his assistant Ng facilitated late trading. The complaint alleges that Conway and Ng utilized a computerized trading platform that enabled them to enter orders on behalf of ABW Direct and ABW Inc. clients for at least an hour after the 4:00 p.m. market close without observing the forward pricing requirements. The brokers’ hedge fund customers would send emails or faxes containing “indications of interest” in proposed mutual fund transactions that the hedge funds might or might not execute that day. The “indications of interest,” however were not the customers’ actual orders. Subsequent to sending the “indication of interest,” the customers would telephone Conway and Ng and verbally instruct them which of the “indications of interest” to enter as actual orders. In at least 243 transactions at ABW Direct and ABW Inc., Conway and Ng entered transactions after 4 p.m. where emails show that the “indications of interest” were also not received until after 4 p.m., after the funds’ NAVs had been calculated.
The complaint further charges that ABW Direct and ABW Inc. failed to maintain required books and records for mutual fund transactions. The firms did not record the time that they received customer orders for the transactions, thus leaving open the possibility that Conway and Ng engaged in late trading in thousands of additional transactions where records showed that Conway and Ng entered orders after 4 p.m.
In addition to the problems regarding late trading, the complaint alleges that during the period of July 2002 to September 2003, Conway and Ng also helped their clients engage in deceptive market timing. Conway and Ng systematically disregarded “block letters” and other directives from mutual fund companies (and from the clearing firm for ABW Direct and ABW Inc.) that restricted the hedge fund clients’ market timing trades. NASD charged that in at least 405 instances, Conway and Ng submitted transactions through accounts at ABW Direct and ABW Inc. where they either knew or should have known that the transactions were in violation of funds’ restrictions on market timing.
To facilitate the impermissible market timing, the complaint alleges that Conway and Ng helped clients set up multiple accounts, utilizing different names and even utilizing different branch codes in an effort to conceal the clients’ efforts to evade market timing restrictions; opened multiple accounts for one client at both ABW Direct and ABW Inc. in an effort to conceal the client’s identity; and, ignored a directive from ABW Direct’s and ABW Inc.’s clearing firm that the firms cease trading in international mutual funds until they had provided a written commitment to the clearing firm that they would abide by mutual fund prospectus trading limitations.
The NASD charged that Conway and Ng’s misconduct could not have occurred without the supervisory lapses by Nwaigwe and Malin. Nwaigwe is the Chief of Compliance of ABW Direct and also held that position at ABW Inc. Nwaigwe is charged with having failed to perform supervisory duties delegated to him that should have led him to discover the wrongful activity. For example, Nwaigwe did not review Conway’s and Ng’s incoming and outgoing correspondence and emails and, as a result, never saw the communications from the mutual fund companies and the firms’ clearing firm complaining about impermissible market timing. Nwaigwe was also the person with responsibility for updating ABW Direct’s and ABW Inc.’s written procedures, and NASD charged that he failed to include procedures designed to prevent late trading and impermissible market timing.
Malin is the President of ABW Direct and held that position at ABW Inc. He is charged with having failed to take reasonable steps to ensure that Nwaigwe was performing supervisory functions assigned to him.
Please click http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_016340 to access a copy of the NASD release about the action.
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NASD Fines American General Securities $1.1 Million for Directed Brokerage Violations
4.5.2006 The NASD announced that it fined American General Securities, Inc. (AGSI), a member company of American International Group, Inc. (AIG) located in Houston, Texas, more than $1.1 million in connection with its receipt of directed brokerage in return for providing preferential treatment to certain mutual fund companies and for other violations.
The action involved violations of the NASD’s Anti-Reciprocal Rule, which prohibits firms from favoring the sale of shares of particular mutual funds on the basis of brokerage commissions received by the firm. Among other things, the rule prohibits a firm from recommending funds or establishing preferred lists of funds in exchange for receipt of directed brokerage.
The NASD found that from January 2002 through September 2003, AGSI operated a shelf space (or revenue sharing) program in which participating mutual fund companies paid a fee in return for preferential treatment by AGSI. That treatment included enhanced access to AGSI’s sales force, including being identified as a “Preferred Product Sponsor” on AGSI’s internal website, being featured in AGSI internal marketing publications distributed to its sales force, and participating in AGSI’s “top producer” or training meetings.
The benefits provided by the shelf space program were offered to only 12 mutual fund complexes during the relevant period. These fund companies paid extra fees for the preferential treatment they received. Three of the 12 fund complexes paid their fees for participating in the shelf space program by directing approximately $2.7 million in mutual fund portfolio brokerage commissions to AGSI. This use of directed brokerage allowed the fund complexes to use assets of the mutual funds instead of their own money to meet their revenue sharing obligations. The remaining nine fund complexes paid their fees in cash for participation in the program.
The NASD also found that from July 2003 through September 2003, AGSI failed to promptly forward more than 2,100 customer checks that it had received in connection with certain mutual fund and variable annuity transactions; that from November 2001 through September 2003, AGSI failed to maintain electronic communications in violation of the books and records provisions of the federal securities laws and NASD rules; and, that it failed to establish and maintain a supervisory system and procedures that were reasonably designed to detect and prevent these violations.
In settling with the NASD, AGSI neither admitted nor denied the allegations, but consented to the entry of the NASD’s findings.
Please click http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_016331 to access a copy of the NASD release about the action.
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