TD WATERHOUSE CHARGED WITH MAKING UNDISCLOSED CASH PAYMENTS TO INVESTMENT ADVISERS
9.21.2004 TD Waterhouse Investor Services, Inc., a national brokerage
firm, was charged with making undisclosed cash payments to three investment advisers
to encourage them to use TD Waterhouse for their clients' brokerage
business.
According to the SEC, TD Waterhouse knew its payments
created potential conflicts of interest between the advisers and their
clients. Each adviser that received compensation from TD Waterhouse
compromised its ability to evaluate independently whether to recommend
that its clients use TD Waterhouse to handle the clients’ brokerage
business. TD Waterhouse had adopted
written procedures that required TD Waterhouse personnel to ensure that
the advisers made the proper disclosures. However, the firm failed to follow
these procedures.
TD Waterhouse made the payments to the advisers from its profits on the
advisory clients’ brokerage business. The payments, however, did not
directly benefit the advisers’ clients. Instead, the advisers used the
money for their own purposes.
The SEC also instituted administrative proceedings against the advisers. In one case, the SEC alleged
that the firm agreed to distribute a $7,500 cash payment from TD
Waterhouse to its advisory clients to compensate them for fees they
incurred when moving their accounts from another broker to TD
Waterhouse. The SEC stated that the adviser did not inform their
clients of the payment, but rather fraudulently misappropriated the
money for their own uses.
Please click http://www.sec.gov/litigation/admin/34-50415.htm for a copy of the administrative action.
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SEC PROVIDES FURTHER GUIDANCE ON ADVISER USE OF PROXY VOTING FIRMS
9.15.2004 The SEC issued a no-action letter that elaborates on its guidance provided in the Egan Jones Proxy Services (pub. avail. on May 27, 2004) no-action letter (the "Egan Jones Letter") concerning investment advisers that use the recommendations of independent third parties to vote client proxies.
In the Egan Jones Letter, the SEC stated that a proxy voting firm could be an independent third party for purposes of making proxy voting recommendations for an investment adviser's clients, even though the firm receives compensation from an issuer for providing advice on corporate governance issues ("corporate services"). The SEC also stated, however, that an investment adviser could breach its fiduciary duty of care to its clients by voting its clients' proxies based upon a proxy voting firm's recommendations because the firm could recommend that the adviser vote the issuer's proxies in the firm's own interests, to further its relationship with the issuer and its business of providing corporate services, rather than in the interests of the adviser's clients.
In the Institutional Shareholder Services no-action letter, the SEC reiterated that an investment adviser, consistent with its fiduciary duty, should take reasonable steps to ensure that, among other things, the firm can make recommendations for voting proxies in an impartial manner and in the best interests of the adviser's clients. Those steps may include:
- a case by case evaluation of the proxy voting firm's relationships with issuers,
- a thorough review of the proxy voting firm's conflict procedures and the effectiveness of their implementation, and/or
- other means reasonably designed to ensure the integrity of the proxy voting process.
When reviewing a proxy voting firm's conflict procedures, the SEC stated that an investment adviser should assess the adequacy of those procedures in light of the particular conflicts of interest that the firm faces in making voting recommendations. An investment adviser should have a thorough understanding of the proxy voting firm's business and the nature of the conflicts of interest that the business presents, and should assess whether the firm's conflict procedures negate the conflicts. The investment adviser should also assess whether the proxy voting firm has fully implemented the conflict procedures. In addition, For example, when assessing a proxy voting firm's conflict procedures, an investment adviser should consider whether the procedures effectively (a) preclude the natural persons who make the firm's proxy voting recommendations from obtaining access to information about the firm's business relationships with Issuers and (b) insulate those persons from direct or indirect influence by the firm's employees who know of those relationships. In addition, an investment adviser should consider evaluating the frequency with which the proxy voting firm recommends voting in favor of the management of Issuers that have engaged the firm to provide corporate services.
Please click http://www.sec.gov/divisions/investment/noaction/iss091504.htm for a copy of the no-action letter.
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CHARLES SCHWAB CHARGED WITH IMPROPERLY ALLOWING CERTAIN CUSTOMERS
TO PURCHASE MUTUAL FUND SHARES AFTER MARKET CLOSE
9.14.2004 The SEC settled charges against Charles Schwab &
Co., Inc., alledging thatSchwab allowed investment adviser
customers to change mutual fund orders after the 4:00 p.m. Eastern Time
market close, creating the risk that such customers could unfairly
capitalize on late-breaking news at the expense of other mutual fund
investors.
The SEC found that, since at least January 2001, Schwab engaged
in a practice of allowing its investment adviser customers to change
mutual fund orders after market close under certain circumstances and
still receive that day’s fund price. This occurred when a customer’s
original pre-4:00 p.m. mutual fund order was rejected by Schwab’s
computer system (such as when the customer had been banned from trading
in a particular mutual fund or the mutual fund was closed to new
investors). Schwab permitted the adviser to submit a substitute order
in a different mutual fund. According to the Commission’s Order, on
hundreds of occasions since 2001, Schwab personnel contacted customers
after the 4:00 p.m. market close and allowed the customer to submit a
substitute order in a different fund while still receiving the current
day’s price. Schwab’s practice of processing the substitute purchase
order at the current day’s price violated Rule 22c-1(a) under the
Investment Company Act, which requires orders for mutual fund shares
placed after 4:00 p.m. to receive the next day’s fund price.
Please click http://www.sec.gov/litigation/admin/34-50360.htm for a copy of the administrative action.
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PIMCO SETTLES MARKET-TIMING CHARGES
9.13.2004 The SEC entered an administrative order against PIMCO Advisors Fund Management LLC ("PIMCO") and certain affiliates resolving market timing charges. The SEC order found that from February 2002 to April 2003,
various PIMCO entities provided Canary Capital Partners with at least $60
million in “timing capacity” in their equity mutual funds in return for
as much as $27 million in long-term investments (referred to as “sticky
assets”) in an equity mutual fund and a hedge fund from which the PIMCO organziation earned management fees. The prospectuses for the mutual funds
failed to disclose that an agreement had been made to permit timing in
the funds in exchange for sticky assets. In addition, the prospectuses
also gave the misleading impression that the PIMCO mutual funds
discouraged timing. From February 2002 to April 2003, Canary made over
100 round-trip exchanges exceeding $4 billion in overall dollar volume
in several PIMCO equity funds pursuant to its special market timing
arrangement. While allowing Canary to engage in this market timing
activity, a PIMCO affiliate simultaneously prevented hundreds of other accountholders
from engaging in the same rapid trading as Canary by issuing warning
letters, freezing accounts, or blocking trades. Finally, PIMCO disclosed
nonpublic portfolio holdings to the broker-dealer executing Canary’s
trades.
Please click http://www.sec.gov/litigation/admin/34-50354.pdf to access a copy of the adminsitrative order.
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U.S. CHAMBER OF COMMERCE FILES SUIT CHALLENGING SEC 75%/INDEPENDENT CHAIR MUTUAL FUND DIRECTOR RULE
9.2.2004 The U.S. Chamber of Commerce filed a lawsuit challenging the requirements in the SEC's new fund governance rules that investment companies have a board composed of at least 75% independent directors and an independent chairman. The Chamber's complaint claims that the SEC exceeded its statutory authority, failed to adequately justify its exercise of its rulemaking authority, and engaged in rulemaking that is arbitrary and capricious. The complaint asks that the independent chair and 75 percent independent director conditions be declared unlawful and set aside, and that the Commission be enjoined from giving effect to the conditions.
Please click http://www.sec.gov/rules/final/ccusastay090904.htm to access a copy of a letter providing more information about the suit.
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FUNDS PROHIBITED FROM PAYING FOR BROKERAGE BY DISTRIBUTING SHARES THROUGH EXECUTING BROKER
9.2.2004 The SEC adopted amendments to a rule amended rule prohibits funds from paying for the distribution of their shares with brokerage commissions.
It is common for some mutual fund advisers choose which broker or dealer will effect transactions ("executing broker"), and can use commissions to reward brokers or dealers for promoting the sale of fund shares ("selling brokers"). Brokers are prohibited from conditioning the promotion of fund shares on the receipt of brokerage commissions from a fund. Fund brokerage is an asset of the fund, and its use to pay for distribution expenses implicates rule 12b-1, which regulates the use of fund assets to pay selling brokers or otherwise finance the sale of fund shares. After reviewing the current directed brokerage practices, the SEC decided to amend rule 12b-1 to prohibit the use of fund brokerage to compensate broker-dealers for selling fund shares.
Rule 12b-1(h)(1) prohibits funds from compensating a broker-dealer for promoting or selling fund shares by directing brokerage transactions to that broker. The prohibition applies both to directing transactions to selling brokers, and to indirectly compensating selling brokers by participation in step-out and similar arrangements in which the selling broker receives a portion of the commission. The ban extends to any payment, including any commission, mark-up, mark-down, or other fee (or portion of another fee) received or to be received from the fund's portfolio transactions effected through any broker or dealer.
The SEC stated that the fact that a selling broker provides best execution would not cure a violation of the prohibition on funds or their advisers directly or indirectly compensating the broker for promoting fund shares with payments from portfolio transactions. Rule 12b-1(h)(2), as amended, will permit a fund to use its selling broker to execute transactions in portfolio securities27 only if the fund or its adviser has implemented policies and procedures designed to ensure that its selection of selling brokers for portfolio securities transactions is not influenced by considerations about the sale of fund shares.
The procedures, which must be approved by the fund's board of directors, must be reasonably designed to prevent:
- the persons responsible for selecting broker-dealers to effect transactions in fund portfolio securities transactions (e.g., trading desk personnel) from taking into account, in making those decisions, broker-dealers' promotional or sales efforts;
- the fund, its adviser and principal underwriter from entering into any agreement or other understanding under which the fund directs brokerage transactions or revenue generated by those transactions to a broker-dealer to pay for distribution of the fund shares.30 These procedures must be designed to prevent funds from entering into informal arrangements to direct portfolio securities transactions to a particular broker
The compliance date of these rule amendments is December 13, 2004. No later than the compliance date, funds must be in compliance with the ban in paragraph (h)(1) of the rule and funds that use their selling brokers to execute portfolio securities transactions must have in place the policies and procedures prescribed by paragraph (h)(2)(ii) of rule 12b-1.
Please click http://www.sec.gov/rules/final/ic-26591.htm for a copy of the adopting release.
