MULTILATERAL AGREEMENT REACHED ON ENFORCEMENT COOPERATION
10.31.2003 SEC Chairman William H. Donaldson announced the International Organization of Securities Commissions of
its Multilateral Memorandum of Understanding Concerning Consultation and
Cooperation and the Exchange of Information (MOU). The MOU is the first
global multilateral information-sharing arrangement among securities
regulators.
The MOU provides for the exchange of basic information in investigating
cross-border violations, including bank, brokerage, and client
identification records. Information provided through the MOU may be
used to enforce compliance with securities and derivatives laws and
regulations, including through civil and criminal prosecutions.
Please click http://www.sec.gov/news/press/2003-145.htm for a copy of the press release announcing the MOU.
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ICI RECOMMENDS REFORMS TO SOLVE LATE TRADING AND MARKET TIMING ABUSES
10.30.2003 The Investment Company Institute, the trade group for the mutual fund industry, recommended the following reforms to combat late trading and market timing abuses:
- 4:00 p.m. deadline for all mutual fund trades to be reported to mutual fund companies;
- mandatory, industry-wide minimum two percent redemption fee on the sale of virtually all mutual funds (other than money market funds) for a minimum of five days following purchases; and
- amended codes of ethics that include oversight of all trading activity in mutual funds offered or sponsored by the company.
Please click http://www.ici.org/statements/nr/03_news_exec_comm.html for a copy of the ICI's recommendations.
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FORMER HEDGE FUND MANAGER CHARGED WITH FRAUDULENT VALUATION
10.29.2003 The SEC filed an enforcement action against Edward
J. Strafaci, the former portfolio manager of the Lipper convertible
hedge funds, charging him with fraud in connection with the valuation of
the funds. The Office of the U.S. Attorney for the
Southern District of New York also brought criminal charges against Strafaci for the same conduct.
The SEC alleges that from at least 1998 until January 2002, Strafaci knowingly and recklessly overstated the value of
the convertible bonds and preferred stock held by the funds, resulting
in the dissemination of materially false and misleading fund valuations
and performance figures to investors and prospective investors, and the
filing of false reports with the SEC. The complaint alleges
that, contrary to representations in the funds' private placement memorandum,
Strafaci valued the funds' convertible securities at prices materially
in excess of, and not reasonably related to, market prices or the fair
value of such securities.
The complaint charges Strafaci with violating or aiding and abetting
violations of certain antifraud provisions of the federal securities
laws and with aiding and abetting various books-and-records and
reporting provisions applicable to registered investment advisers and
broker-dealers.
Please click http://www.sec.gov/litigation/complaints/comp18432.htm to access a copy of the release announcing the administrative action.
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SEC INSTITUTES PERSONAL TRADING CASE AGAISNT PUTNAM
10.17.2003 The SEC instituted administrative proceedings against
Putnam Investment Management LLC (Putnam) in connection with the
personal trading by two former Putnam Managing Directors and portfolio
managers, Justin M. Scott and Omid Kamshad, and other investment
professionals at Putnam. The SEC alleges that Putnam engaged in securities fraud by failing to disclose
to the funds or to the fund boards the potentially self-dealing
transactions in fund shares by Scott, Kamshad and other employees.
The SEC further alleges that Scott and Kamshad, for their own personal
accounts, engaged in excessive short-term trading of Putnam mutual funds
for which they were portfolio managers. According to the SEC, Scott
and Kamshad's investment decision-making responsibility for those funds
afforded them access to non-public information about the funds,
including current portfolio holdings, valuations and transactions. The
Division further alleges that Scott and Kamshad's short-term trading
violated their responsibilities to other fund shareholders, that Scott
and Kamshad failed to disclose their trading and that, by their trading,
they potentially harmed other fund shareholders. The SEC further
alleges that Putnam failed to supervise Scott, Kamshad and other
employees, that it failed to have policies and procedures reasonably
designed to prevent the misuse of non-public information and that it
failed adequately to enforce its code of ethics.
The SEC charged Putnam with violating Sections 204A, 206(1) and 206(2) of the Investment Advisers Act of 1940
and Section 17(j) of the Investment Company Act of 1940
and Rule 17j-1(c) thereunder and that it failed to supervise under
Section 203 of the Advisers Act.
Please click http://www.sec.gov/litigation/admin/ia-2185.htm to access a copy of the release announcing the administrative action.
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FORMER VICE CHAIRMAN OF FRED ALGER MANAGEMENT INC. CHARGED WITH AIDING AND ABETTING MARKET TIMING
10.16.2003 The SEC brought charges against Patrick Connelly, a former vice chairman of Fred Alger Management Inc., a registered investment adviser located in New York City. Alger Management manages the Alger Funds.
Connelly approved agreements permitting select investors to "time" Alger mutual funds. "Timing" refers to the practice of short term buying and selling of mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Alger Management maintained policies and procedures to detect and prevent timing. By allowing select investors to time Alger Funds, Connelly violated the antifraud provisions of the federal securities laws.
The SEC's notice stated that timing can dilute the value of mutual fund shares to the extent that a timer is permitted to buy and sell shares rapidly and repeatedly to take advantage of arbitrage opportunities. In addition, timing raises transaction costs for the fund. Consequently, mutual fund managers often maintain policies and procedures to detect and prevent timing, such as imposing early redemption fees or exercising discretion to cancel timers' purchases. Prospectuses for mutual funds often contain representations that the fund seeks to deter timers. The statement of additional information for one Fund indicated that investors could make only six exchanges, or trades, of mutual funds per year. Investors seeking timing capacity usually offered to commit additional assets to other funds in the Alger complex. These additional assets were referred to as "buy and hold" positions. (Buy and hold positions are also referred to as "sticky assets.") Over time, Connelly developed a de facto practice of requiring that timers commit assets to buy and hold positions to earn access to timing capacity. In early 2003, Connelly formalized this practice by requiring that investors seeking timing capacity maintain at least 20 percent of their investment in buy and hold positions.
Alger's timing activity reached its peak during 2003, at which time there were more than one dozen timers with approximately $200 million of timing funds invested in Alger mutual funds. Thus, in return for providing timing capacity, Alger earned a fee on the funds invested equal to approximately 70 basis points, or 0.70 percent of the total assets invested.
The SEC stated that Connelly understood that the Alger Fund prospectus and statement of additional information did not disclose that Alger Management permitted select investors to "time" Alger mutual funds and to make significantly more than six exchanges per year. The SEC also noted that Connelly also understood that the Alger mutual fund prospectus did not disclose that Alger Management required investors seeking to time Alger funds to maintain buy and hold positions in other mutual funds managed by Alger Management. Connelly further understood that Alger Management did not disclose that it treated investors differently based on whether they had entered into timing agreements in exchange for buy and hold positions. Finally, Connelly understood that allowing investors to engage in market timing of Alger funds harmed other shareholders in the "timed" funds.
Please click http://www.sec.gov/litigation/admin/33-8304.htm to access a copy of the release announcing the administrative action.
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SEC OCIE DIRECTORS GIVES SPEECH ON SMALL FIRM COMPLIANCE
10.9.2003 SEC OCIE Director Lori Richards at the Securities Industry Association's Small Firms Conference delivered a speech entitled: "Keeping Pace with the Speed of Change for Small Firms."
She stated that supervision in small firms is generally not problematic, but
the lack of documentation is problematic. She suggested that small firms should write
down who is responsible for each area of compliance. They should check for inappropriate activity by receiving exception reports
from clearing firms. She also recommended that they use inexpensive vendor software, as well as the firm's internal databases.
Please click http://www.sec.gov/news/speech/spchlar100903.htm for a copy of the speech.
Director Richards also gave another speech last month entitled "Current Examination and Enforcement Issues."
Please click http://www.sec.gov/news/speech/spch102903lar.htm for a copy of the speech.
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PROPOSED RULE WOULD INCREASE PROXY ACCESS BY SHAREHOLDERS
10.8.2003 The SEC proposed rules that would require
companies to include in their proxy materials the names of nominees for
director that are submitted by certain shareholders, as well as
disclosure relating to those nominees. Companies subject to the proposed proxy rules would be required to include in their proxy materials the names and certain
other information regarding security holder nominees for election as
director. The requirement would arise in cases where:
- state law establishes the right of a shareholder to nominate a
candidate for such an election; and
- one or more specified events has occurred, providing evidence of
shareholder dissatisfaction with the effectiveness of the company's
proxy process.
The proposed rules also would require a company to include information
regarding a security holder nominee for election as a director where:
- state law provides security holders with the right to make such a
nomination;
- the procedure is applicable to a particular company (for example,
the procedure would not be applicable to foreign issuers);
- the security holders submitting the nomination meet specified
eligibility requirements; and
- the nominee meets specified eligibility requirements.
The SEC is soliciting comment on the proposals for a 60-day
period following the proposed rules' publication in the Federal Register.
Please click http://www.sec.gov/rules/proposed/34-48626.htm for a copy of the release proposing the rule.
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CALIFORNIA ADVISER CHARGED WITH FRAUD
10.6.2003 The SEC instituted a securities fraud charge against a Santa Monica, Calif. investment
adviser, alleging that the adviser for over three years deceived its clients and prospective
clients by concealing a massive decline in the value of their assets,
providing clients with false and misleading account statements, and
taking over $1.2 million in undisclosed management fees.
The SEC's complaint alleges that National Financial Systems, Inc. (NFSI) assumed management of the
an unregistered pool of assets called the "Fixed Fund," which consisted of real estate,
equity securities, mutual funds, and bonds. Although Terese Herwick, the owner and
president of NFSI, knew that a significant number of Fixed Fund assets had not performed for years or
had been foreclosed upon, neither NFSI nor Herwick disclosed these facts
to the Fixed Fund's investors. In January 2002, NFSI wrote off the
worthless assets, another fact that NFSI and Herwick never disclosed to
Fixed Fund investors. The value of the Fixed Fund's assets has fallen
to approximately 50% of the amount owed to Fixed Fund investors as
principal and purported accrued dividends. As of March 31, 2003, the
value of the Fixed Fund's assets totaled no more than $7.4 million while
the amounts it owed investors in principal and purported accrued returns
totaled at least $14.1 million. NFSI never disclosed this fact to Fund
investors.
Instead, the SEC alleges, NFSI continued to promote the Fixed Fund
as an investment vehicle that purportedly seeks preservation and
protection of capital while providing regular monthly cash
distributions. Moreover, NFSI has provided Fixed Fund investors with
quarterly account statements that purport to credit those investors with
their contracted-for rates of return -- returns which have not been
generated by the Fund's underlying assets and which neither the Fund nor
NFSI can possibly repay. In addition, NFSI defrauded the Fixed Fund and
its investors by charging the Fixed Fund an undisclosed management fee,
which for 2002 constituted more than 10% of the value of the Fixed
Fund's assets. In 2002, NFSI took over $700,000 in management fees,
while in 2001 it took over $520,000 in fees, none of which was disclosed
to investors.
Please click http://www.sec.gov/litigation/litreleases/lr18392.htm for a copy of the administrative order.
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SEC PROPOSES FUND-OF-FUNDS RULE
10.3.2003 The SEC proposed rules granting certain exemptions for funds that invest
in other funds (funds-of-funds). Proposed rule 12d1-1 would permit a registered fund to acquire
shares of a registered or unregistered money market fund without regard
to the statutory limits. The proposed rule also would permit unregistered funds
to acquire any amount of shares of a registered money market fund.
Proposed rule 12d1-2 would permit a fund that invests in other funds in
the same fund complex, in reliance on section 12(d)(1)(G) of the Act,
to:
- make limited investments in funds outside the fund complex;
- invest in securities not issued by a fund; and
- invest in money market funds in reliance on proposed Rule 12d1-1.
Proposed Rule 12d1-3 would permit a fund that invests in other funds in reliance on
Section 12(d)(1)(F) of the Act to charge a sales load greater than 1%, provided that the aggregate sales loads and distribution-
related fees of the acquiring and underlying funds are not excessive
under the NASD rule regarding fund of funds fees.
The SEC also proposed amendments to disclosure forms that funds
use to register under the Act and to offer their shares under the
Securities Act of 1933. The proposed amendments would require any fund
that invests in another fund to include in its prospectus fee table an
additional line item that discloses the costs of investing in underlying
funds.
Please click http://www.sec.gov/rules/proposed/33-8297.htm for a copy of the release proposing the rule.
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ADVISER SANCTIONED FOR MAKING FALSE STATEMENTS
10.2.2003 The SEC sanctioned the Barr Financial Group, Inc., an
investment adviser, and Alfred E. Barr, Barr Financial's president, for making untrue statements of material fact in
SEC filings during 1997 and 1998. Respondents' statements
concerned the amount of assets Barr Financial had under management and
Barr's academic background. The SEC further found that
the adviser and its officers were permanently enjoined in 1999 from violating the
Advisers Act based on their failure to cooperate with an examination of
Barr Financial by SEC staff.
Please click http://www.sec.gov/litigation/opinions/ia-2179.htm for a copy of the administrative order.
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ADVISER EMPLOYEE CHARGED WITH AIDING AND ABETTING LATE TRADING AT MUTUAL FUND
10.2.2003 The SEC charged Steven B.
Markovitz (Markovitz) with late trading of mutual fund shares through at least three registered broker-
dealers.
Please click http://www.sec.gov/litigation/admin/33-8298.htm for a copy of the administrative order.
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CRIMINAL AND CIVIL CHARGES BROUGHT AGAINST INVESTMENT ADVISER EMPLOYEE IN CONNECTION WITH FRAUDULENT TRADE
ALLOCATION SCHEME
10.1.2003 The SEC charged Paul Joseph Sheehan with allegedly carrying out a
fraudulent "trade allocation" scheme known as "cherry-picking." The SEC alleges that Sheehan
fraudulently allocated profitable securities trades to his own personal
accounts at the expense of his clients' accounts. From at least April
1999 until September 2000, Sheehan "cherry-picked" at least $7.4 million
in profitable day trades for himself and thereby stole economic
opportunities that rightfully belonged to his clients. Sheehan, without
admitting or denying the allegations of the SEC's complaint,
consented to the entry of a permanent injunction. Sheehan operated in
West Hollywood, California, where his firm provided investment management
services to individuals, pension and profit-sharing plans, trusts,
estates, charitable organizations, and corporations.
A criminal complaint was also filed in connection with the case in United
States District Court in Los Angeles. This charge carries a maximum
penalty of 5 years imprisonment and a fine of $250,000.
Both complaints allege that Sheehan implemented the
fraudulent scheme by calling in trades to executing brokers without
designating whether the trades were for his own personal accounts or the
accounts of his clients. After the trades were executed, the shares or
trade proceeds were allocated to an account at Salomon Smith Barney.
Sheehan did not instruct Salomon Smith Barney to which particular client
account or personal account the shares were to be allocated until the
end of the trading day, by which time Sheehan knew whether or not a day
trade had been profitable.
Please click http://www.sec.gov/litigation/litreleases/lr18386.htm for a copy of the administrative order.
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